by Peter C. Katt, CFP®, LIC
Peter C. Katt, CFP®, LIC, is a fee-only life insurance
adviser and sole proprietor of Katt & Company in Kalamazoo,
Michigan. His Web site is www.peterkatt.com.
Although the estate tax (as of January) is in hibernation for
the year, it will awaken in 2011. Large estates with difficult to
market assets face a potential estate tax liquidity problem. Life
insurance is ideal for this situation. (For a complete discussion
of estate planning life insurance issues, see my November 2008
column in the Journal of Financial Planning.) There are
two excellent liquidity life insurance options. Each has different
potential advantages and disadvantages. These differences are not
benign. They are potentially huge and depend on future events.
Helping clients and advisers understand the differences is
important so an informed choice can be made. In my experience, most
insurance agents only recommend the no-lapse universal life (with
lifetime guarantee) choice. This is a mistake. The following case
study explains the two options and the differences.
The client, 57 and single, has a $15 million estate represented by
a fractional interest in real estate. Although the estate tax is in
flux, it is believed that a credit equivalent of $3.5 million and
45 percent tax rate will emerge. Based on this, her estate tax is
$5 million. This is the life insurance amount covered in this case
study. The client is in excellent health and I assume she can
qualify for preferred underwriting.
Of many options two are the most reasonable to consider. One of
them I refer to as static-priced universal life (UL), and the other
market-priced UL.
A few years ago, many life insurance companies developed and began
selling universal life (UL) policies with no-lapse secondary
guarantees based on paying specified premiums. I refer to these
no-lapse policies as static priced. The premiums and death benefits
are guaranteed—what you buy is what you get. We
can think of this as term insurance for life.
Static pricing is in stark contrast to market pricing. A
market priced policy's performance (and premiums) will depend on
future fixed-income yields and mortality experience. Static-priced
policies have low to no cash values, whereas market-priced policies
have robust cash values.
Static-Priced UL—Acme Life
My review of static-priced policies indicates that Acme Life has good pricing relative to financial strength. A $5 million policy has guaranteed annual premiums of $52,827 paid every year. As with term insurance this is a simple deal—pay the $52,827 and $5 million death benefits are guaranteed lifetime. As noted below the cash values are low to zero compared with the market-priced alternative.
Table 1 shows Acme Life's financial strength ratings.
Market-Priced UL—Premier Life
I believe the best option for market-priced UL is a low-expense Premier Life policy. The target premium for $5 million coverage from Premier Life will change as the crediting rate changes. Based on the current 5.6 percent rate, the target premiums are $65,359. I have estimated the target premiums based on various average crediting rates, shown in Table 2.
You will note that if Premier Life's crediting rate averages less
than about 7.1 percent, the target premium will exceed Acme Life's
static-priced guaranteed premium of $52,827.
Table 3 shows Premier Life's financial strength ratings.
Cash Value Difference
Static-priced policies have little to zero cash values. In contrast, market-priced policies have robust cash values. There is a tremendous liquidity difference between the Acme Life static-priced and Premier Life market-priced options. Table 4 shows the cash value difference. The premiums for Acme Life are $52,827 and $65,359 for Premier Life.
Conclusion
This report demonstrates that there aren't right and wrong ways to buy life insurance. Each option has potential advantages and disadvantages. Some clients have a significant preference for one approach and would make their entire purchase in that manner. Others have split preferences and would mix the purchase among them.
- If you believe that fixed income yields will remain low for an extended period and cash value liquidity isn't important, Acme Life is the better choice.
- If you believe that fixed income yields will go up on a sustained basis and/or cash value liquidity is important, Premier Life is the better choice.
- I believe that maximum cash value liquidity is a very important characteristic of life insurance.
I am very comfortable that this client and her advisers know the important differences between static- and market-priced UL. I am also satisfied regardless of the decision that is made for the purchase of this liquidity life insurance.
