Objective Insurance Review

Why Is an Insurance Review Needed?

Permanent (cash value) life insurance can be a significant asset on a personal balance sheet—yet it is often the most neglected asset for two reasons. First, it is commonly misunderstood due to limited transparency and a lack of understanding as to how these policies work.  Secondly, permanent life insurance is often misunderstood because of the inadequate measuring tools used to report costs and assess policy performance.

This article will discuss several misunderstandings related to permanent life insurance and the importance of a periodic objective review.

Like any asset you own, life insurance needs to be continually monitored and reevaluated. You should periodically ask yourself “Why do I own life insurance” and is this the “optimal” policy I can own to satisfy my objectives? For life insurance policies in an Irrevocable Life Insurance Trust these questions take on added weight as the Trustee of the Trust has a Fiduciary duty to monitor the policy on behalf of the beneficiaries.  Ultimately, any proper insurance review should fully answer these two questions.

Contrary to intuition, the premium paid on life insurance is not the same as the cost of life insurance. Premiums are paid into the policy and overtime accumulate to build cash value.  Various costs are deducted both from the premium and the policy cash values annually. Premium charges include sales expenses and state taxes. Cost of insurance, administrative charges and other fees are deducted from policy cash values.

The most common measuring tool is a life insurance illustration. Life insurance illustrations provide very long-term projections based upon cost and performance assumptions, however there is no industry standard to assure that reasonable assumptions are being used. As a result, life insurance illustrations are considered by many respected sources to be a misleading, inappropriate, and unreliable tool to measure the effectiveness of a life insurance policy.i

Review of the Life Insurance Strategy: Why Do I Own Life Insurance?

The first step in reviewing any life insurance policy is to understand the purpose behind it. Why was the policy first put in place? What purpose was it intended to serve? Does the purpose still exist?

Life insurance is generally used to satisfy two common planning needs: survivor income protection and estate tax payments.

The most common financial planning need that life insurance attempts to satisfy is survivor income (i.e., income required for dependents to maintain their current lifestyle if the primary earner were to pass early). Life insurance to provide for survivor income needs is most relevant when children are young, and/or a family balance sheet is generally illiquid. If children are now grown and self-supporting and the family balance sheet is sufficiently liquid, perhaps insurance is no longer needed. Keeping the insurance—while not having a financial need could serve as an additional financial benefit for your family. Alternatively, terminating the policy and recovering the cash value for use elsewhere could be beneficial.

Life insurance is also commonly used to replace the assets lost to estate taxes. This may have been a prudent strategy in 2004, when the combined (married couple) Federal Estate Tax Exemption was $3 million. However, in 2019 that number is $22.8 million—a much higher level of assets that can pass free of Federal Estate Tax.  While there is no guarantee that this exemption will remain this high until death, it is something to consider when evaluating current policies. You could choose to keep the policy to provide benefits above the estate tax free amount your heirs would receive or stop paying premiums and distribute the cash surrender value proceeds to your beneficiaries. A decision to terminate a policy purchased for estate tax purposes should be considered carefully—if the estate tax does return and your health has deteriorated you may not be able to purchase a new policy or the cost of insurance could increase to a point where it is prohibitive.

After determining the purpose for having life insurance, the next step is to consider if the insurance policy you currently have in place still makes sense given changes in personal circumstances and/or tax laws. Insurance policies established 10-20 years ago may not make sense today.

Review of the Life Insurance Policy(ies): Is it the Optimal Policy?

Once you have confirmed the appropriateness of the insurance strategy, the next step is to review whether the life insurance policy in place is aligned with your strategy.

Life insurance comes in various forms including term, whole life, universal life, variable universal life, and guaranteed premium universal life, and each have different risk/reward characteristics. (A full discussion of these differences is beyond the scope of this piece. Please contact a Round Table advisor if you wish to learn more.) Insurance policies have evolved in response to market needs, with more options in terms of guarantees and transparency. Importantly, mortality costs (i.e., the cost of the underlying insurance rates) have declined over the last 20 years as people live longer, so a newer policy may cost less than your current one.

In addition to reviewing whether you own the right type of life insurance, it is important to consider the specific terms of the policy. The following are a few important considerations that any proper review should answer: Should the death benefit be higher or lower? Have you been adequately funding the policy and is the policy performing well enough to deliver benefits if you live a long time? Are you healthy enough to qualify for a new policy if desired or do you need to stay with your current policy due to health problems?

The final step in the review of a life insurance policy is to evaluate if the specific policy you have is the most effective given the current offering of products. If the policy type and terms are appropriate, how can you be sure that your policy is among the best available? As discussed above, life insurance illustrations are considered inadequate measuring tools. So, what can you do to review the effectiveness of the policy?

A proper review should compare the policy to different benchmarks—just like you should do with investments. Benchmarks are available for cost and performance categories. Categories include, among other items, the financial strength and historical performance of the insurance carrier, cost competitiveness, pricing stability, and relative policy values. Benchmarks exist for retail policies (small policies sold to mass markets), institutional policies (larger policies with lower cost structures marketed to a more limited market), and experience rated policies (policies with the lowest cost structure that are marketed to wealthier and generally healthier markets). Comparing your policy to these benchmarks can determine whether your policy is among the best available.

Using an Objective Professional to review your policy

Using an objective professional to review your policy is paramount. An insurance broker is incentivized to sell you a new policy or replace your existing policy. An objective fee-only professional is engaged without conflict of interest and will provide an independent third-party analysis of appropriateness.  Round Table Wealth Management offers a comprehensive objective assessment of both your current insurance strategy as well as your policies. You will receive a written report including observations and recommendations based on your background and stated objectives. Additionally, the report is prepared alongside an in-depth comparison of your policies to retail, institutional and experience-rated benchmarks. This will determine if your policy is an optimal policy to serve your planning needs. Please contact Round Table Wealth Management to schedule a comprehensive review today if these issues are relevant to your personal situation.

i Brokerage, banking and insurance authorities hold these views. Financial Industry Regulatory Authority (FINRA) which regulates brokers states that “it is inappropriate to compare a…..life insurance policy with another product based on hypothetical performance….and would be misleading.” The Office of the Comptroller of the Currency (OCC) which regulates banks states that illustrations are “not reliable.” The Society of Actuaries states that “illustrations should not be used for comparative policy performance purposes” because doing so “is fundamentally inappropriate.” More recently, the New York State Department of Financial Services (NYDFS) which regulates insurers enacted Regulation 187 (effective February 2020) which requires those selling and servicing insurance to consider costs, performance and risks related to benefits when assessing insurance products. None of these requirements are satisfied using illustrations. Given NY DFS reputation as a “first mover” on insurance regulation other states are likely to follow.

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