More than two decades of evaluating life insurance policies for thousands of clients has yielded a number of valuable insights about policy performance, sales practices and carrier behavior.
From uninformed policyholders who wrongly assumed they had adequate coverage to industry professionals who knowingly sold grossly exaggerated policies, I’ve observed a number of insurance policy pitfalls. Here are some cautionary tales I want to share in the hope they help you avoid these perils and better serve your clients.
Early Payments Sometimes Wreak Havoc
If a payment is due on the first of the month and your client pays early, you might think he would be rewarded for his diligence. But in reality, there could be costly consequences. Many guaranteed universal life contracts issued prior to 2012 include premium accounting clauses that could trigger a significant loss of guarantees if premiums are paid ahead of scheduled dates, particularly in the early years of the contract.
One client had a $20 million policy that required 10 annual premium payments. The policy, if paid accordingly, guaranteed coverage through age 115. Our client was cautious and prompt, paying each year according to schedule — or so he thought. We conducted our annual policy audit with him in the 10th (and last) year of required premiums, only to discover his second premium payment was early, causing the guaranteed death benefit to terminate at age 96. That’s right — advance payment cost this client 19 years of coverage. After working with his carrier, we were able to reapply his second payment correctly and restore his full benefits.
1) Lesson learned: Meet with an unbiased industry advocate. Audit annually. Know the policy terms for payment timing, and stick to them.
Young Policyholders, Wrong Counsel
A couple with limited cash flow, minimum investment experience and three young children are not appropriate clients for variable life insurance. My team recently reviewed coverage for a married couple who fit this profile, yet were convinced by their advisor that variable life insurance, funded at the lowest allowable level, was appropriate for their needs.
A major mutual company issued their current policies with death benefits of $250,000 each. An audit uncovered an enormous discrepancy: This young couple’s benefits, which were inadequate to begin with, would lapse before the couple reached their mid-50s!
We discussed this couple’s needs, which included providing a surviving spouse with enough income to raise and educate three children. Fortunately, we were able to obtain a more appropriate and safer option that matched their previous premium. We replaced their current policies with 30-year term insurance that had a $1 million face value. Eventually, clients such as these will grow in their professional lives and often will be able to purchase a cash value-focused policy. But until then, they can enjoy the peace of mind that comes with knowing they have satisfactory coverage for their family.
2) Lesson learned: As life evolves and changes, so should your clients’ insurance policies. Empower clients to ask the right questions and make adjustments in coverage when appropriate.
Reinvesting Policies for Retirement May Be Unnecessary
Policyholders often lose sight of their benefits, especially if they haven’t touched their policies for decades. We were introduced to a 65-year-old client through his investment advisor, who was working with him to build a retirement income portfolio. The advisor requested a thorough policy audit to determine if his client’s cash value could be deployed for retirement. Thirty years earlier, this client had purchased a whole life policy and paid every premium, but he no longer needed the death benefit.
Our challenge was to determine whether this client should surrender the policy or use it for income. But why choose?
In fact, this client was able to create tax-free retirement income and keep his policy. Based on his tax bracket, age and retirement needs, we determined this client could keep his current whole life policy and simultaneously access an immediate stream of tax-free payouts. This man was able to reap the best of both worlds: He had access to a new income stream and avoided drawing from his investment account for many years.
3) Lesson learned: The best solution is not always obvious.
A $1 Million Tax Blunder — Almost
We recently audited a whole life policy for a client who intended to use his cash value for retirement income. Before he came to us, his insurance agent advised exchanging his whole life contract for a new index universal life (IUL) policy.
While the client was fairly sophisticated about insurance products, he didn’t understand the intricacies of IUL. Even worse, neither the client nor his agent knew how much income his current contract might generate. And the agent failed to inquire about his client’s tax basis.
Both assumed the contract could be exchanged tax-free — a common misconception. The client also had surrendered $500,000 of paid-up additions, which reduced his tax basis from $630,000 to $130,000. With a current cash value of close to $1 million at stake, the proposed change would have resulted in a sizable taxable gain. Moreover, the change would have resulted in any future income from the new contract being taxed as ordinary income.
After our analysis, the client retained his whole life contract, avoiding a serious tax mistake.
4) Lesson learned: The devil is in the details. Research and an audit will help clients make informed, strategic decisions about their current coverage and possible alternatives.
Fears of Uninsurability Can Limit Outcomes
Clients can be their own worst enemies. Recently, a client asked us to audit a number of smaller guaranteed issue policies. All were unnecessarily cost-prohibitive with negligible potential to yield cash value.
During a meeting with the client, he shared reasons why he previously had assumed his health concerns rendered him uninsurable. We shared with him ways to disclose his medical situation properly. After years of worry and angst, this client was able to obtain great coverage for standard rates. In fact, his new policy has a better death benefit and costs only a fraction of what he was paying previously.
5) Lesson learned: Never assume a client is uninsurable. An unbiased underwriter can debunk a client’s misconceptions and assist with obtaining coverage at reasonable rates.
Our responsibility as insurance professionals is clear: We must advise our clients to make decisions based on their own circumstances, families and means. Our clients deserve the benefit of our breadth of knowledge about our complex and evolving industry, and we owe them a thorough and unbiased view of their options.
While these cautionary tales shed light on the complicated nature of different types of policies, the purpose of telling them is to empower clients and ensure they’re able to use the benefits of their investments. Satisfied clients who purchase and maintain proper coverage over a lifetime should be the norm, not the exception.