-by Michael “Woody” Wodchis, FLMI, ACS
The July 20, 2017 Wall Street Journal article, “Happy 100th Birthday! There Goes Your Life Insurance,” points out a major hidden flaw in older life insurance contracts: the risk of living too long. In the mid-20th century, the life insurance industry, along with government regulators and actuaries, did not expect or anticipate that more than a handful of policyholders would reach age 100. But today, some insureds fortunate enough to approach these “golden” ages are surprised to learn that their policies will “endow”– that is, coverage will end and any cash values will be paid to the policy owner. The Journal describes how one of those age 99+ policy owners, faced with losing all or part of what he originally intended to purchase – income tax-free death benefit for life – is taking his case to court.
For over a decade, “the industry has used age 121 as the standard maturity date in new contracts,” the newspaper reported. “But an unknown number of older contracts with the 100-year-old limit remain in consumers’ hands.” Many carriers subsequently added an Extended Maturity Rider (EMR) to their in force block to protect their policyholders against outliving their coverage, or provided other assurances that policies would stay in force indefinitely at the request of the policy owner, subject to some limitations (on loans or withdrawals of cash, for example). Joseph Belth’s recent blog (The Age 100 Problem – The Achilles Heel of Life Insurance – Lands in Court) outlines the problem, and explains both the ways in which many carriers responded to this dilemma, and how others simply chose to ignore the problem and let the original contract language prevail. This recent press reinforces an absolute truth, as obvious as it may be, about life insurance death benefits: the policy must be in force upon the death of the insured for an income-tax-free death benefit to be paid. If a policy is cancelled, or endows as mentioned previously, any gain over the investment in the policy – premiums paid – is taxable to the policy owner.
The underlying problem, and opportunity, we have in the life insurance industry is to be aware of, and offer solutions for, longevity risk. As mortality continues to improve, more of our clients will live into their 80s, 90s and even beyond 100. Even though carriers offer continued protection beyond this point, these improved product features won’t help if the policy is not in force. Obviously, this is very important when the product is purchased for death benefit protection rather than other needs, such as supplemental retirement income.
We ask our clients to trust in our advice as well as in the suitability of the products and carriers we recommend. Where protection is the primary objective, what can we do to meet and exceed client and beneficiary expectations?
Presenting the lowest premium product may help win a case but may not be best for the client in the long term. Whether an existing policy or a new sale, all products need to be appropriately funded so that they have a realistic chance to last to life expectancy (at a minimum) and well beyond. With hopes of AG 49 leveling the playing field, we have actually seen indexed universal life illustrations become increasingly complex as many carriers project guaranteed or non-guaranteed bonuses. Unfortunately, “illustration games” do little to help instill a sense of certainty and predictability down the road.
Beyond your own servicing systems to ensure that clients are regularly communicated with and understand how their policies are performing, work with carriers with effective and proactive processes in place that clearly track how policies are doing, be it behind, on, or ahead of schedule. Just as important, these communications have to provide easy to understand guidance relative to adjusting premium payments on an annual basis.
To avoid unexpected and unpleasant surprises down the road, take advantage of low cost guarantees available today. This is particularly appropriate for risk-averse clients who would pay “a little more” to lock in future certainty. Once the exclusive province of no lapse guarantee universal life and whole life products, there are now very competitive variable and indexed universal life products available today with extended guarantees, ranging from beyond life expectancy all the way to lifetime. By using these low cost guarantees, we take can take a lever out of the hands of the insurance company and help clients sleep at night.
As clients live longer, their chance of living with extended and debilitating illnesses also increases in direct proportion. The various living benefit riders now available on life insurance products can provide much-needed funds to help offset the cost of care. In addition, there are riders that allow the policy owner to “convert” death benefit into a stream of retirement income…a powerful feature for clients who have lived longer than they might have expected.
Historically, the insurance industry has addressed longevity risk with its annuity products – products designed to provide an income that clients could not outlive. Today, our professional recommendations must also consider a client’s potential longevity risk as it relates to life insurance products. As Joseph Belth explains:
“It is an understatement to say the age 100 problem is serious. Indeed, I think the problem is the Achilles heel of life insurance. The bedrock principles of life insurance marketing are the income-tax-deferred inside interest and the income-tax-exempt death benefit. The problem is so serious that . . . the companies do not want to discuss the matter. I further believe that neither the Internal Revenue Service (IRS) nor the income-tax-writing committees of Congress want to discuss the matter.”
Despite what the companies, the IRS or the Congressional committees might want, your clients need you to review their life insurance and examine the contracts for the kind of longevity risk that Belth and the Journal describe. If you find that you’re not sure how to start or what to look for, call us at Windsor. We’ll be glad to help.