There are options for underfunded life insurance. Some of these options will depend on the type of product, other options may work for all product types, but optimization of a life insurance portfolio and knowing your return is a must.
The heartburn I hear from all my fiduciary clients is that some of their key donors or clients have stopped paying premium. As a fiduciary, it is your duty to optimize the assets in your care to maximize the return to the beneficiary, which in many cases may not be the death benefit. Life Insurance is a financial asset, it has value in some cases larger than simply the cash or surrender value, but when a client stops paying scheduled premiums the clock starts ticking on what to do next.
When scheduled premiums stop, time is of the essence. The shortfalls in premium cash flow will begin to erode the cash value, which in turn will erode the lapse age. As I have discussed in previous Neifer’s Notes (‘Why Policy Charges Matter’), continued insurance company changes to internal charges and crediting rate returns, will compound this issue. Paying premiums on time and as scheduled is the single biggest component of any insurance product.
Each product type, like Whole Life or Universal Life, may have options unique to their specific design. For example, most whole life insurance products offer a reduced paid up option. Any loans would be paid off coupled with a reduction in death benefit, will keep the policy inforce to maturity with no additional premium. This can be a strong option to maintain coverage if a policy is no longer being funded or there are substantial loans on the policy. There are potential tax consequences, so you must be mindful of the entire strategy and account for any taxation.
Universal life products typically do not have a ‘Paid Up’ option built in, so reductions in death benefit or surrender may be used to optimize the prior gifting. It is important to make sure that you are taking into consideration, the general health of the donor, looking a projected cash value growth and measuring the best time to surrender a policy or reduce the death benefit. Keep in mind that a face reduction, may be costly. If there are still surrender charges on the policy cash value, the reduction in death benefit could have a dramatic reduction to the cash portion of the policy.
Life settlements can also be a solution, generally for those doners over 70. These transactions allow for a third party to purchase the policy at a value above the cash value. Some programs may even allow the owner to keep a portion of the death benefit. All life settlement programs should be reviewed by a professional and never use individual buyers to purchase a policy.
The key takeaway is that life insurance needs to be considered an asset class. Insurance should be looked at, much like a bond portfolio. The returns matter, the ratings of the companies matter, reviewing the policies’ performance is critical and no single strategy works for all policies. However, the good news is that in every scenario, you will have multiple options. Reviewing the financial benefit of those options and taking into consideration potential taxation and risk associated with the options is what we are here for.