Don’t file those life insurance policies away

With lower interest rates, it is crucial that advisors keep an eye on the condition of in-force policies.

Life insurance is a key component of any estate plan, but chances are, your client’s life has changed since he purchased it — and so have his financial needs.

Given the shifting economic realities of the past decade, clients need to take a more active role in understanding what they purchased and the potential consequences if certain assumptions are not achieved. As advisors, it is our obligation to notify our clients of any pending problems by monitoring the performance over the insurance policy’s lifetime.

In the 1980s, many clients bought insurance policies when the interest rates were hovering between 12 percent and 14 percent. The policy premiums were predicated on the assumption that those rates would continue in perpetuity. However, in recent years, interest rates have fallen sharply, and the assumptions made at the time the policies were purchased are no longer valid, creating a scenario where those policies could lapse without value.

Further, following the tech bubble of the 1990s, policyholders assumed the equity markets, and thus their variable life’s policy performance, would continue to grow at unsustainable annual rates of return. Since that has not been the case, many policy assumptions made then are also invalid, forcing clients again to re-evaluate their policies or suffer the consequences.

Case in point

Taking into consideration those factors, let me share with you how one potential client’s estate plan was thrown off course.

A father in his 70s purchased a $1 million universal life insurance policy approximately 10 years ago. At that time, the assumed interest rate was 6 percent, which dictated that he pay an annual premium of $12,000. After evaluating the policy using a revised 4 percent interest rate, it was determined that he now has to pay an annual premium of $25,000 until a respectable possible mortality age.

Simultaneously, he had his own personal economic downturn, which left him feeling apprehensive about paying any premium at all. In order for the insurance policy to stay in force, someone had to pick up the premium payments or the family would risk walking away from the policy with nothing to show for it.

This client has four sons who are the beneficiaries of his trust, which owns the life insurance. However, only one of them had the financial capacity to pay the annual $25,000 premium. To help the family maintain the policy, the wealthiest of the four sons loaned the trust $300,000. Every year, the trust would withdraw $25,000 to pay the annual premium. The trust is also now obligated to pay interest on that loan each year to the son. When the father passes away, the first $300,000 of insurance proceeds will be paid to the son who loaned the money to the trust and the remaining $700,000 will be divided equally among all four brothers.

Reviews are critical

Policies are rarely audited, and therefore, clients are unaware of any potential problems. As the aforementioned illustration demonstrates, for a policy to be viable 20 or 30 years down the line, it is critical to periodically review it and validate or update the original assumptions. If interest rates go from 12 percent to 4 percent, that’s one-third of what clients assumed they were going to earn. Therefore, since the policy may not be generating the kind of dividends needed to fund the premium payments, the policy is in danger of lapsing, and more importantly, the client will not receive the benefit they were expecting.

To prevent this from happening to your clients, it is wise to build an annual review into your sales practice process. Only by reviewing a policy will you know if it is properly funded. If it isn’t, you will be able to determine whether the policy is in danger of lapsing with no value or death benefit. That is a situation no one wants to explain to the client’s beneficiaries.

Reviewing a client’s life insurance portfolio is also a good marketing tool because clients often have the financial wherewithal to either increase their existing coverage, evaluate possible gains from more current, cost-effective coverage or refer new clients.

Life insurance continues to have many uses in an estate plan, including estate liquidity, debt repayment, income replacement and wealth accumulation. As trusted advisors, we must play an active role managing our clients’ financial affairs, so when the moment arrives, they know the funds they were counting on will be there for their families.

Gone are the days when clients can purchase an insurance policy and file it away.

By Tom Henske, CFP for December 2012 issue of Life Insurance Selling Magazine.  Tom Henske, CFP, is a partner with Lenox Advisors in New York and an 11-year MDRT member.
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