SECOND-TO-DIE LIFE INSURANCE:
A
Primer
Lisa Nachmias Davis
Davis O'Sullivan & Priest LLC
59 Elm Street, Suite 540
New Haven, CT 06510
203-776-4400
203-774-1060 or 776-4411
davis@sharinglaw.net
If
you are a couple that plans to establish a life insurance trust that
will
ultimately pay your beneficiaries' share of the death taxes in
your estates OR is intended to fund a special needs trust, the trust is
very likely to invest in second-to-die insurance on your lives. With
this type of
insurance, there is no payout until the survivor of you dies. With some
exceptions, the premium is usually lower because the odds
that you will both
die before your life expectancies is statistically lower than the risk
that one of you would
die before your life expectancy had expired. Therefore, it is a
better bet for the insurance company. If you're single, you don't
have that option, but there are still many choices to be made when it
comes to life insurance.
However, insurance is a confusing business, alas. The
options include traditional whole life insurance, term life insurance
with a long term such as 20-year or 30-year (no premium increases
during the term), a "blend" of whole
life and term, universal, and universal
with a guaranteed death benefit. Not to mention those hybrid life
insurance policies that give a long-term care benefit.
Whole Life. The theory here is that the premiums build up "cash value," which in turn generates income in the form of dividends that eventually helps offset premiums to keep the thing going. If the investment performs well, the premiums may purchase "paid-up additions" to even increase the death benefit. However, whole life tends to be a lot more expensive.
Blended. A "blended" arrangement consists of part whole life, part term insurance. The less expensive (initially) term portion is paid for in part by the dividends from the whole life portion. As you get older, the term policy premiums go up so it is important that the whole life throw off enough income to pay the higher premiums. The expectation is that the policy would be “paid for” after the number of years specified. There are two variables, however, which cannot be guaranteed: (1) the premium cost for the term insurance, which could conceivably rise based on the company's experience with greater mortality rates or changes in insurance regulations, and (2) the dividends that the company will earn. For example, a ½ % decrease in dividends could mean an extra year's premium payment. With the blend, you are betting that the company will handle your investment -- the premium -- well, and also act as a prudent insurance company so that the premiums don't get too high. As well as showing a projection as to what the agent thinks will happen based on past performance, the company and agent should show you an "assumed" rate that is less than the company's actual current rate of return, just in case. The risk is still there, however, that the policy would require additional premium payments after the specified number of years, which would require: (a) additional contributions by you to the trust, (b) the trust taking a loan against the cash value, or (c) the trust exchanging the policy for a new one with a lower death benefit. The greater the proportion of term to whole life, the more risky the set-up. Be careful of policy loans to pay premiums! If you select an automatic loan feature to prevent a lapse if you forget to pay, and then you fail to pay off the loan or pay the interest, you may wind up draining the cash value to pay the loan through compounding interest.
Universal. Strict "universal" policies work like whole life, but with greater flexibility for you to reduce premium payments if and when they become inconvenient, without the policy lapsing. These can be very handy if your own cash flow varies significantly, particularly when compared with whole life policies that will make you "borrow" against the policy to pay premiums when you can't. However, universal policies have gotten a bad name. Historically, universal companies had a bad record of overly optimistic predictions about future performance and/or imprudent clients who forgot that you eventually need to pay premiums to keep insurance in force. If you don't pay enough, or base your payment on an initial projection without adjustment for future events, you may have a nasty surprise when the policy implodes. "Variable universal" policies compounded this problem by allowing the insured to direct the policy's investment of the premiums paid in. Two problems: First; if your investments don't pan out, the surprise can be even nastier; Second, many such policies have a host of hidden fees and costs associated with the various investment funds. Universal is probably only as useful as your own self-discipline and/or your agent's conscientiousness.
Guaranteed
(Universal). The new "guaranteed" universal policies are a bit
different. Unlike the
blend policy, provided you pay the premiums quoted when required, with
the universal guarantees the death
benefit is absolutely guaranteed until a specified age even if
mortality rates go up and returns go down. However, the cash value is
less during this time. In effect, the company gives you less cash value
in
exchange for giving you the guarantee. You are "purchasing" the
guarantee by sacrificing cash value. Unlike the traditional universal
policy, however, if you miss a premium, you lose the guarantee. When the
guarantee term expires, however (often, age 100), the policy reverts to
a more traditional universal type
policy. If at that point you still want a guarantee (let's say the
policy hasn't built up enough to keep the policy
in force) you can pay for another guarantee, but you hope that the
premiums invested will have done well
enough to make this unnecessary.
The
Bottom Line: Insurance is
not "get it and forget it." First, you have to remember that the
"illustration" you're given when you buy is NOT a guarantee and can be
highly unrealistic. Make sure you get one that uses conservative
projections and make sure you can tell which schedule is guaranteed and
which projected. Secondly, you have to keep on top of the
policy's performance and the appropriateness of the premium for the
thing to work the way it should. Be particularly cautious about
taking loans to pay premiums; the interest may be high and if you don't
catch up, may bleed the policy dry. Finally, if you don't have
the time or know-how to monitor the insurance yourself, be sure to keep
in touch regularly with a trustworthy and conscientious agent who will
keep an
eye on the policy for you.
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THIS INFORMATION IS NOT PROVIDED AS LEGAL ADVICE AND
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Lisa Nachmias Davis
Davis O'Sullivan & Priest LLC
59 Elm
Street, Suite 540
New Haven, CT 06510
Phone: 203-776-4400
Fax: 203-774-1060 or 776-4411
