Isn't it interesting how hindsight helps us seem smarter? I've often reflected on life insurance sales ideas that have come and gone. Many had an IRC Code section number attached to them -- as if that alone would legitimize them -- since they tried to exploit a tax loophole.
In my imagination, I see a run-down office building south of San Diego filled with accountants poring endlessly over the tax code for loopholes that will allow life insurance producers to sell more policies -- at least for a while! As the "latest and greatest" ideas emerge, they usually create a big splash up the West Coast. Then they leap to the East Coast and gain more favor. Finally, they reach the Midwest, by which time the IRS has red-flagged some of them. But, that's OK -- a new batch of ideas is probably making its way across the country at this very moment.
The newest brainchild on the scene is stranger-owned and investor-owned life insurance, or SOLI/IOLI, in which policies are sold to investors who have no insurable interest in the insured person. However, through the ownership transfer by sale, they suddenly have a financial interest in the insured's death! This concept goes against everything we've ever learned about how life insurance ought to work.
Among the ideas that died an early death, "vanishing premium" caught our imagination for a few years. Producers and home office marketers alike loved the idea. Such was our blinding optimism that we convinced ourselves the high dividends (or interest rates) of the 1980s would continue unabated and allow policyholders eventually to suspend their premiums forever.
Which leads me to my current concern. Building client expectations about outcomes based on a life insurance illustration's non-guaranteed performance characteristics, however appealing, is at best risky, and sometimes ethically wrong. At worst, it becomes fodder for future lawsuits. The way universal life is illustrated and sold is a case in point.
Without question, flexibility is the hallmark of the UL policy. Ironically, because of that same wonderful UL characteristic, I can easily foresee lawsuits involving senior clients. Widespread marketing of UL as a means to generate both lifetime supplemental income (without annuitizing cash values), and death benefits to accomplish the wealth transfer goals, in one policy, could become the figurative "elephant in the living room" from a legal/compliance perspective. Death benefits and lifetime income have long been antithetical ideas.
As marketed, the retirement income will come from systematic annual tax-favored withdrawals of a set amount down to the basis of premiums paid in. Then, the policyholder will take policy loans to provide "tax-free" income. Of course, the withdrawals and loans will reduce the death benefits. Yet the illustrations I've seen show large net death benefits being maintained, and even growing.
The tax advantages of a life insurance policy are real and valuable -- and marketable. Affluent people are particularly attuned to leveraging tax advantages, but as such, they may also be seduced by illustrations showing them how they can gain more tax advantages than may be realistic.
Notwithstanding NAIC-mandated footnotes galore, have we become deluded once again by the power of an illustration? In the past, we learned that illustrations that looked too good to be true usually were. Remember the maxim: those who fail to learn from history are doomed to repeat it. We'll find out soon enough if the UL policies owned by seniors have been funded properly to do all the things expected, based on implied but non-guaranteed factors in illustrations.
A small change in an illustration assumption -- premium payments, interest rate fluctuations, differences in the timing of money received and credited, differences in crediting methods, periodic partial withdrawals or loans -- can create a new performance reality and render useless the original illustration on which a UL purchase (or any policy for that matter) may have been based.
Illustrations involving systematic partial withdrawals, followed by policy loans, assume the policyholder will pay all interest charges on the escalating loan. Because it's growing, that interest charge diminishes the actual income value of each subsequent loan, and finally exceeds it. And beware: If and when those policies collapse, leading to lapse, a large tax bill will come due on the policy's gain. Valuable life insurance benefits that might still be needed could be irretrievably lost, too.
Imagine an 87-year-old whose policy has lapsed, and who now faces a large income tax bill. He also no longer possesses life insurance protection still needed for wealth transfer purposes. Can you imagine his outrage, even if his inattention or inaction is partly responsible for his plight? It wouldn't take the sharpest attorney to present a sympathetic case on his behalf, charging exploitation by that nasty insurance company. And here comes a six- or seven-figure lawsuit.
Of course, if heavily loaned policies are managed properly by both the policyholder and the agent, they could stay in force until the insured dies. But we should not underestimate the possible consequences of aging -- memory loss or diminished mental capacity. Older people may forget why they made decisions years earlier; insurance agents retire and die; and no one may be available to help manage the UL policy properly in the later years.
At some point, some UL policyowners may refuse to pay, or be unable to pay the interest on the policy loans. Within a few years, their policies likely would collapse. Further, a son or daughter managing the financial affairs of an aged parent, under a power of attorney, might not understand what has happened to the policy, much less what's supposed to happen next.
So what's the alternative? To accomplish these two seemingly antithetical ends -- death benefits and lifetime income -- I'd recommend that you sell two UL policies: one with the highest possible death benefit, at an affordable and sustainable premium, to meet the wealth preservation needs; and the other for strong long-term cash value accumulation to meet future income needs. Don't confuse the purpose of the two policies, so that your client won't, either.
Your client can annuitize the latter policy through settlement options for guaranteed income, on one or two lives, that he or she cannot outlive. Some of each income payment will be taxable, but there should be no disastrous surprises for your client in the future.
Most of us dislike doom and gloom projections, but these cautionary notes are worth your serious consideration, in case you see a distant elephant moving closer.
Larry L. Cox, CLU, president of Cox Insurance Marketing Solutions, has been in the life insurance business for 34 years. In the field, Cox was an agent and agency sales manager; and in several home offices, he served as director of training, field development, product marketing, marketing services, and marketing communications. He now writes for insurance and financial services companies. He can be reached at larrycox@metrocast.net.
