Aug 29 2008
Reasons To Replace An Existing Policy
REASONS TO REPLACE AN EXISTING POLICY
There are many reasons to consider replacing an older policy with a new one, including:
Secondary insurance company guarantees
One of the newer policy design features for universal life policies is the ability to have the carrier fully guarantee the death benefit based on a given premium structure. In recent years, many policies, particularly universal life policies, have seriously underperformed due to declining interest rates. These new carrier guarantees totally remove any fear that policy performance will be adversely affected by future changes in interest rates or mortality experience.
Loan treatment
Large policy loans often make it difficult to maintain policies on an affordable basis. Fortunately, under the Sec. 1035 rules for tax-free policy exchanges, loans can often be transferred on a favorable basis along with the cash value of an existing life insurance policy to a new life insurance policy on the same insured, as long as the owner of the new policy is also the same. More competitive plans
Whether it’s a TV, a computer, or an insurance policy, product improvements are inevitable, and prices tend to decrease with product innovations. With insurers cutting their expenses and distribution costs and making other pricing improvements, more competitive products, with lower costs and/or features and benefits not available on earlier plans, may now be available.
More underwriting classes
When universal life policies were introduced about 25 years ago, only two classes of standard underwriting were generally available: smoker and non-smoker. Since then, many new classes have been added for both smokers and non-smokers, ranging up to SuperPreferred. This means that healthy insureds can now often acquire much more attractively priced policies.
Company strength
One of the most important factors to consider is the strength and stability of the issuing life insurance company. This is particularly true with the new policies that have secondary carrier guarantees. The higher the rating of a company, the more likely it is that this company will keep its promises to policy owners. Ratings are reviewed annually by third parties and vary by criteria.
Special underwriting programs
If you are currently rated, and your current insurance company will not remove the rating, it is possible that you could qualify for a new policy under a special underwriting program under which rated cases up to a certain table rating, often Table 4, will automatically be issued standard. If your health has improved from a previous rating or is currently viewed more favorably, this type of program could be of significant benefit.
Life settlements
A life settlement is an innovative wealth and estate planning tool that involves the sale of an inforce life insurance policy in the secondary market, generally to institutional investors. It is typically used when the coverage is no longer needed or has become too expensive, or when a more attractive new policy is being obtained and the sale price is in excess of the policy’s cash value that could otherwise be rolled over in a Sec. 1035 tax-free exchange. In other words, a life settlement enables policyowners to get cash out of their policies in excess of the policies’ cash value (if any) while they are still alive. Convertible term policies on older insureds that would otherwise lapse are excellent candidates for life settlements.
Extended maturity
Many existing policies have an age 95 maturity date. When a policy matures, the policy cash values could become payable to the policyowner, and taxes could be due on any gain. If that occurs, the insurance contract will be deemed completed, and the face amount will not be paid. If you live to the maturity of a policy, another issue could arise related to loans. One of the real benefits of universal life policies is the ability to withdraw cash values up to cost basis tax free, then switch to loans, also tax free. However, if a policy lapses or matures with an outstanding loan, any previously untaxed gain that was received will become taxable. Paying income tax at that time could be devastating to a policyowner, as the taxes that are due could significantly exceed the net cash value received from the policy. This problem is avoided with some new policies that have no maturity date. They are designed to continue the death benefit as long as the insured lives. At age 100, most internal policy charges are often discontinued, but cash value (if any) continues to accumulate at the current interest rate. If loans exist, as long as there is a positive cash value, no tax will be due. At death, the net death benefit (face amount minus loans and withdrawals) is paid free of income taxes.
Legislative changes
We mentioned previously that recent legislative changes have adversely affected how certain policies or policy transactions are treated for income tax purposes. However, if a policy subject to the prior more favorable rules is exchanged to a newer plan pursuant to a Sec. 1035 tax-free exchange, the prior more favorable rules typically carry over into the new policy.
Underwriting pool
In pricing their policies, insurance companies include provisions in their mortality charges that reflect natural changes over the years in the overall health status of each pool of insureds underwritten at the same time. This leads to higher built-in mortality costs as the pool of insureds ages and becomes “stale”, for two reasons: (1) The insureds in the pool have become older, and (2) Their overall health has declined. Replacing a policy (in the same underwriting class) places you in a new “fresh” pool of healthy insureds, with corresponding lower mortality costs. In addition, improvements in medical science and the way insurance companies structure their policies can have a dramatic positive effect on the cost of insurance. As a result, many new policies have lower mortality charges leading to more favorable policy performance.
