Managing Life Insurance Like a Pro

I often talk about “managing life insurance” and advisors occasionally ask me what that means or looks like. Fair question. There are multiple ways to manage life insurance, depending on what type of contract we’re talking about. Today I have a very simplistic and obvious example which is often overlooked.

The bottom line idea behind managing life insurance is the same as managing anything. To manage something is to handle it in a certain way, typically to improve results. We all try to improve the results of financial transactions by managing them, or hiring professionals to manage them, appropriately.

At the outset of a life insurance transaction, much attention is usually given to shopping the market and attaining the best underwriting result. After all, a more competitive premium is generally associated with a better return. Why then is this aspect of the transaction generally ignored after the policy is put in force? The premiums are systematically forwarded to the carrier and little attention is paid beyond that, too often with disastrous results due to the fact that few people understand how life insurance actually works.

It’s still a shock to too many policy owners and their advisors that dutifully remitting checks per the invoice does not necessarily go hand in hand with getting a death benefit. Premiums consumers believe to be supporting death benefits don’t always work that way, even when paid every year on time. However, blindly forwarding premiums actually does work for some types of life insurance contracts in the sense that the death benefit will ultimately be paid but there is a difference between a decent transaction and a great one. Following are a few examples of what I mean.

Example A: About a year or so ago, as I was chatting with the son of a client, I asked him how his mother was doing. Unfortunately she was not doing well at all and he didn’t expect her to be around much longer. Her life insurance policy was a “full pay” contract which meant the premium schedule was such that the premium needed to be paid every year for the policy to be guaranteed indefinitely. Upon hearing the news I ordered an in-force ledger assuming no additional premiums. What came back was a projection of the policy being guaranteed another decade without dropping a cent into it.

Think about it. He was doubtful that his mother would survive another year but he was also dutifully paying premiums as he reasonably assumed he should. In fact, knowing that his mother’s death was unfortunately imminent, he was specifically careful to make sure the premium was paid as though this was a term insurance policy. Had he understood that the contract would be fine for many years with no premiums and that paying the additional premiums would not enhance the death benefit by a dollar nor would ceasing premiums reduce the death benefit by a dollar, would he have paid them?

Example B: A couple years ago I received a call from a trustee regarding a policy where the premium was due but because of some liquidity issues it would likely be a few weeks late. Since I have beat into him that Guaranteed Universal Life (GUL) contracts can be very sensitive to premium timing he was justly concerned with jeopardizing the policy guarantees. I ordered a few in-force ledgers to judge the sensitivity of this particular contract. It turned out that the entire annual premium could be skipped and the life time guarantee would remain in effect. Why on earth would anyone pay a premium, all things being equal, if you would neither gain anything by paying it or lose anything by not paying it. Of course, not all contracts work this way but this one did and they are better off for it.

Example C: Last week I had a situation where an attorney called me because his client was asking him about the more than $50,000 annual premium she was paying for the $3,000,000 policy on her life. The client is 85 years old and the attorney informed me she is quite unhealthy and not expected to live many more years. In-force ledgers from the carrier show me that $53,000 is indeed required to guarantee the policy for life. $51,000 will guarantee it through age 110 but that is not much of a savings. $44,000 would guarantee it though age 105 and $24,000 would do so through age 100. Finally, no more premiums at all guarantees it for a dozen more years, through age 97.

It’s not my decision to say whether or not she should pay or not pay premiums. It is my job to bring to the table information such as this for the client, family and advisors to consider relative to managing the life insurance policy. Maybe they will not be willing to take the risk that mom will be gone by 97. They understand the situation much better than I do. We’ve since ordered ledgers showing no premiums for the next five years (saving over $250,000 for now) and then calculating for required premiums starting in year six to hold the policy to age 100 and 105 and 110. This gives us the chance to evaluate the bogey six years down the road to see what the back stop costs would be if it turns out mom is still alive and kicking and appears to be doing better than she is now and they want those guarantees back. In this situation, there are very few angles where it would make sense to pay the premiums for now.

In the policy I own on my own parents I pay only 50% of the required premium to guarantee it for life. That number holds the contract to actuarial life expectancy but I am also intimately familiar with the numbers required to keep it going if need be and when I would have to do so. Not everyone is capable and/or willing to manage a transaction this way but it it is possible, why not talk about it?

The savings could amount to hundreds of thousands of dollars which would tack hundreds of basis points to the ultimate return on some of these transactions. I’m not suggesting everyone start playing Russian roulette with their life insurance but blindly paying premiums into policies which are sustainable well beyond life expectancy with no additional contributions is going to be a smart play for some.

Finally, why do I title this piece “Managing Like a Pro?” Few manage life insurance more efficiently than the life settlement market. Once a funder purchases a policy, there is no sense put-ting more money into it than is necessary to obtain the death benefit. Of course, they may have a fund with large amounts of capital to throw at a policy if the insured on a given contract exceeds life expectancy and they have the benefit of dealing with the law of large numbers. Furthermore, they have ordered life expectancy calculations based on medical records and they may perform extensive policy modeling and stress testing but that doesn’t mean the typical consumer can’t emulate some aspects of astute management. By the way, modeling, testing and life expectancy calcs based on medical records are available to anyone if desired.

This is one reason life insurance companies hate the settlement market with a passion. The idea of someone managing a life insurance policy more effectively and efficiently than expected eats into their bottom line. I harken back to the adage “Those who don’t understand how the system works subsidize those who do”. Which side do you want to be on?

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