For the majority of our clients, we are a trusted source, and they come to us first when considering anything financial. Whether they are considering a change in their estate plan or a refinance of their mortgage, we are there to guide them. Over the years, we have helped our clients avert countless minifinancial disasters by acting as their trusted resource and sounding board.
There is one area, however, where many clients are averse to recommendations. And that is when it comes to their legacy insurance policies, as we call them.
More often than not, newer clients in their mid-50s and early 60s are looking to understand whether they have saved enough for retirement, and how retirement distributions will be made to them. But, when it comes to their life insurance contracts, they are at an age where they generally already have existing policies.
As part of the planning process (included on our agenda), we ask to review their existing life insurance coverage, but we often get this response: “It’s a permanent policy. As long as I pay the $300 per month, I will have $500,000 of life insurance coverage. Don’t worry about the life insurance. I am covered.” Yet when we press them to do a simple review, it typically shows that they own very expensive variable life or whole life policies that don’t make sense for them.
A thorough life insurance review not only creates the opportunity for you to save your clients money and add value, but it is a gold mine of opportunity for advisors as well. Last year, we were able to convert nearly $350,000 of cash value into advisory assets under management and write over $80,000 in premium for new policies. Let’s take a look at the common circumstances we encountered in 2017 and how we approached these situtations.
1. The overfunded and unnecessary variable universal life policy
We have found that many of our clients were improperly sold permanent insurance policies to address even very specific short-term needs. For instance, one of our clients, a 62-year-old small business owner, at age 41 purchased $500,000 of insurance; he wanted to feel secure that, if anything happened to him, his mortgage could be paid off and his two children’s college education would be paid for.
Thanks to our standard client review meeting agenda, which includes a line item requiring “ review of insurance policies and needs,” we discovered this policy during a client meeting. He mentioned, “I have this old life insurance I have been paying $500 per month toward for more than 20 years. Do I still need to do this?”
We learned that the client had a $500,000 variable universal life policy. When I asked him why he hadn’t just purchased a term policy, which would have probably cost about $40 per month, he told me that the insurance agent told him this was the best option because, in addition to the policy coverage, he would also build cash value that would be invested in the market. I cringed.
The client agreed that we should do a review of the policy. It turns out that the policy had a cash value of approximately $102,000. Since the client’s children were both out of the home and there was $2.5 million of liquid investments and a paid-off home to leave to his wife if he were to pass away, he felt he no longer needed the coverage. His financial plan also demonstrated that there were adequate assets to support his wife in the event that he was to pass (though we did recommend that the client secure a 10-year term policy which he could allow to lapse after he retired). Ultimately, this client was able to walk away from the policy with $102,000 of cash value tax-free, which he then invested in his portfolio.
To the previous agent’s point about the investment aspect of the policy, it’s true, the policy did work as an investment. The client had approximately $102,000 in cash value after 21 years. However, had the client purchased a 20-year term policy and invested the $460 difference between the term insurance cost of about $40 and the $500 variable policy cost per month, he would have had nearly $213,000 (assuming a 6% rate of return). That is more than twice as much money!
2. The 25-year-old insured whole life policy
How many of your clients purchased a whole life insurance policy in the 80s or 90s that they have been paying premiums toward for nearly 30 years? You would be surprised how many of these old legacy whole life insurance policies are probably held by your clients, and you don’t even know it.
Last year, we learned that one of our clients purchased a $38,500 death benefit whole life policy when he was 24 years old. He had paid his scheduled premiums since age 24, and now had $145,667 in cash surrender value in a whole life insurance policy with a $231,448 death benefit. The client is a recently retired widower with no estate planning need for insurance and adequate liquid assets to leave an inheritance to his children and grandchildren.
The client was ecstatic that there was $145,667 that he could access in cash value. However, the insurance policy had a roughly $100,000 gain that, if surrendered, would become taxable. We took this opportunity to review with the client two alternatives that could provide access to the cash value with few or no tax consequences.
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Option A: 1035 exchange to an annuity to make capital available and defer taxes
The client could transfer the cash value of the policy to an elite access variable annuity (we use Jackson National) through a tax-free 1035 exchange. By doing so, he would reduce his annual insurance costs, defer his tax liability, and have access to the money (subject to the liquidity provisions of the annuity contract). We selected the Jackson product because, with a contract fee of 1.0%, it provided a low-cost annuity “shell” to keep the funds in a tax-deferred vehicle with nearly 100 investment options and without the bells and whistles of expensive riders and benefits.
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Option B: 1035 exchange to a hybrid long-term care insurance policy
The client was unable to be underwritten for a long-term care insurance policy due to rheumatoid arthritis in his hands. While we are not generally fans of using a hybrid approach to long-term care insurance, this was a viable option for this client because he already had a large lump sum set aside in insurance policies that, in some respects, would be a cash windfall if surrendered. In addition, he otherwise would be unable to secure traditional long-term care coverage.
For this client, a $145,667 lump sum premium payment transferred from his whole life insurance policy to a hybrid long-term care insurance policy would be able to secure him a $4,981 per month tax-free benefit with unlimited lifetime benefits growing by 3% per year (subject to the policy terms) through OneAmerica. This alternative would have allowed for the client to surrender his overfunded whole life policy, potentially eliminate taxes on the surrender value of the whole life policy, and prepay potential future long-term care costs (while also providing a return of the premium to his children if the funds were never used for long-term care).
3. The underfunded variable universal life policy
One of our clients, now 50, purchased a $5,000,000 variable universal life policy when she was 37. At the time she purchased the insurance, she had a very lucrative sales position for a technology company and had made very generous estate plans. Over the years (and after the tech startup went bankrupt), her financial situation changed. Although she still had a successful career, she was earning less and could not support the high premiums necessary to continue the policy. As a result, she reduced her annual premium payments, and over the years the high costs of insurance were beginning to erode her cash value.
Through a tax-free 1035 exchange, we were able to reduce the client’s insurance coverage and obtain a guaranteed universal life policy with a lower cost of insurance that would provide her family with $1,000,000 of permanent coverage, with a drastically reduced annual premium.
Conveying the value of an insurance review
As the industry continues to shift toward fee-based financial planning services and a focus on lower costs, the review of insurance and other commission-based products don’t always get the attention that they deserve. While insurance, annuities, and commissions are generally perceived as “dirty words,” there is still a great deal of value that can be provided to clients simply by reviewing their existing coverage.
In order to broach these topics, you should include a broad review of existing insurance policies, and insurance needs, as part of every client meeting agenda. If clients push back with the usual “we are all covered with life insurance,” sharing one insurance success story as an example will definitely peak the client’s interest.
Whenever we face the “I am all covered with insurance” objection, I usually reply with something simple like this:
Mr. and Mrs. Jones I am sure that you are covered. However, we often find that our clients may be overfunding their life insurance contracts and there are viable alternatives to provide them adequate coverage more cost effectively, sometimes saving thousands of dollars on insurance costs. If you ever want us to take a look, all it takes is one form and we can talk with the insurance company.
After hearing that, most clients become interested in the potential savings and allow us to at least review their existing coverage. Broach the insurance topic—they may resist at first, but when all is said and done, your clients will be thanking you.