Life Insurance Policy Valuations
New Challenges Bring New Opportunities
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Client or Advisor would contact the insurance carrier
Ask for policy value
A week later they would receive it
ITR (Interpolated Terminal Reserve)
Increase in Types of Policies
Increase in Regulation of owners
Disclosure and Tracking
Old IRS Regulations are not as relevant
State Law differences
Why Do We Care?
The marketplace is huge
American families have more than $19.3 trillion worth of life insurance
protection through individual policies and group certificates.
146 million individual life insurance policies were in force at the end of 2012.
Of the new individual policies issued in that year, 64 percent were
permanent life insurance policies.
Sixty-two percent of all people in the United States were covered by some
type of life insurance in 2013, according to LIMRA’s 2014 Insurance
Income Tax purposes
Transfer Tax purposes
Generation Skipping Tax
Life Insurance Evolution
This is a pure death benefit without cash value. The policy is renewable annually without proof of insurability. The premium increases each year with age based on underwriting classification. These policies normally have a right to convert to
permanent life insurance without proof of insurability.
The carrier guarantees a fixed term premium over a period of time in blocks of five years up to 30 years depending on the age of the insured. Since the premium is
fixed, it is generally higher than an annual renewable term premium in the early years of the level term. These policies usually have a conversion to permanent life
insurance feature without proof of insurability. Even if renewable at the end of the term, the premium for the renewed policy will be significantly higher.
This employer provided insurance is available to a group of employees without proof of insurability. The first $50,000 of employer provided coverage is income tax free to the employee. Any excess coverage is generally taxed to the employee using the Table I rates in the regulations.
Permanent Life Insurance
Current Assumption Universal Life (Traditional)
Indexed Universal Life
Variable Universal Life
Guaranteed Universal Life Policies
Single Premium/Limited Pay Policies
Pay for life
Whole Life Insurance
The premium is fixed for the life of the insured and the death benefit is guaranteed if the premiums are paid (either by the owner, policy dividends or cash value loans). A minimum cash value growth is also guaranteed. The cash value growth is low in the initial policy years in order for the carrier to recover its front-end expenses in case the policy owner surrenders the policy or lets it lapse.
Thus the carrier assumes the mortality, investment return (for the guaranteed cash value), expense and lapse risks of the policy. As a result, in setting the premium, the carrier makes very conservative estimates in determining the risks. If the policy
performance exceeds the conservative estimates, the cash values may exceed the guarantee and mutual carriers may pay dividends and the stock carriers may credit for larger policies, additional interest to the policy account values. Dividends and interest sensitive payments are not guaranteed.
Death benefit is normally fixed at the date of policy purchase. However, the death benefit may increase without proof of insurability through purchase of paid up
additions with policy dividends or the exercise of a guaranteed purchase option rider added to the contract.
Current Assumption UL
Current Assumption Universal Life (Traditional)
It is a general account subject to carrier creditors.
These are called flexible premium policies. The owner may pay any amount of premium, may change the amount paid or even skip premium payments for some years. The owner normally sets a target premium payment designed to keep the policy in force during the insured's lifetime but it can be changed. The death benefit is adjustable within limits.
The annual premium payment is placed into the policy cash value account with the annual expenses, premium taxes and mortality charges being deducted. The carrier will credit current interest to the cash value annually: universal life policies generally do not pay dividends since the cash value reflects all charges, expenses, premium payments and interest credits.
The carrier will guarantee the death benefits only as long as the cash value is able to pay the
mortality and other charges and policy expenses. The cash value is not guaranteed but the
carrier normally guarantees a minimum interest credit to the cash value. There are several types of death benefit options for universal life policies.
(i) Option A-level death benefit regardless of size of cash value or premium payment.
However, the death benefit can be increased in order to meet the definition of life insurance contract under IRC Section 7702.
(ii) Option B-the death benefit is the initial death benefit plus the cash value. Since the pure death benefit remains fixed, the mortality charge will increase as the insured ages.
(iii) Option C-the death benefit is the initial death benefit plus the aggregate amount of premiums paid on the policy.
Indexed Universal Life
Indexed Universal Life
These are the same as traditional universal life policies except that all or part of the cash value may be invested in indexed equity funds (DOW, S&P, NASDAQ) subject to a floor on losses, a ceiling on gains and participation rate equal to a percent of growth rate. Indexed policies are between traditional and variable policies since they have some investment exposure. There is no minimum guaranteed interest credit.
Variable Universal Life
Variable Universal Life
These are traditional universal life policies but the owner is able to invest the cash value in investment funds made available by the carrier including bonds, equities, money markets, etc. These are securities for SEC purposes.
Any cash value invested in investment funds offered by the carrier are separate
accounts from the general account of the carrier and therefore are protected from the carrier's creditors. Because of the insurance policy wrapper, any sales and
reinvestments of the separate accounts are free from income tax at the time of the sale or reinvestment.
To the extent invested in these separate accounts, there is no minimum guaranteed interest credit to the cash value by the carrier.
Variable universal life has the potential advantage of a greater return on the
investment but it is also potentially the most volatile of the cash value investments. All investment risk is shifted to the owner.
Whole life variable policies are also available but they are not as popular as the more flexible variable universal life policies. A variable whole life has fixed premiums,
Guaranteed Universal Life
These are universal life policies where the carrier guarantees the death benefit if the agreed annual premiums are timely paid. If the premium payments are not timely paid, the secondary guarantee of the death benefit is lost. There is no flexibility of premium payments.
These policies are for owners who are more interested in the death benefit than the cash value build up. The premium is lower than for traditional universal life policies but there is little or no cash value available at surrender. There is no carrier
guarantee of a minimum interest credit to the cash value. Some policies avoid loss of guarantee by catch-up premium payments or a positive shadow account. Loans or withdraws are either prohibited or limited because of small cash value.
If the annual premium is timely paid, the carrier assumes all of the risks of mortality charges, expenses, and investment return.
General Rules for Gift Tax
Willing Buyer/Willing Seller
Actual Sale or Comparable Contract Rule
What if these don’t exist or aren’t readily
Gift Tax–What if?
When actual sale or comparable contract is not available
A. Value of a brand new policy
Initial cost or premiums paid
B. Value of a limited pay policy or single premium
New single premium cost for similar coverage (Reg. Section 25.2512-6)
Cash value or Interpolated terminal reserve (ITR) if higher than
C. Value of a policy in-force with future premiums
Interpolated terminal reserve
D. Value of existing Term policy
What is it?
A. An amount designated by the insurer to fulfill its
obligations under the contract
B. It is determined by making pro rata adjustment
upward between the previous terminal reserve and
the next terminal reserve
C. Designed for Whole Life insurance policies
D. Several different reserves for Universal Life policies
Female, age 64
$6.2 million policy death benefit
Guaranteed Universal Life Policy
Policy has been in-force for 6 Years
$840,000 paid in premium ($140k a year)
Just bought a new $7 million death benefit policy for annual premium $170k
Male, age 48
$5 million policy death benefit
20 Year Term policy
Policy has been in-force for 4 Years
$32,000 paid in premium ($8k a year)
Secondary MarketOLD WAY FAIRLY OLD WAY RELATIVELY NEW WAY LAPSE SURRENDER LIFE SETTLEMENT
THE LIFE SETTLEMENT
Discovering Life Settlement Opportunities Evaluating Potential Opportunities Generating and Negotiating Offers The Client Decision
The Closing and Funding Process
Life Insurance Example 1
Needed to confirm insurance company’s valuation of $2,000,000
Alternate methodology–willing buyer/willing seller
Examined the Secondary Market for Life Settlement
Additional premiums required for guarantees
Interest rate increases impacting carrying cost
Life expectancy reports indicated almost 20 year joint life expectancy
(outside target range)
No potential buyer offered the total premiums paid ($840,000)
Determined there was no market for this policy
Which provided an alternate valuation
Tax preparer utilized the alternate valuation in gift tax filing instead of
Determine the situation in which the policy may be
Determine the type of policy, when issued and current
status (including loans against the policy)
Make sure the lawyer is involved to keep Privilege
Ask for Informal 712 Valuation(s)
ClientInsurance Company Tax Preparer
MFG & M3 Advisors
Martin Financial Group
Family run financial services firm headquartered in Savannah, GA
Independent and provide unbiased advice coupled with
Independent consults specializing in privately held businesses
Focus on your most important asset first…your business
Unique combination of business, financial, and tax expertise along
with a multigenerational vision
Disclosure under IRS Circular 230: This communication is not intended to and does not comply with the U.S. Treasury Department’s technical requirements for a formal legal opinion. Consequently, it cannot be used by a taxpayer to avoid any penalty that might be imposed on a taxpayer. Nothing in this communication may be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any person.
Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein.
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