Recently, there have been several articles written in prominent newspapers and magazines that have addressed the phenomenon of some older life insurance policies “aging out” with the result being the policy owner ,who often has paid premiums for decades, not collecting the death benefit. The articles are more alarming than informing. This is an attempt to be more informing than alarming.
As CEO of The Madison Group, a 53-year-old firm that has delivered over $500MM in life insurance benefits and has over $6B of life insurance in force, my first mission is to make sure we understand our role in making sure that promised benefits are delivered as expected. In fact, a constant mantra at our firm is, “We are not in the life insurance sales business; we are in the benefit delivery business.” It is not as easy as it would seem. While permanent life insurance is built to deliver a benefit, there are several fundamental issues which can derail the benefit delivery. Some of these are:
The compensation structure – commissions are heaped upfront and then there are no revenues throughout the life of the insured. This is a tough business model. A firm must place new business in order to support the infrastructure necessary to service existing clients. The Madison Group discloses commissions on every life insurance placement so that we can explain to the clients how this works and our pledge to deliver benefits through our succession planning and corporate mission.
All policies have maturity features. Older policies sometimes had unfortunate maturity features which thankfully, no longer exist. These provisions made sense, actuarially, at the time they were incorporated into the life insurance policy contract. The intent was to reduce the policy expenses and in so doing, reduce premium, by reducing the reserve requirements. Sometimes the policy maturity feature resulted in the policy to “age out” typically between the insured’s age 95 or age 100. This maturity feature results in the policyowner receiving the cash value and if cash value is in excess of premiums paid, the excess would be subject to ordinary income tax. This outcome is vastly different than the perfectly reasonable expectation and the typical outcome of the policy owner receiving an income tax free life insurance benefit. Some companies have been proactive in allowing policyowners to fix this maturity feature and not have policies mature. Other companies have not been as accommodating and policyowners of policies that mature prior to the insured’s death are indeed in a very undesirable and contractually defensible but ultimately unfair position. The fix is in the servicing, monitoring, and taking corrective action when needed on all life insurance policies. Life insurance policies require this active management. Many buyers are misinformed in thinking it is not essential to favorable outcomes. If life insurance policies are properly managed, the insurance advisor has informed the client of this maturity feature long in advance and has proposed various solutions. Again, today’s policies do not have maturity features that cause the policy to “age out”. They will last throughout the lifetime of the insured regardless of how long the insured lives if the policy is properly funded.
A good proxy for how life insurance can and should work is a guaranteed premium policy. These policies are in the minority. Most of all life insurance policies are current assumption policies. The difference is a guaranteed premium policy puts the responsibility on the insurance company to deliver the benefit for the premium stipulated, regardless of the insurance company’s mortality experience, expenses, or investment returns. The majority of life insurance policies are current assumption policies which put the onus on the insured to manage the policy in a way that delivers a benefit. This may cause the policyowner to pay more premium or if investments are outperforming the as-placed illustration, the policyowner may pay less premium. On all current assumption policies, if you are in the benefit delivery business, you use conservative assumptions, monitor them carefully, and adjust as called for. There are several ways to adjust the policy which do not require additional premium and still deliver a death benefit. The guaranteed premium policy, as a proxy, is expected to deliver between a 3-6% tax-free internal rate of return as measured by premium-to-death benefit at extended actuarial life expectancy (based upon the population of affluent insureds as evidenced by M Financials’ reinsurance company) of age 90 for individuals and age 100 for couples. The guaranteed policies can be funded with this range of illustrated IRR’s with a premium guarantee and a benefit guarantee for the life of the insureds regardless of how long they live. Therefore, we like to use guaranteed policies as a proxy to compare to current assumption policies which can perform better but with increased risk of additional premium required.
All life insurance gets more expensive as the insured ages. The life insurance premiums may be level, but underlying the level premium, the fundamental expense features of a life insurance policy are that each year that the insured ages, the cost of insurance increases. Most insurance companies reinsure their policies so that they are paying the increased cost of insurance to a reinsurance company. The way a permanent life insurance policy offsets that mortality curve, which looks much like a hockey stick, is to put enough excess premium in the early years to begin to build income tax deferred cash values. The accumulation of these cash values replace the need for life insurance so that at older ages, less insurance is being purchased and cash values make up the majority of the benefit. This is an example of why life insurance is not a commodity, but a financial product requiring ongoing management. In the case of a guaranteed premium policy, the same fundamentals are at work, but the insurance company has assumed the risk. Flexibility, premium and risk tolerance typically factor into which is best. We often use guaranteed and current assumption policies in combination to create a customized life insurance portfolio.
In term insurance, there are no cash values. Practically all term insurance today is a level premium term for a specified duration such as 10-, 15-, 20- or 30-years. The rising mortality charges are levelized which means you overpay for the first half of the policy’s duration and underpay for the second half. The level premium became more popular because it was psychologically easier for a policyowner to commit to a level premium than to pay an annual increasing term premium. All term insurance “term-inates” at the end of the specified period of coverage. It is, as the name implies, appropriate for a specified duration. It is not appropriate to collect a death benefit since no term policy duration matches the actuarial life expectancy of the insured. This is intentional and why the premiums are so low. Most term policies do not extend beyond age 80. This does not mean term insurance is a bad policy; it just means you need to make sure you have the right policy for the planning purpose. Term insurance is excellent for most buy/sell agreements with unrelated partners who plan to monetize the business around retirement age. It is typically not a good policy for family enterprises where the ownership is expected to be held for longer periods of time, often until death.
When life insurance is properly structured, it is the ideal asset to mitigate estate taxes or any financial liability at the death of the insured. As an example, estate taxes (aka death taxes) are an off-balance sheet liability. Balance sheets typically do not reflect a future estate tax. If the estate tax remains, this liability is going to appear at some uncertain time in the future. Meanwhile, life insurance is ideally suited to match that liability. This is classic asset and liability matching. Life insurance is also an off-balance sheet asset, typically owned by a trust. This asset will monetize at the exact time that the estate tax liability appears. As we know, the more often you match your assets with a liability, the less often you find yourself in a difficult financial position. The most unique attribute of life insurance is once a policy is placed, if the insured dies shortly thereafter, the benefit pays. Full stop. The Madison Group has delivered over $500MM in life insurance benefits. As a 53-year-old firm, we are delivering, on average, $40+MM in benefits a year over the last several years. Not only does life insurance pay a benefit when properly structured, it typically pays within weeks of the policy owner making a claim by furnishing a death certificate for the insured. We have never experienced any claim disputes and interest is accrued at 4% from the date of death until the claim is paid. The truth is that permanent life insurance is not even insurance in the classic sense. Term insurance is pure insurance because it assigns a large uncertain risk for a smaller certain premium. Permanent life insurance insures a large certain risk (the insured’s death) at a cumulative premium that is significantly less than the benefit that will be delivered. Therefore, permanent insurance is better understood as an investment.
The Madison Group often inherits policies from clients who no longer are receiving any service. This is too common and we feel it is a directly correlated to the compensation structure. We service those policies to make sure that they are going to deliver the benefit and inform the policyowner of any provisions which they should be aware of. I recommend anyone who is utilizing life insurance to recognize that all life insurance companies are not alike. There are approximately 25 top tier companies and there is no reason to work with any company that is not a top tier company. Additionally, all life insurance distribution/advisory firms are not alike. The most important question that should be asked whenever anyone is dealing with a life insurance professional is, “What is your succession plan? What kind of service can I expect from you? What type of assurances do I have that you will deliver these services?” As mentioned, there is a big disconnect between the compensation structure and the servicing tail of the life insurance policy. Dealing with this , in my opinion, is the number one responsibility of any professional life insurance organization.
In summary, you should be able to recognize the difference between someone who is in the life insurance sales business as opposed to someone in the benefit delivery business. If you’re in the sales business, you try to make a policy look as good as it can possibly look. This is typically using aggressive assumptions on earnings and, perhaps, solving for a permanent policy for limited duration i.e., age 100, in order to show a lower premium and make a sale. If you’re in the benefit delivery business, you are concerned about how premiums will be paid in the future. Does the trust have the proper resources? Are we using conservative assumptions with the hope that we will be able to report better than illustrated performance and perhaps, even reduced premiums in the later years?
This is the fork in the road and which path you take makes all the difference.
“As long as there’s one person on earth who remembers you, it isn’t over.”
-Oscar Hammerstein, Musical Carousel
Mark J. Richards, CLU, ChFC, CFP, AEP
President & CEO
The Madison Group, Inc.
Over 50 Years of Making Legacies Happen
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