Today's investment and political climate is causing a perceptible change in the way many clients approach the role of life insurance in their financial and estate planning. I see clients aggressively reassessing their life insurance needs, whether those needs are for basic protection or preservation of an estate for the next generation.

Those reassessments are generally calling for more life insurance. But clients are more cautious in the amount they're willing to spend for the coverage and the extent of the commitments they're willing to take on for premiums.

I am also seeing a resurgence of proposals for policy exchanges to accommodate clients' cash flow or gift tax constraints.

Terra Not So Firma

The most basic of the life insurance analyses that we do for our clients helps them determine how much insurance is needed to provide financial security for their survivors. But the last few months' upheaval in the financial markets and the November election results are leading many clients to revisit the assumptions they used when determining both the amount and duration of that insurance need. It won't be a pleasant visit.

Many of the factors that these clients counted on to meet the needs of survivors are going to be discounted, perhaps significantly. The investment asset base that will generate income for the survivor likely has been depleted, while the survivor's life expectancy is probably increasing. The attractive after-tax returns on that investment capital likely will be harder to achieve in the coming era of higher tax rates on dividends and capital gains. Projected increases in compensation are likely to be more conservative than before. Maybe survivor benefits from pensions and deferred compensation won't be as assured as they seemed in calculations past. Finally, surviving spouses' ability to re-enter the work force could be more difficult than clients previously reckoned.

The upshot: the newly recalculated, absolute dollar amount of the survivors' need is likely to be considerably greater than it was even a year ago. And, when clients factor in the headwinds they'll be facing in accumulating capital that could eventually displace the need for life insurance, they'll find that their need for insurance is far more permanent than they'd banked on just a year ago.

Term Insurance — A Port In the Storm

The logical reaction to these circumstances is for clients to embrace cash value insurance to meet longer duration needs. After all, unlike term insurance, cash value insurance offers the ability to have enduring coverage without enduring cost. And cash value insurance can be an integral part of clients' retirement planning.

Many clients concede these points. But their hands are stayed by concerns about the impact of an enduring recession on cash flow, benefits and job stability. At least for the time being, they don't want to commit to significant premiums for cash value insurance.

So, instead, they are buying term insurance.

Discussions about term insurance have always been pretty cut and dry, as if it were just a commodity to be purchased solely on the basis of price. But it isn't, especially when newly recalculated needs are projected to endure years beyond the point when term insurance will continue to make sense.

Clients — who, despite their current economic constraints, recognize that they'll need life insurance for many, many years — will purchase term policies that are convertible, meaning the carrier will allow the policyholder to exchange the term policy for a cash value policy. The conversion is done without evidence of insurability but at the client's attained age, meaning their age at time of conversion. This obviously can be a very helpful provision for a client who eventually wishes to “go long” on the insurance but comes up short on the medical exams.

Insurance professionals know that when it comes to conversion features, the devil is in the details. So, those details can and should be major factors in the selection of a term product. Beyond the usual information about ratings of the proposed carrier, pricing of the product and availability of re-entry after the initial guarantee period, here is what clients should see regarding the conversion feature of any proposed policy:

  1. Is the policy convertible to all of the carrier's cash value products that it offers at the time of conversion or just some (or certain types) of those products? Ideally, but only ideally, the term policy purchased today should be convertible to any cash value product the insurer offers at the time of conversion. The more choices the client has upon conversion, the more he will be able to select and design a cash value product that fits his needs at that critical time. Always ask the agent for the conversion provision from the policy itself and not just from a marketing piece or a policy illustration.

  2. Is the policy from LittleLife really convertible to the policies of LargerthanLife? We might see that an attractively priced term policy is issued by the subsidiary of a larger carrier. The term carrier does not have attractive cash value products — but the parent carrier does. The representation is made that the term policy of the subsidiary is convertible to the cash value products of the parent. But that flexibility is nowhere to be found in the policy from the subsidiary. Therefore, ask the agent to provide a letter from the parent company that the term products of the subsidiary carrier are in fact convertible without evidence of insurability to the cash value products of the parent. (Of course, also determine whether conversion is available to all of the parent's products.) Planners must also consider what would happen to that conversion privilege if the parent doesn't happen to own that subsidiary when the client wants to convert the term policy.

  3. How long is the conversion feature valid? Time limitations can be a trap for the unwary. For example, not every 15-year term policy is convertible without evidence for 15 years. The client should be comfortable that the duration of the conversion period will give him enough time to avoid having to make a decision (or go to the marketplace) under duress.

  4. Will the conversion (without evidence) be done at the same underwriting classification as the term policy for the entire amount of the new policy?

In practice, agents will “spreadsheet” the term products, comparing the pricing, carrier's ratings, conversion provisions and other details. The choice is then up to the client, the buyer.

Some clients will opt for price, plain and simple. As long as the term policy is seamlessly convertible to a cash value product, these clients are satisfied that they have obtained cost-effective coverage while adequately preserving the opportunity to go long on the insurance regardless of their health at the time of conversion. They feel that further analysis is “over-engineering” at best.

Other clients will pay more, if necessary, to buy the term insurance from the carrier whose ratings and cash value products they feel most comfortable with today. This approach, they believe, mitigates some of the risk that if impaired health at the time of conversion limits their access to the marketplace, then at least they are with the carrier whose cash value products they liked at the outset.

The Gradualist

There is an alternative to the “buy convertible term and see what happens” approach that can make sense when a client intends to go long on the coverage but expects to be short on cash for the foreseeable future: The agent shows a current assumption universal life policy that is designed in the most efficient way possible for the client.

For example, if available in the product, the death benefit would be comprised of the minimum amount of base and the maximum amount of term. The agent would show the lowest level premium that the policy is projected to require under current assumptions for credited interest and costs-of-insurance to support the death benefit for however many years the client needs to minimize his outlay. As soon as practicable, the client will increase the premium (without evidence of insurability) to a level that will support the death benefit for as long as he deems appropriate. Incidentally, this approach might work with a no-lapse universal policy. It just depends on pricing and other policy features.

This approach also can make sense for the client who is concerned that the kind of attractively designed and priced cash value products available today might not be as widely available when he is ready to convert. So, the gradualist approach makes a lot of sense to them today. By the way, it also can make sense in an estate-planning context.

Of course, the gradualist approach has to prove itself on an economic basis, meaning the numbers have to work when compared against the straight-forward purchase of the level-term product. That comparison should be done on a rigorous basis: The universal policy should be illustrated at something below the carrier's current crediting rate.

Estate Planning

Beyond life insurance for the purposes of basic financial security, there's the role it can play in more comprehensive financial and estate planning in this unique economic and political climate. Some very intriguing factors, including most notably the likelihood of “permanently” increased estate tax exemptions, are at work here.

Let's consider estate planning first.

For the past several years, clients who looked for reasons to put off their planning and insurance purchases didn't have to look very far. After all, even though taxable estates were growing, there were legitimate prospects for estate tax repeal or at least reform at a high enough level to eliminate their concerns about estate tax. So why do all that wealth transfer planning or buy a lot of life insurance to pay a tax that might be repealed or irrelevant in their circumstances?

What a difference a year makes! We now appear to have a great deal of certainty about the continuity of the estate tax — but far less certainty about the continuity of prosperity. In other words, procrastinators have a new lease on… procrastination.

But let's put off thinking about procrastinators to another day.

Instead, let's consider the clients who are taking an earnest look at their estate planning and the role of life insurance in that planning for the foreseeable future. I find these clients are generally expecting that they will have a $3.5 million exemption and/or $7 million combined (and portable) exemption for a married couple. Just raw numbers? Hardly! In many cases, those new exemptions will be the final, end-of-discussion answer to the eternal question, “How much is enough for the kids?”

Even clients who are still interested in reducing their taxable estates and can afford the cash value product may find that a 15- to 20-year term policy will provide all the coverage they need for them to allow an aggressive wealth transfer program (for example, gifts, grantor retained annuity trusts and sales) ample time to bring their taxable estates down to a level that either will eliminate the liquidity need altogether or just assure passage of a nicely satisfactory sum to the next generation.

In other words, the term policy is a hedge against an early mortality that could otherwise prevent the wealth transfer plan from meeting its objective.

As foreshadowed, even clients who have every intention of going long on their life insurance for estate liquidity (or pure capital transfer to assure an inheritance) can use convertible term insurance as part of an approach to minimize the tax cost of paying large premiums. These clients tend to use irrevocable life insurance trusts (ILITs) to keep the proceeds of the insurance out of their estates. So, the ILIT can buy convertible term. That buys time for the client to fund the ILIT with income-producing property that the ILIT, no doubt designed as a defective grantor trust for income tax purposes, can use to pay premiums. Every dollar of premium that the ILIT can pay with its own money is a dollar of gift the client doesn't have to make to the trust. This approach can not only save clients considerable gift tax dollars in the early years, but also may give them needed time to determine: (1) just how much coverage they will really need in the context of their overall estate plan; and (2) when ready for conversion, what kind of product is most suitable for both the estate plan and the strategy they will pursue for paying premiums.

To be sure, the gradualist approach with the flexible premium policy that I described also could work in the ILIT context.

Policy Exchanges

Policy exchanges are an old standby that keeps showing up at the top of the charts. Years ago, policy exchanges were largely driven by improvements or innovations in product, with particular emphasis (or fingers pointed at) no-lapse universal life. Nowadays, there is much more at play than meets the eye. For starters, some clients are seeing reductions in the dividend interest rates on whole life policies and credited interest rates on universal life policies. They've obviously noticed the hit on the cash values in many variable life policies. The implications of these developments depend on the type of product a given client owns, but generally speaking, the problems are manifesting themselves in at least two ways.

First, lower dividend interest rates, credited interest rates or gross returns on cash values will effectively increase the premiums for the policies or extend the number of years those premiums will be required. That's a cash flow issue for any client, but it's also a gift or generation-skipping transfer tax issue for clients using ILITs. Now in many cases, real or perceived problems with policy performance can be addressed by pro-active policy management. But in other cases, clients who are still insurable and want to retain their coverage yet reduce their premium outlay, are going to have to look for new products that will allow them to cut back (or eliminate) the premium without making today's solution tomorrow's problem.

Next, many clients with pre-final regulation collateral assignment split-dollar arrangements are coming to the conclusion that those plans are irretrievably broken.1 There is simply no way that the policies will ever achieve the promise of the initial split-dollar illustrations, which was to generate enough cash value to (1) finance repayment of the employers' premium advances (a “roll-out”); and then (2) sustain an adequate death benefit without further cash premiums from the insureds. These clients are unhappily preparing to pay the tax and economic cost to unwind the arrangements, the “breakage fee” as it were, and move to a new policy that will maintain a desired level of coverage at affordable cost.

As I have written on these pages during the years, exchanges can sometimes make a lot of sense. But, as in years past, there is no question that some exchanges are being pushed for reasons that will not withstand scrutiny. I am seeing exchanges proposed to “rescue” clients from very adequate policies that at most should be tended to more carefully but certainly not replaced. I am seeing proposals to move clients out of policies that don't offer long-duration guarantees to policies that do, but at the cost of significant loss of cash value and/or death benefit. Of course, I am seeing proposals based upon “concern” about the financial stability of the current carriers, when that financial stability may not be in question.

Finally, I continue to see proposals for exchanges from one carrier to another, a so-called “external” exchange — without evidence that the agent explored a replacement with the same carrier, an “internal” exchange. Internal exchanges should always be explored first, because they might be available with less rigorous underwriting, might allow the exchange at the account value rather than the lower surrender value, might eliminate commission on new product, and might reduce or eliminate certain sales loads and premium tax. But even if the exchange is internal, always check the illustration for the replacement product to be sure it is coded for an internal exchange.

Aside from these few precepts, discussion of guidelines for evaluating policy replacement is well beyond our discussion here. But it's fair to say that any proposed replacement must bear the heavy burden of showing, in clear and convincing terms, that it can legitimately meet the client's needs more effectively or more efficiently than the existing policy.

A Wise Policy

In today's economic and political climate, clients who are willing and able to pay the premiums for cash value life insurance might well find that a single policy can enable them to meet a number of seemingly disparate needs for risk management, income tax planning, investment planning, retirement planning and, if they care about leaving something significant to their children, estate planning.

My sense is that, for the foreseeable future, fewer and fewer clients will be interested in rearranging their affairs to save estate taxes on what will pass to their children. So, more and more clients will decide that they should own those valuable policies in their own names to take maximum advantage of their multi-faceted benefits. As always, the keys to being able to deploy a single premium dollar to meet more than one planning objective are good policy selection and design.

Come to think of it, maybe the climate hasn't changed so much after all.
— The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP. This document should not be construed as legal, tax, accounting or any other professional advice or service. No one should act upon the information contained herein without appropriate professional advice after a thorough examination of the facts of a particular situation.


  1. Charles L. Ratner and Lawrence Brody, “What To Do With Those Existing Split-Dollar Plans,” Trusts & Estates, March 2007, at p. 29.

Charles L. Ratner is the Cleveland-based national director of personal insurance counseling for Ernst & Young LLP


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