Take the TOLI Challenge: Only Permanent Life Insurance Policies Can Be Sold, True or False?

Earlier this year we started the TOLI Challenge with the question: What is most important when determining the liability of a trustee’s actions? Click here for that answer.  Today, we have a follow up true or false question.

Only permanent life insurance policies can be sold in the life settlement market, True or False?

It may surprise you that the answer is false – some term policies actually can be sold.  Term policies, without cash value, are most often surrendered back to the carriers for no value when, under the right circumstances, they can be sold into the secondary market, providing the trust with additional cash that can be passed down to the beneficiaries or used to fund other policies.

The key is whether the policy is still convertible.  As you may know, term policies can have a feature that allows the policies to be converted to a permanent policy with the same carrier at the same underwriting class but at the new age of the insured.  So, a term policy taken out on a 45-year-old insured ten years ago and initially underwritten as a preferred risk can be converted to a permanent policy at preferred rates for a 55-year-old – without the insured going through the underwriting process.

Most conversion options are for a limited period, or to a certain age, so you must check to see if the term policy conversion option is still available.  If it is, the policy may be marketable.

To see if it is, you will have to ask the carrier to provide you with a conversion illustration showing the premium requirements for the new permanent policy.  Once obtained, you can contact a life settlement broker who will review the policy costs and the health records of the insured to determine whether the policy is saleable and at what price.

Not only are convertible term policies often sold into the secondary market, they rank just behind current assumption universal life policies, as the most popular life settlement policies.  However, most TOLI trustees are unaware of this opportunity.  The fiduciary duty of a TOLI trustee includes maximizing the value of the asset in their trust – even a term policy that appears to have no value.

Canadian Court Rules on Life Insurance Investment Scheme

Back in November, we wrote about the possible “squashing” of “investors’ hopes for unlimited returns using life insurance.” At that time, the government of the Canadian province of Saskatchewan altered the regulations for a specific universal life insurance policy that some investors had hoped would be their pot of gold. However, the regulation change did not affect a court case that has since settled in favor of the insurance companies involved, including Manulife.

The policies in question were Canadian current assumption universal life policies that the investors felt set no limit on the amount of money that could be injected into the policies. Similar policies in the United States place restrictions on premium contributions.

According to a white paper we referred to in our earlier report, one of the policies in question had two cash accounts: a tax-exempt account and a taxable account. Cash placed in the tax-exempt account went to pay policy expenses, but an additional amount over and above that cost could also be contributed. Each year on the policy anniversary date, a test would be run, and any cash over a specific amount would be moved from the tax-exempt account to the taxable account to preserve the tax status of the policy. Both accounts guaranteed at least a 4% return (some other policies had up to a 5% guaranteed return), and the tax-exempt account paid an annual bonus of .85 percent on the policy’s anniversary date.

Investors, including private citizens, hedge funds and money managers, purchased policies hoping to take advantage of the guaranteed returns by placing millions into the policies. The outcome could have been catastrophic for the carriers, with a Manulife expert testifying that a $100 million deposit would cause “an immediate reported loss to the insurer in excess of $45 million,” according to the referenced white paper.

The Saskatchewan regulation change limited investors to contributing only an amount equal to the premiums required under the contract. Last week, a judge of the Court of Queen’s Bench of Saskatchewan agreed with the new regulation. According to a Wall Street Journal article, he stated in his ruling “that although the disputed policies didn’t set investment limits, the contracts were designed to restrict investments for such insurance related costs as taxes and fees.”  (1)

The judge did rule that the Saskatchewan amendment was not retroactive. The investor group plans to appeal the decision and according to the Wall Street Journal article, “the reversal of the retroactive claim means that if the investors are successful with future appeals of the ruling, the province can’t block their investments under the current act.”

Manulife issued a statement that the investment scheme was a “commercially absurd” use of the policies and that they were confident future appeals by the investors would fail.

We will report back with updates, as warranted.

  1. Canadian Insurers Win Court Battle Over Investment Strategy, Jacquie McNish, Wall Street Journal, March 18, 2019

Prudently Managing ILITs – It Is More Than Just Tracking a Policy

When we first ventured into the trust-owned life insurance (TOLI) servicing business, our lead product was a policy tracking and trust administration system – what is known today as InsuranceIQ, and it was light years ahead of anything TOLI trustees had at their disposal. At the time, most trustees simply got an in-force ledger every couple of years, along with a rating update for the carrier, placed it all in the trust file and moved on. When asked about the condition of the policy, few could provide an in-depth answer. InsuranceIQ changed that. A proprietary rating system now alerted the trustee to issues with the policy and provided information on the (new) premium needed for under-performing policies to reach their goal. The InsuranceIQ annual report provided most trustees with their first systematized review of their portfolio.

Traditional ILIT support software solutions, even our own Standard InsuranceIQ Solution, as well as our competitors’ “policy review” products, do little to mitigate risk effectively. Granted, they can help minimize potential administrative miscues, and housing portfolio information in a centralized location is certainly a step up from past practices. But, you could argue that all you have done with a policy review is gather potentially liable policy information in a form that is easier to access. Annual policy reviews designed to “check the box” for audit and regulatory compliance purposes that were a viable option in the early 2000s to appease regulators do not solve policy problems or mitigate the liability associated with managing this unique asset. That is why many corporate trustees now realize handling the complexities of life insurance takes more than a policy reviewit takes expertise and significant internal resources above and beyond software. Maintaining the required expertise in-house and dedicating the necessary resources internally, for an asset class that is revenue neutral at best, is nearly impossible.

Over the last few years, there have been dramatic changes in the TOLI marketplace. Cost of insurance increases from mainstream carriers like Transamerica, Voya, John Hancock, Lincoln National, and others have more than doubled the carrying costs in some policies. You may be able to show that in a policy review to your client, but how will you deal with the policy?

We have written about new policy illustration schemes that take a 6.75% illustrated rate and turn it into a 9% internal rate of return by adding bonuses and multipliers that are not guaranteed. Your policy review may have projected a successful outcome, but if it was based on faulty or misunderstood information, what good is it?

Unless you have experts on hand who can correctly analyze a policy and deal with policy issues as they arise, you will not be able to effectively maximize the value of the asset, which is your duty. You will only be able to document that the problem occurred. Taking the next step beyond policy review  –  remediation  –  is required, and it is what sets ITM TwentyFirst apart from the policy review competition. Our Managed Solution product provides trustees with life insurance experts who analyze and develop succinct solutions to policy problems and document the trust file to help mitigate your risk.

Our remediation team does not just deal with problem policies but provides insight for any policy changes. Let’s say your client wants to lower the death benefit because of estate tax law changes; does your staff have a process in place that maximizes the value of the policy? If your client wanted to surrender their policy because they believe they no longer need it, does your staff have the capability to show that client the value of their policy – potentially keeping that policy and trust in place? Our team does.

For many enlightened TOLI trustees, the Managed Solution provides the perfect alternative. It allows them to raise client service levels and to mitigate liability for a fixed price that is often less than the cost of doing the work in-house.

Your best business decision in 2019 starts by contacting ITM TwentyFirst. Call John Barkhurst today at 319.504.1581, or email him at jbarkhurst@ITM21st.com to get started.

Life Insurance Premium Financing, a South Dakota Trust and the Life Insurance Trust Company – A Perfect Combination

Life insurance premium financing is a specialized strategy that has gained favor in recent years for high net worth individuals looking to purchase large life insurance policies without tapping their personal or business cash flow.  For these qualified wealthy individuals, the retained capital that would go to pay a premium can be better utilized for investment opportunities they believe will outperform the cost of the third-party financing.

Prospects for these strategies include privately held business owners, corporate executives, hedge fund managers and private equity executives, real estate owners, entrepreneurs, and successful physicians – all working with specialized life insurance advisors in conjunction with insurance carriers that have developed products tailored to the strategy.

To date, there has not been a trust company that specialized in life insurance, including premium financed policies – but now there is.  ITM TwentyFirst, the largest manager of life insurance for trustees and institutions nationwide, has created an affiliated South Dakota-based trust company that focuses exclusively on life insurance. Though the trust company does not provide any financing themselves, it does provide the premium financing market with a logical option for housing premium financed policies.

South Dakota has long been a superior trust situs – ranked as one of the best places to house a trust in the US year after year by leading trust and estate planning publications. South Dakota has the lowest insurance premium tax of any state – 8 basis points.  It prides itself on client confidentiality and does not require trust documents to be filed publicly.  The legislators are cooperative and proactive toward trusts and have levied no state income taxes on trust assets, and state legal statutes allow for the trust creators to direct the trust company to follow the investment decisions of an outside advisor, making the life insurance professional part of the process.

The Life Insurance Trust Company is the perfect company to work with.  Started as an affiliated company of one of the country’s most highly regarded life insurance policy managers, the firm focuses exclusively on life insurance, with no eye toward acquiring other assets.  By utilizing the services of its parent company, the trust company provides expert trust administrators and life insurance specialists that work daily with tens of thousands of policies – this is not a side asset for the company – it is their daily work.  And it shows in the level of services provided.

The staff at Life Insurance Trust Company knows the trust business and understands the life insurance business – many come from that industry.  It is extremely advisor friendly and will work with you to ensure that your clients and their beneficiaries maximize the value of the policy in their trust.

Premium financing is a specialized strategy.  It just makes sense that you partner with a specialized company skilled in the management of life insurance as an asset class.   For more information, contact Leon Wessels, Corporate Business Development Manager, at 605.574.1703 or lwessels@lifeinsurancetrustco.com.

How Whole Life Dividends Are Calculated

Near the end of last year we posted a blog reporting the 2019 dividend payouts for the big four mutual companies, all whose primary product line is whole life insurance. Dividends are a return of premium when carrier results exceed a very conservative projection for investments, income, and expenses.  Dividends are paid annually on participating whole life insurance and determined at the discretion of the board of directors.  They are paid in addition to the guaranteed cash values in the policy, but the dividends themselves are not guaranteed and will fluctuate. Over the last twenty to thirty years dividends have trended downward causing many whole life policies to underperform relative to expectations at policy issue.  The primary driver of this decline in dividends has been the drop in the dividend interest rate or DIR, the investment component of the dividend, but the dividend itself is based on the performance of three parts.

Investment Results: The interest rate portion of the dividend, the DIR, is based on the actual rate of return generated from the investment portfolio.  The cash value of a whole life policy is invested primarily in fixed instruments, a typical breakdown for the investments might be:

  • Bonds: 70%
  • Mortgages: 12%
  • Policy Loans: 4%
  • Cash and Short Term: 4%
  • Stocks: 4%
  • Real Estate: 1%
  • Other Assets: 5%

Over the last few years with low-interest rates affecting investment decisions, carriers have become a bit more aggressive in their investing style, but regulations limit the investment that can be made in equities.  Some carriers have developed venture capital investments in companies that can help them compete in the changing technology environment.  Investment returns are still driven by fixed investments that have lagged, and it is hoped that with current higher fixed market returns, carrier investments will trend upward.

Mortality: Carriers make conservative assumptions about the underwriting risks in their whole life policies.  The mortality most carriers experience is less costly – meaning there are fewer death claims than projected.  When this occurs, the dividend is affected positively.

Operating Expenses: Operating expenses of a carrier are reasonably easy to predict and include overhead and marketing expenses, including commissions and underwriting costs.  But as with mortality charges, the carriers make conservative assumptions about them, and when the operating costs are less than expected, the savings accrue to the dividend paid to the policyholder.

Dividends paid on a particular policy will be affected by the cash value in the policy, whether the policy has a loan and whether out of pocket premiums are still being paid on the policy. In general, a loan-free, premium-paying policy will have the highest dividend payments, all else equal.

The actual dividend paid will have a dramatic effect on the performance of a whole life policy and should be tracked annually especially if dividends will be or are currently being used to pay a premium.  Out of pocket premium expectations may have to be adjusted based on the actual dividends paid. 

Trustees of ILITs should monitor carrier dividends as part of the policy management process.

The Big Four Carriers Announce Their Dividends for 2019

For the last few years, we have tracked the dividends paid by four large mutual carriers whose main product offering is whole life.  These carriers are owned by their policyholders, not stockholders and operate with a long-term business view. Unlike most life insurance carriers, they sell their products through a career agency system – a dying breed.  Their dividend rate and payments are a major marketing tool for their agents and dropping dividends is never a major selling point.  But in the last decade, even they succumbed to the historic low-interest rate environment and dividends trended downward.  

The big four carriers we have tracked – Northwestern Mutual, Mass Mutual, Guardian Life, and New York Life expect higher dividend payouts for 2019. 

  • Northwestern Mutual: Will pay out $5.6 billion, up from $5.3 billion in 2018
  • Mass Mutual: Will pay out $1.72 billion, up from $1.6 billion in 2018
  • Guardian Life: Will pay out $978 million, up from $911 million in 2018
  • New York Life: $1.8 billion, up from $1.78 billion in 2018

All four carriers appear to have held or raised dividend investment rates (DIR), with none dropping, a good sign.  The DIR drives the actual dividend amount paid.  

  • Northwestern Mutual: At 5%, up from 4.9% in 2018
  • Mass Mutual: Stays at 6.4%, as in 2018
  • Guardian Life: Stays at 5.85% where it has been since 2017
  • New York Life: Although they have not released yet, it appears to stay at 6.2%, where it has been since 2015

Overall, the dividend direction is positive.  We will not be seeing the 8% plus dividends of the 90s or early 2000s, but the worst seems to be over with dividend interest rates heading up, not down.  And that is a reassuring sign for those of us who manage whole life policies. 

In a future blog, we will review the components that makeup and drive the dividend calculation.

Trustee Alert: Don’t Be a Casualty of the Life Insurance Illustration War

In the 1980s when current assumption universal life (CAUL) hit the market, sales illustrations were created showing cash value returns of 10% and more every year – for a product that was invested in fixed instruments.  When equity markets soared and variable universal life (VUL) became the rage, many sales illustrations projected 12% returns – again, every year.

Life insurance illustrations are at best a guide – they do not guarantee the future, they are based on hoped-for returns which do not occur as projected.  All else equal, in a universal life chassis without secondary guarantees, the higher the rate of return assumption, the lower the premium that has to be shown in a sales illustration to carry the policy to maturity (or some other goal).

The premium shown in a sales illustration is not the cost of the policy – costs are shown on the expense page of the illustration.  An unreasonably high return assumption can easily hide higher policy charges.  Why?  Because over the lifetime of the policy, the highest expense is typically the monthly deduction for the cost of insurance – the mortality charges.  Those charges are based not on the death benefit, but on the net amount at risk, which is the difference between the death benefit and the cash value. (For a more detailed explanation of net amount at risk, go to Chapter 6 of the TOLI Handbook, available as a free download here.)  As the cash value climbs, the net amount at risk drops and the actual charges deducted drop.  A high assumed rate of return creates a double-edged cycle – a higher return creates higher cash value which lowers costs which creates higher cash values.  A perfect situation – for a disaster.

The CAUL policies issued in the 80s and into the 90s with unreasonable returns crashed and burned with policy lapses that fueled the rise the rise of secondary death benefit policies, guaranteed universal life (GUL).  The 12% returns of VUL policies did not hold up either and after the market crash of 2007-08, many people fled to equity indexed universal life (EIUL). These were considered more “conservative” because while the returns were tied to an equity index, an interest rate floor – typically 0%, limited the downside – “you could not lose money” with this product. (Note that even though the investment component may not be negative, policy charges still accrue so cash value does drop.)

The policy also has a limit on the upside, called the cap, set by the carrier.  A policy with a cap of 10%, which is typical, means that any returns over 10% will be lost.  This is one reason that the rate of return assumption in EIUL policies is tricky to project.  When we first started seeing these policies, the assumed crediting rate in sales illustrations was well above 7%, often approaching 8%.  Now with regulation AG 49 in force, sales (and in-force) illustrations are limited to a maximum return of around 7%.  One carrier has created an online tool that translates the actual return in an index, like the S&P 500, into the crediting rate applied to the policy.  For example, assuming a 10% cap and 0% floor, to credit a policy with a 7% rate, the actual return in the S&P 500 would have to be between 10 and 11 percent.

However, there is more.  Regulation AG 49 capped the rate of return that could be shown in the policy, but it did not stop the use of various interest bonuses and multipliers that might not be seen or understood in an illustration.  We are in the midst of an illustration war with carriers determined to create products that illustrate better in a sales situation.  According to one life insurance expert, these AG 49 compliant illustrations can take a “6.75% illustrated rate” and “generate a 9% illustrated internal rate of return on cash value.” (1) The industry is turning lead into gold.

Unfortunately for the TOLI trustee taking in a new policy, this creates issues. As a fiduciary, you must make sure that the assumptions on the asset in the trust are reasonable.  As a business person, you must make sure your clients are not disappointed by policy performance – when the policy crashes, it will be your problem.

So what is the answer?  First, have skilled life insurance professionals on staff.  An untrained administrator will not be able to decipher today’s sophisticated products.  If you do not have skilled staff – find them or outsource the service.

Second, do not accept policies with assumptions you deem unreasonable.  Hopefully the current crediting rates on new current assumption policies and dividends on whole life policies are bottoming out, and rates will be rising – a plus.

For variable universal life policies, review the asset allocation and develop a conservative assumption for the expected returns.  If you think 8% is reasonable in an equity-rich allocation, also show the outcome at 5.5% or 6%.  If a more balanced allocation generates an assumed return of 7%, also show 4.5% or 5%. Show the clients the downside funding needs, you will be glad you did.

For equity index UL policies, get an illustration assuming a crediting rate of 5% along with the 6-7% return that is usually shown.  And make sure you (and your grantors) understand the bells and whistles of the policy. (See Chapter 10 of the TOLI Handbook for a thorough discussion of the equity index UL policy.)

Document the higher carrying costs that come with a lower return assumption and have the client sign a document acknowledging those additional costs and make that a part of your trust file.

Generate a report annually that shows the current condition of the policy and any premium changes that should occur to keep the policy on track.

Do not assume the aggressive assumptions made by salespeople to lower the projected premium and increase the chance of a sale will actually occur.  Your job is not to sell a policy – it is to deliver a death benefit.

Be careful out there.

  1. Voya ICAR & The Indexed UL Illustration War, Bobby Samuelson, The Life Product Review, October 11, 2018