The TOLI Handbook – Chapter 15: Understanding Life Expectancy Reports

In our last blog, we wrote about remediation and the challenges that TOLI trustees have when managing a policy.  Remediation is not just developing the best options for an under performing policy, increasingly it means maximizing the value of a policy that a grantor believes is no longer needed, or one whose expected funding has stopped. These decisions must be well-thought-out and every data point that can be gathered should be utilized in a process that prudently steers the choices made. Often the decisions made are not black and white, they are grey and while the outcome may not be controlled, the process can.

One tool that TOLI trustees need to become aware of is a life expectancy (LE) report.  It grew out of the life settlement market where investors needed to gauge the expected lifespan of an insured and the premium costs until a benefit will be paid to calculate a fair purchase price for a policy that would enable them to make a profit on the investment.

It also provides a great tool for TOLI trustees attempting to make decisions about the management of a policy. The underwriters at ITM TwentyFirst determine the life expectancy calculation based on age, gender, lifestyle, smoking status, family history and medical condition (underwriting factors) to create the LE report. The life expectancy report typically includes the life expectancy estimate and can include the probability of mortality each year based on the insured’s specific underwriting factors.  The best way to show the value of an LE report is through an example.

A trustee of a portfolio of three current assumption universal life (CAUL) policies totaling $10 million in death benefit has been informed by the grantor, a male, age 85, that no more gifting would occur to the trust. The trustee contacted the beneficiaries who informed the trustee they too were not interested in providing additional funding. The trustee was concerned about the possibility of policy lapses but wished to uphold his responsibility to maximize the benefit of the trust to the beneficiaries.

In force illustrations were obtained on all three policies assuming no further premium was going to be paid into the policies. In addition, a life expectancy report was obtained on the insured/grantor and the percentage chance the insured would be alive was plotted.  The information was summarized in the spreadsheet below.

ChartforBlog-8-15-2018

As seen in the spreadsheet, it was projected no premium would have to be paid on any of the policies until the 8th year when Policy #2, the $2 million policy would have to be funded. All the policies would be nominally funded, allowing policy cash value to run to near zero before funding the policies with a minimal amount to keep the policies in force. The last column shows an approximation of the percentage chance the insured would still be alive. The LE report obtained showed that the insured was expected to have passed away by the end of the 9th year. While the LE report is not precise, it can provide guidance, and in this situation, it gave the trustee comfort that, at least for now, nothing should be done to any of the policies in the trust.

Using an LE report adds a data point to a prudent process. The key to mitigating liability is in the process, not the outcome.  A great example of that is shown on page 127 of the TOLI Handbook, a 155-page guide for TOLI trustees and anyone dealing with life insurance.

To download your FREE PDF copy of the TOLI Handbook, go to www.TOLIHandbook.com.

TOLI Trustee Work Load and Liability Climbing as Use of ILITs Diminish

As the federal estate tax laws changed in the last year, the use of new irrevocable life insurance trusts (ILITs) diminished, but the work required to administer existing ILITs went up along with the potential liability attached to the asset class.  There are several reasons for this.

  • As a country, we are aging and the population of the average TOLI portfolio is aging too. For example, 25% of the insureds in policies we manage for TOLI trustees are above age 80, 6% are above age 90.  These demographic realities create decision-making dilemmas with policies, especially those that might be underfunded. Life insurance costs rise with age and problems also increase with age.  Longevity combined with poor policy performance makes policy management decisions more complex and the wrong decision can render a policy funded for a lifetime worthless or near worthless.  For example, there are 72,000 Americans over the age of 100 (1) when most older policies mature.  Unfortunately, the outcome at maturity is often not what you (and your clients) may expect. Many older policies mature for the cash value only, creating two issues.  If the policy contract matures with significant cash value, the proceeds could be subject to taxation. Or worse – the policy matures with minimal cash value leaving the trust with little value. There is an adage with life insurance, “I want to die with a dollar of cash value in my policy.”  Unfortunately, for some who live to maturity, a dollar is about all their beneficiaries get. Try explaining that to a beneficiary that has forgone thousands of dollars over the years by waiving their Crummey rights.
  • Products have not lived up to projections over the years and the problem is growing worse. The use of whole life, with its guarantees, has dropped while the use of universal life (UL) chassis products has increased.  Some UL policies have death benefit guarantees, but most are cash value dependent policies driven by policy performance, which has lagged.  And in the last few years, many carriers have raised the cost of insurance (COI) on policies, exacerbating the performance problem.  Policies with well-known carriers like Transamerica, Lincoln National, AXA, Banner, Genworth and John Hancock, and others, have had carrying costs raised by 200 percent and more, quickly dissipating policy cash value and placing trustees in a precarious situation as policies deteriorate.
  • Even those UL policies with guarantees can have issues. According to an industry expert, (2), a major guaranteed UL carrier performed an audit of policies issued in the 4 years since it started selling the product and found that, in that short timeframe, 31% of the policies already had compromised death benefit guarantees with the major culprit being early payments. Yes, paying early actually damaged policy guarantees putting trustees at risk.
  • The greatest increase in liability and workload for TOLI trustees will accelerate in the coming years as grantors decide they no longer need their policy because of changes in the estate tax law or wish to alter the asset in the trust. The process behind analyzing options besides simply surrendering or lapsing a policy is beyond the capabilities of many trustees and we have come across trustees who have surrendered multi-million-dollar assets with no analysis – a recipe for legal disaster.
  • Policy replacements are flourishing and the number of bad replacements coming into ITM TwentyFirst has increased in the last year. One bad replacement (see Case Study #6, page 146 in the TOLI Handbook) would have robbed the TOLI trust of $900,000 leaving the trustee liable if we had not intervened. Another bad replacement caused a prospect of ours (now a client) to write a 5-figure check to make the client whole because the new policy was inferior to the one it replaced.

It’s a dangerous time out there for TOLI trustees.  And it will not be improving but growing worse.  In the coming weeks, we will be providing some guidance to TOLI trustees.  In the meantime, for guidance now, you can download the free TOLI Handbook, a guide for trustees, regulators and fiduciaries dealing with TOLI policies.  It is available at www.TOLIHandbook.com.

 

  1. Worlds Centenarian Population Expected To Grow Eightfold By 2050, Renee Stepler, Pew Research Center, April 21, 2016, http://www.pewresearch.org/fact-tank/2016/04/21/worlds-centenarian-population-projected-to-grow-eightfold-by-2050/
  2. Bobby Samuelson, The Life Product Review, https://lifeproductreview.com

The Life Insurance Dividend Season (Continued)

In an earlier entry, we reported on the dividend declarations from two of the gold standard mutual insurance companies – Northwestern Mutual and Massachusetts Mutual. Both are very highly rated carriers, and have paid dividends each year for well over 100 years. However, like most insurance companies these days, both are feeling the effects of the historic low interest rate environment, and as a result, have reported lower dividend interest rates (DIR).

MassMutual’s reported DIR for 2018 is 6.40% – a drop from the 2017 rate of 6.70% (which was down from the 2016 DIR rate of 7.10%). Northwestern Mutual declared a 2018 dividend interest rate that dropped to 4.9% from the 2017 DIR rate of 5% (which was down from the 2016 DIR rate of 5.45%).

Since our last post, both New York Life and Guardian Life have reported their dividend interest rates.

New York Life reported a 2018 dividend payout of $1.78 billion, the largest in the history of the company and the 164th consecutive year of dividend payouts. The DIR rate for NY Life was 6.1% (which was down from their 2017 rate of 6.2%). In announcing the DIR drop, their first since 2012, New York Life referenced, “the continued historic low level of interest rates, which constrain our investment returns.”

Guardian Life, who has paid dividends each year since 1868, reported a $911 million dividend payout. The DIR for Guardian remained the same as it was in 2017- 5.85% (which was down from their 2016 rate of 6.05%).

So, for 2018, 3 of the 4 carriers mentioned lowered their DIR. It will take a while for portfolio returns to turn around for insurance carriers. Almost exactly 3 years ago we reported on the dividends for these same four carriers. In that entry, our visual was a battleship and the title referenced the fact that raising dividends is much like turning a battleship around. We featured a quote from the chairman of New York Life at the time, who noted, “The downward pressure on interest rates continues to be challenging for life insurers.”  In announcing the 2018 dividend, Roger Crandall, MassMutual Chairman, President and CEO, referenced the “backdrop of a prolonged low interest rate environment.” Not much has changed.

However, this week the Fed raised rates by a quarter of a percentage point to a range of 1.25 to 1.50 percent, its third rate hike this year, with its forecast of three additional rate increases in 2018 and 2019 unchanged.

Maybe by next year the battleship will really begin to turn around.

Trustee Alert: New Tax Law Changes (Simplifies) Tax Reporting On Life Settlement Sales

Back in May we wrote about the need for trustees to be aware of life settlements. A life settlement can provide a TOLI trust with more value than a policy surrender. The role of a TOLI trustee dictates that all assets are maximized – including “unwanted” life insurance policies.

In the past, tax reporting around a life settlement was onerous, primarily because of an IRS ruling enacted in 2009. IRS Ruling 2009-13 dictated that policy sellers reduce the cost basis in the policy sold by the cumulative cost of insurance charges incurred. The requirement was, at best, burdensome. Often it was impossible to comply with. Most carriers had difficulty providing the information, for some policies it was virtually impossible to compute the amount. The reduction in cost basis also increases the tax burden to the seller, reducing the net amount available to the trust and the beneficiaries.

The new tax bill, The Tax Cut and Jobs Act, in Section 13521, Clarification of Tax Basis of Life Insurance Contracts, reverses the IRS ruling, allowing for “proper adjustment” … for… “mortality, expense or other reasonable charges incurred under an annuity or life insurance contract”.

The taxation of a life settlement is now similar to the taxation of a policy surrender – with a twist since in a sale the policyholder is receiving an amount greater than just the cash surrender value. In a policy surrender, ordinary income tax rates apply to the amount received (cash surrender value) above cost basis. With a life settlement, the policyholder receives more than the cash surrender value and that amount is considered an “investment” taxed at capital gains rates.

Determining the taxation of a life settlement is now an easier three-step process. Let’s look at an example:LSTax.jpg

Assume a policy holder sold a policy and received $375,000. Further assume total premium paid (we will assume this is the cost basis for simplicity, as it usually is) was $100,000 and the policy had cash value of $125,000.

In the first step, you simply subtract the cost basis from the amount received to arrive at the total gain in the sale.

In Step #2, you determine the amount that is attributable to ordinary income tax rates by subtracting the cash value from the cost basis to arrive at the ordinary income received. In Step #3, to compute the capital gains amount you simply subtract the ordinary income amount in the second step from the total gain found in the first step. Note that if there is no cash value (a term policy, for example) the entire amount received would be taxable at capital gains rates.

The change in the tax code will simplify the tax computation of a policy sale and perhaps prompt more policyholders to investigate a life settlement. It will certainly make the transaction more profitable for those that do. In our example above, the policyholder received $375,000, with taxes due on $275,000 ($25,000 at ordinary rates, $250,00 at capital gains rates). If the policy in question had $50,000 in cost of insurance taken out, taxes would be due on $325,000 ($25,000 at ordinary rates, $300,000 at capital gains rates).

One final note…the effective date of the amendment was listed in the new bill for “transactions entered into after August 25, 2009,” which corresponds to the date of IRS Ruling 2009-13. Does this mean that those who may have paid higher taxes in the last eight years are in for a tax rebate? That part is not clear.

TRUSTEE ALERT- Why We Started An Affiliated Trust Owned Life Insurance (TOLI) Trust Company

On November 21, 2017, ITM TwentyFirst received a South Dakota charter for an affiliated trust company, the Life Insurance Trust Company, the first trust company focused solely on life insurance trusts.  On December 22, 2017 President Trump signed into law The Tax Cuts and Jobs Act with sweeping tax changes that included a doubling of the federal estate tax exemption amount to just over $11 million, lowering the number of estates affected annually by the federal estate tax from 5,000 to 1,700, less than 0.1 percent of all deaths (1).  Yet, we are extremely bullish about the prospects for our affiliated company.

The federal estate tax is fluid. It has been repealed four times only to reappear again.  If less than 100,000 voters had changed their votes in the last presidential election we could be looking at a $3.5 million exemption and a top estate tax rate of 65% (2).  News reports focused on the $1.7 trillion the tax bill will add to the federal deficit (3), but this is on top of the current $20 trillion dollars in debt ($170,000 per taxpayer) (4), and the additional $10 trillion that was already projected to be added to the debt over the next 10 years (5).

That much debt should raise interest costs. Interestingly, since 2008, while $8.4 trillion was added to the federal government debt, federal net interest costs incurred were near the lowest levels in 50 years (6).  That is going to change as the historically low interest rates rise.  It is projected that net interest costs will more than double in real terms and as a share of the economy over the next decade (7).  More government revenue will be needed, and if the political climate changes, the estate tax will be a target.  “We think there will be times when Congress is looking for new revenue sources, and this is a fairly easy one,” said one executive with a group that is a proponent of the estate tax (8).

But even if the political climate and federal estate tax situation does not deviate from the current, post Tax Cuts and Jobs Act climate, our affiliated trust company is still primed for success.

Life insurance, is at best, a cumbersome asset.  And ramping up internal resources – human and capital – to successfully manage an asset fraught with liability is a tougher business decision for financial institutions to make these days.  Some are looking for an opportunity to offload their life insurance trusts to a firm that will be a partner, not a competitor, and that is the business model that has been created at the Life Insurance Trust Company.  Managing life insurance trusts well without interest in the other assets a client may have, creates the perfect win/win scenario.  In some situations, a firm may wish to offload only those trusts with grantors that have no other relationship with the institution, so called orphan or stand-alone accounts.  The new company stands ready to accept only those trusts, leaving a more profitable ILIT business line.  For each situation, a tailored approach can be created.

Compliance managers at accounting and law firms whose members and partners have accepted the TOLI trustee role for clients are beginning to understand that the unchecked liability this creates is simply unacceptable with an asset such as life insurance.  A specialized trust company with robust individual and portfolio reporting provides a built-in tracking mechanism found nowhere else.

Financial and life insurance advisors looking for a home for life insurance trusts created over the years will find the advantages of this new trust company hard to pass up.  The life insurance experts servicing the Life Insurance Trust Company are advisor-friendly, and though the trust company bears a fiduciary duty solely to the beneficiary, its professionals understand that the success of the policy comes partly from working with the advisors in the field.  Another plus – advisors are provided with one of the most complete annual policy reviews available anywhere, alleviating them of this back-office expense, a welcome benefit for those advisors looking to downsize or reduce office expenses.

Life insurance trusts have many benefits besides tax advantages, including protection from creditors and the ability to control the passing of wealth to beneficiaries, important in those situations where spendthrift, mental illness or addiction issues may play a role.  But in the last few years, we have seen that the management of this asset may best be handled by an organization with specialized resources and talents.

For those who would like to learn more about the Life Insurance Trust Company, a special one hour webinar is planned for Tuesday, January 30th, 2018 at 2PM eastern.  To register, click here.

For more information about this new trust company, contact Leon Wessels, Director of Business Development, at 605.574.1703, or lwessels@lifeinsurancetrustco.com

 

 

  1. Howard Glickman, Tax Policy Center, December 6, 2017, http://www.taxpolicycenter.org/taxvox/only-1700-estates-would-owe-estate-tax-2018-under-tcja
  2. While President Trump won 290 electoral college votes, 70 electoral college votes were won by less than 1.5% of the vote, including; Wisconsin (10), Pennsylvania (2), Florida (29) and Minnesota (10). Michigan (16) and Vermont (3) were won by less than .4% of the vote.  Clinton proposed a $3.5 million estate tax exemption and a top tax rate of 65%, Hillary Clinton Proposes 65% Top Rate for Estate Tax, Wall Street Journal, Richard Rubin, September 22, 2016
  3. Congressional Budget Office, Estimated Deficits and Debt Under the Chairman’s Amendment in the Nature of a substitute to H.R. 1, the Tax Cuts and Jobs Act, https://www.cbo.gov/publication/53297
  4. org, amount as of 1/24/2018
  5. CBO’s January 2017 Budget and Economic Outlook, Committee for a Responsible Federal Budget, January 24, 2017
  6. Policy Basics: Deficits, Debt, and Interest, Center on Budget and Policy Priorities, August 29, 2017, https://www.cbpp.org/research/federal-budget/policy-basics-deficits-debt-and-interest
  7. Congressional Budget Office, The 2016 Long-Term Budget Outlook, July 12, 2016
  8. Death Tax Repeal In 2017?, Ashley Ebeling, Forbes, June 6, 2013.

John Hancock To Raise Cost Of Insurance (COI) On Performance Universal Life Policies

In February of last year, we reported on limitations placed on inforce illustrations for John Hancock Performance universal life policies. At that time, the carrier announced a “temporary” situation, saying they were unable to provide current inforce illustrations because “regulatory standards that govern illustration practices . . . prevent us from illustrating currently payable amounts based on our current non-guaranteed elements.”

In that report, we mentioned that in the past, the inability to provide inforce ledgers was often a precursor to a cost of insurance (COI) increase. It appears as if it was for John Hancock.

On January 18th, The Life Settlements Report, a trade publication, reported that John Hancock will be raising the cost of insurance (COI) on 1,700 Performance policies. The publication cited a representative of the New York Department of Financial Services, who confirmed that the carrier had provided “voluntary” notice to the regulatory body.

In September of 2017, we reported on a regulation approved in New York state that required carriers to notify the department “at least 120 days prior to an adverse change in non-guaranteed elements of an in-force life insurance policy.” Though the regulation has not gone into effect, the agency spokesman did confirm that the carrier provided notice, according to the earlier report.

Our New York City office was told that John Hancock is “expecting to have illustration availability in early 2018.” We manage approximately 200 of the 1,700 policies affected and as soon as we receive the information and analyze it, we will report on the size of the cost increase.

Another Insurance Executive Rings An Ominous Industry Bell Because Of Low Interest Rates

In the last few years we have written over 20 articles on the cost of insurance (COI) increases that have plagued the life insurance policies we manage.  The main reason for those increases?  Most would say the historic low interest rate environment that we are (still) in. In a post published just over a year ago, we listed some low rate winners and losers. When rates are historically low, the winners are the borrowers, the losers are the lenders…and who are bigger lenders than insurance companies?  They take in premium, invest it, and hopefully make enough to support future benefits. By regulation they must invest the vast majority of those premiums in fixed investments. It has been widely reported that the industry has been hurting, but this week in an article in the Financial Times, an industry executive took it a step further saying that because of “anemic” returns, the environment in the insurance industry is “unsustainable.”

Moody’s, in a report we wrote about back in December, downgraded the insurance industry for 2017 from Stable to Negative.  At that time, they cited the low interest rate environment as the main reason for the negative rating, and though much had been written about the Trump bump possibly helping raise interest rates, that has not really happened.  Moody’s believes the low rates will continue to “depress the sector’s investment returns and profitability” (1).

One of the first executives to speak out on the severity of the issue was Larry Fink,CEO of BlackRock, Inc., the world’s largest asset manager and biggest investor in insurance companies.  At a conference, Mr. Fink commented that the “persistent low rates” were “destroying the viability of insurance companies.”  He believes that there is not enough discussion of the negative effects that low rates have on “pension funds, retirees, savers and insurance companies” (2).

Mr. Fink’s comments are two years old and many believe the situation has worsened.  In the Financial Times article, Evan Greenberg, the head of Chubb, the world’s largest publicly traded insurer, said “the current environment is unsustainable over any reasonable period of time.” Because of the low rate environment, “many companies are not earning their cost of capital — and many are losing money, or will lose money in the future.” The article points out that the investment income for property and casualty insurers last year was $48 billion, which was $10 billion less than a decade ago.

The investment income drop has also affected life insurance. In an ITM TwentyFirst University webinar, we pointed out one carrier that was required by contract to credit their life insurance policies with a rate higher than the return on their investments. That carrier has raised the cost of insurance on many policies.

More cost of insurance increases are probably on the way if interest rates do not rise, but the more dire executive predictions will hopefully not occur.  The National Association of Insurance Commissioners (NAIC), in a posting on their website, noted that they are “actively monitoring the low interest rate environment” and though the low interest rates have created “spread compression on earnings, it did not materially impact life insurers’ solvency” (3).   Besides additional insurance rate increases, we will probably also see more movement and consolidation in the industry.

For those of us who manage life insurance policies for a living, these are trying times.  It looks like it may not be getting better anytime soon.

 

  1. Life Insurance – Global: 2017 Outlook – Low Interest Rates, Risk of High Volatility and Legislative Changes Turn Outlook to Negative, Moody’s Investors Service, December 5, 2016
  2. Low interest rate “destroying” insurance companies: BlackRock, Insurance Journal, April 21, 2015
  3. http://www.naic.org/cipr_topics/topic_low_interest_rates.htm