The
Efficient Edge
Protecting tomorrow begins today.
The Current vs. The Future
We were called by a CPA firm that was concerned about some life insurance coverage for one of their key
clients. The client had been called by an insurance professional and his take-away was that the agent told him
he could replace his coverage for the same amount of death benefit with no medical exam!
Setting the Stage:
Client had a very good business which he owned and had bought some joint life insurance for estate and
business liquidity purposes 15 yrs. ago. As in most situations, the client is wondering if he needs the coverage
any longer. If the recommendation is to keep it, he wants to continue paying NO PREMIUM as is the current
case. The life insurance is for $5,000,000 and has a little over a $1,000,000 of cash value. The policy is
owned by a trust and the trustee is a major financial institution. The trustee has informed him each year for
the last few years that the dividends are large enough to pay the premiums, which is true and a good idea.
BUT, upon further review I noticed that the policies were Hybrid Whole Life Policies (a mix of term and whole
life). It turned out the policy was 50% term and 50% whole life when it was issued. The insurance company is
a well-known mutual life insurance company, with very high ratings and credible product line.
The Problem Discovered:
I knew there was a large potential problem as the mix of term and whole life insurance at 50%/50% with
premiums being paid for by the dividends could very well have premiums reappear in the near future much to
the surprise of the insured couple. Why? Well, let me explain:
Back when the policy was issued the only way to keep the premium low was to mix in some term
insurance with whole life. As the client explained, “The agent said I would only have to pay about 8
years of premiums and then the policy would pay for itself, so that is what I did.” I reviewed the
original illustration and the dividends that the insurance company was projecting to pay would be large
enough to pay future premiums.
In these kinds of Hybrid Whole Life policies, with a mixture of term insurance, the way they are
supposed to work is the following:
The term insurance goes up in price each year
The premium pays for the whole life and the dividend will convert a portion of the term
insurance each year so that the premium can stay level
The premium and the excess dividend, if there is any, will build up cash value in the policy
Based on the original illustration the projected dividends after 8 years would be large enough to
continue to convert enough term insurance each year so the premiums would not have to be
paid
The Efficient Edge 500 W. Madison Suite 2740 Chicago IL 60661 P: 312.798.7144 peter.steger@efficientedge.net
Peter F. Steger CLU, ChFC, REBC – Principal, The Efficient Edge
Registered Representative, Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research
Advisors, Inc., a Registered Investment Advisor. The Efficient Edge and Cambridge are not affiliated.
The
Efficient Edge
Protecting tomorrow begins today.
The problem that the client has encountered is that as the dividend crediting rates have decreased, the
cash value that has been generated by the excess dividends in the earlier years has been harvested to
pay for the shortfall. As the term insurance rates continue to increase – which they do every year -
there is a decrease in the level of term insurance that is converted, and at some point the amount of
term insurance needed to sustain the policy starts to increase back up to the 50% level. When the
cash value of the dividends paid has been exhausted, the premium plus the dividend is not large
enough to pay for the total cost of the coverage. The policy’s premium reappears and must be paid to
keep the policy in force.
The client was not aware of how the life insurance blend worked and neither was the trustee. What I was able
to show them was that the premium would reappear in about 7 years. The premium would be, based on
projected dividend payments, about $10,000 and increase to about $63,000 by the 5 th year. By the end of the
10th year the premium was going to be in excess of $100,000.
Solution:
What the client wanted to do was to keep as much insurance as possible and pay the least amount of
premium, sound familiar? We did an Opportunity Matrix™. We came up with several possible solutions and
based on his life expectancy (LE) from our proprietary LE tables, we were able to accomplish the following:
Drop only about 10% of the death benefit
Take some of the cost basis which had accrued and which can be withdrawn on a FIFO method (one of
if not the only financial asset that still has this rule) and use the money to pay for some new life
insurance that would be contractually paid-up with the one-time lump-sum payment
The original policy would still have a significant amount of cash value preserved and based on a
decreased dividend payment assumption would pay for itself beyond their life expectancy at the 90%
level
Conclusion:
If you have whole life, and bought it within the last 20 years, you may have some sort of a term-blended
product. Contact us for questions, and remember, time is never your friend when a policy needs attention!
The Efficient Edge 500 W. Madison Suite 2740 Chicago IL 60661 P: 312.798.7144 peter.steger@efficientedge.net
Peter F. Steger CLU, ChFC, REBC – Principal, The Efficient Edge
Registered Representative, Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research
Advisors, Inc., a Registered Investment Advisor. The Efficient Edge and Cambridge are not affiliated.