 nsurance companies can alter policy terms as
often as they wish. Sometimes the changes benefit the
carriers; sometimes they benefit the policyholders.
Interest, mortality (the probability a given individual will
die) and expenses are the most common things that can change
in a policy. Typically, they manifest themselves to clients
as a rise or fall in insurance premiums. Advising clients on
changing premiums involves getting the right information,
analyzing it and periodically reviewing the policy. Interest
rates and premiums work like a seesaw: During periods of
declining interest rates, premiums usually rise.
Policyholders then have a choice: Keep paying the original,
lower premium but accept a lower death benefit or retain the
original benefit and pay a higher premium. Rising interest
rates have the opposite effect. Here’s how CPAs and clients
can cope.
WHY POLICIES CHANGE
Only a few factors cause
insurance companies to change premiums and benefits.
Interest credited to the policy is one; reducing it allows
the carrier to recoup a loss if premium income,
investment-portfolio income or death-benefit-payment
expenses change to the carrier’s detriment. Only the
insurance company’s board of directors has the discretion to
make changes to interest credits. The second factor
causing premiums and benefits to change is the mortality
charges the company assesses against policy accounts. Using
a more favorable mortality table (one showing a lower
probability of an individual dying, thereby reducing
expected benefit costs) on a given policy block allows
insurers to adjust their minimum reserve liabilities and
minimum cash-surrender values. Both affect the company’s
performance and cause premiums to move accordingly to
maintain profitability. Insurance companies set
aside reserves against future death benefit payments. Since
actuarial science is highly precise, nothing short of a
natural disaster, plague or war would cause unexpectedly
large benefit payment expenses in a given year to exceed the
carrier’s reserves, thus requiring a premium increase to
maintain profit margins. Here are questions CPAs can
ask to help them anticipate volatile policy performance:
Does the carrier offer other types of
insurance in addition to life insurance? This is
important because an expense increase may have nothing to do
with a company’s life insurance business. Unanticipated
expenses could come from, for example, the company’s
property and casualty lines. Hurricane Andrew, which hit
Florida a decade ago, is an example of a huge benefit
expense payout that affected all policyholders—life
insurance as well as property and casualty.
Does the carrier specialize in the type of
risk the client presents? Some insurers may be more
likely than others to make significant policy changes.
Another company, more experienced with a particular risk,
may find the change unnecessary or make it to a lesser
degree.
When comparing illustrations of the same
policy among different carriers, does the policy seem
reasonable? If it seems too good to be true, chances
are it is. If the carrier uses unrealistic assumptions, it
will have to adjust the policy later to bring it back into
profitability.
LIMITS TO POLICY CHANGES
Insurers cannot reduce benefits
to a level below the contractual policy minimums. To find
these amounts, CPAs should look on the insurance
illustration under the guaranteed columns. Compare these
numbers with the current/ nonguaranteed columns. By
definition, the current/nonguaranteed illustrations will
appear better than the minimums. The difference is
significant. If a client were to rely on the
current/nonguaranteed illustration in planning his or her
retirement, he or she may find actual results are well below
the target. This could cause a larger than anticipated cash
outflow and upset retirement plans. Additionally, companies
are required to disclose only in their regulatory filings
(and not to the general public) when they think they cannot
accomplish their assumptions using the current/nonguaranteed
amounts.
IMPACT ON POLICYHOLDERS
CPAs should watch for changes
that could negatively affect a client’s cash resources or
estate plan. Not only can carriers raise premiums, but they
can also lengthen the number of years the client is required
to make premium payments. For clients whose cash resources
count on premiums ceasing at a certain time (perhaps as
described in the nonguaranteed part of the illustration)
this could create a cash crunch if premiums don’t stop when
anticipated. Decreasing death benefits can derail
estate plans in which beneficiaries depend on getting a
certain sum. CPAs should factor in the impact on spouses and
children when advising clients to either pay increased
premiums to preserve the original death benefit or maintain
the original premium but allow the benefits to fall. The
advice CPAs provide today on this seemingly simple issue
will have enormous future consequences.
CALCULATE THE FINANCIAL IMPACT
There are several steps CPAs
can follow to compute what financial effects a policy change
will have on a client.
Obtain from the carrier or the insurance agent
an in force reprojection of the policy showing the
new premiums and benefits based on how the policy was
originally issued. This shows the effect of the changes the
carrier has made over time.
Order a second reprojection based on the
revised premiums needed to restore the policy to the
original projection. This shows the newly revised cost to
get what was originally intended. Note that insurance
carriers do not provide these reprojections unless
requested.
Compare these two documents and shop the
insurance markets. In this way CPAs can determine whether
the client should continue with the current policy or buy a
new one.
STEPS FOR PRACTITIONERS
Best practices dictate that—as
a standard procedure—every year for every insurance policy,
CPAs should review clients’ insurance coverage. Ask the
carrier to furnish the two reprojections identified above.
This is particularly important for policies more than five
years old. For them, the policyholder will certainly have a
different experience than that originally illustrated.
Bring the client into the review process. The purpose is
to assess how the policy now meets the client’s
needs as they have evolved since the last review and as the
policy has changed according to the reprojections. Ask about
the health of the insured. Compare the current information
with that on which the policy was based. Perhaps the client
just quit smoking or his or her cancer is in remission. Both
can cause decreases in premiums and may make keeping the
current policy a better deal. Many CPAs use
information obtained from the annual insurance review to
shop for a “guaranteed” policy. This is a new breed
of coverage where the relationship between premium and death
benefit is fixed—the carrier cannot change it. This type of
policy solves the premium escalation problem permanently and
is an alternative to the client’s paying additional premiums
to repair an old policy. From an estate planning standpoint,
the most significant benefit is the guaranteed policy’s
predictability, making it easier to plan for the future.
At the same time as the annual insurance review, CPAs
also should look at the client’s estate plan and its goals.
Determine whether changes in the client’s life require
adjusting the plan—marriage, divorce and children are just
three. Insurance policies often figure in as a significant
part of such changes. This is also a good time to factor in
the new estate tax laws, which may affect how much insurance
the client needs.
WHAT’S NEXT? Moving
financial markets, coupled with modifications in the
insurance industry, will keep life insurance policies
changing. As CPAs increasingly become the center of their
client’s financial lives through services such as insurance,
they will have to respond quickly to such policy changes.
Since our population is living longer, the decisions
financial professionals make regarding paying additional
insurance premiums, not paying them but accepting lower
benefits or shopping for a guaranteed premium policy will
affect us even more. Neil Alexander, CFP, is founder and
president of Alexander Capital Consulting, LLC, in Los
Angeles. His e-mail address is nalex@alexcap.com .
Clarification The
Insurance Issues column that ran in the December
2001 JofA (page 37), raised the
question about what type of entity CPA firms should
set up to allow them to sell insurance policies that
qualify as investment securities. Generally,
anyone who sells investment securities or receives
commissions from their sale must have the
appropriate NASD license. Additionally, that
individual must be associated with a firm that is
an NASD member. NASD rules prohibit the
sharing of securities commissions with unlicensed
persons. Issues of how to handle securities
commissions within an accounting firm are best
handled by the compliance department of the firm’s
broker-dealer or by outside securities counsel. | |