How to Respond to Policy Changes

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 .