Life Insurance Checkup

Life insurance policies often form a large percentage of a client’s net worth. As goals, needs and products evolve, advisers should review their clients’ insurance portfolio to make sure it is optimized. Follow these steps to get started:

  Confirm the need, purpose and goal of the existing policy. They may have changed. For example, the client may have purchased a policy to provide income for a surviving spouse and for supplemental retirement income. Today, it may be needed only to pay any estate taxes or to pass on additional wealth.

  Determine whether the insured’s health has improved since the policy was purchased. If so, the client may be able to purchase the same coverage at a lower cost. Even if the client’s health is the same, greater longevity means insurance companies are charging less in premiums, because they will be collecting them longer.

  Check the client’s estate tax exposure. As of this writing, for decedents dying in 2010 there is no federal estate tax, but on Jan. 1, 2011, the estate tax exemption is scheduled to revert to $1 million per estate. Several legislative proposals would extend the 2009 exemption amount of $3.5 million. Depending on the client’s expected longevity and what Congress does, if the client’s assets are low enough or have decreased in value, he or she may no longer need the policy to pay estate taxes and could reduce its death benefit, cancel it, or try to sell it in the secondary market (life settlement).

  Check the policy’s design. Many policies issued 10 or 20 years ago were designed to endow at age 100, which means the cash value would equal the death benefit. Today there are new policies that do not endow. Clients who want only a death benefit could pay less in premiums.

  Check the insurance company’s credit quality. Request a financial report for the company that issued the current policy and, if different, that of any proposed new policy.

  Consider alternatives to IRC § 1035(a) exchanges for policies with significant cash value. A client may be contemplating exchanging an old policy for a new one under IRC § 1035(a), to transfer the old policy’s basis while deferring any gain. However, the client should weigh other options. For example, surrendering the policy for its cash value, paying tax on it, and buying a new policy sometimes makes sense. The client could invest the proceeds to offset the cost of third-party financing to fund the new policy.

  Check the policy’s projected performance. A policy should have projections (or “in-force ledgers”) run on how it will perform until life expectancy and beyond. It may have been purchased in a period of higher interest rates, which means the policy projection would have shown a lower premium outlay than in a period of lower interest rates.

  Check who owns the policy. A policy owned by the insured will be included in his or her estate for estate tax purposes. It can be owned by other entities instead, to keep it out of the insured’s estate.

  Make sure any insurance professional involved is independent. Ask if he or she is product- and company- neutral. Ask whether he or she uses a primary company and receives a Form W-2 and/or benefits (health insurance, retirement) from that company. Many captive (nonindependent) agents cannot sell all products on the market, which might put the client at a competitive disadvantage. For example, many may not sell indexed universal life insurance.

—By Cory Chmelka, CFP, (cchmelka@capwm.com) managing partner of Capstone Wealth Management LLC in New York City.