By Bill Boersma
It’s not unusual for policy owners to have questions about their life insurance policies, even ones that might seem fairly straightforward to those of us who work with them every day. For example, someone might ask whether they can stop paying premiums, or if it’s more beneficial to continue. Others may wonder whether it makes sense to repay a policy loan. These are all very reasonable questions.
While the calculations involved are often fairly simple, the challenge usually lies in getting the right information. For the whole life policy example below, projections can be ordered in several ways: full pay, quick pay, offset, auto loan, reduced paid-up, dividends pay premiums, dividends reduce premiums, and so on. To make things trickier, different insurance carriers often use different terms. What one calls “full pay” might not be immediately clear to a policy owner, even though it’s familiar industry language to me.
Ultimately, I order policy projections a number of ways and run a financial analysis of each. What’s the return on the transactions independently and then what’s the return when I isolate the discretionary payment and compare it to the change in values? Maybe we want to see the difference resulting from paying the premium by surrendering dividends and paying the premiums by policy loans.
Here’s an example; a trustee has a client with a mutual life policy. The annual premium is about $50,000, and even though they can easily afford it, they are sick of paying it and didn’t pay a portion of the most recent premium. As a result, there’s a modest loan on the policy. The bottom line is the trustee wants to know the results of various actions. Is it better to pay or not to pay? Is it better to go reduced paid up or pay the premium with dividends and/or policy loans? Should we pay off the small loan? This table shows the results of paying premiums every year out of pocket and stopping all premiums and going reduced paid up (RPU).
We can focus separately on the cash value and the death benefit. When focusing on the cash value we see the returns are better with the RPU numbers. This is largely because we have more cash value supporting less death benefit, so the expense drag on the policy is lower. On the death benefit side, not going RPU is better in the near term and then it switches to the RPU transaction looking more attractive. Note the cash value and death benefit is obviously higher when the premiums continue, but the returns are independent of the size of the values. That was step one. What’s often more telling is isolating the spread in premium to the future spread in cash value and death benefit.
Now things get a little more clear. Here’s how to read the table. In the cash value column on the left, from age 80 through 85 we’re not paying about $50,000 a year but the cash value in five years is only $45,455 higher. That’s obviously a terrible deal. The numbers get less negative the further you go out, but they never get positive, let alone to a positive number that is attractive.
It’s a different story on the death benefit side. For the most part it’s also a bad deal to keep paying the premium and not go RPU unless you’re looking at the short term. In that case the near term death benefit is better. This is because the reduced RPU death benefit takes a big hit and it takes a number of years for it to catch up and become better.
The takeaway could be a simple as letting the advisor know that unless they want to plan for near term mortality, it’s better to stop premium and go reduced paid up. I’m not telling them to do, but the trustee knows if the insured is doing well and likely to be around for a while. It’s a different story if everyone would be surprised if the insured made it Christmas.
The next question is about paying off the loan.
The loan is $39,576. In this case the near-term cash value analysis is the only things that looks decent. Longer term is unattractive and everything on the death benefit side looks bad. Since the client has no intention of surrendering the policy, we don’t have to even consider the short-term cash value bump. This simple analysis shows us there is no benefit to paying off the loan, so they won’t.
There are additional calcs that can be done, such as paying premiums until dividends can take over, auto loaning the premium, etc. and they will all follow the same format; spread in premium over time compared to spread in cash value and death benefit in the future will highlight what’s a good deal and what isn’t. The determination will be relative to the details of that particular situation, including cash flow, what a reasonable value of money is and what timeline makes sense.
Wasn’t that simple? I’m being somewhat facetious, of course. Few policy owners have an idea of how to approach this or even how to get the data to do the calculations. When it’s understood, this is so much better than making a gut decision or a knee jerk reaction.
Bill Boersma is a CLU, AEP and LIC and the founder and owner of OC Consulting Group. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info or email at bill@oc-lic.com or call at 616-456-1000.
