By David Dankwa
With current interests rates so low, healthy individuals who are no longer generating enough excess income to continue paying premiums on their life insurance trust programs may opt en masse to allow their policies to lapse.
Trust owned-life insurance typically is used by the very wealthy and their families for estate planning purposes. It is estimated that as much as $1 trillion of assets is held in irrevocable life insurance trust in the United States.
Bill Kaufman, a registered principal of MoneyWatch Consultants, said the current economic environment presents a risk that significant portions of healthy individuals with trust-owned life insurance could stop paying into their policies. That could be a catastrophe for insurance companies, which would be left holding pools of high-risk policies.
“My theory is that once people understand the repercussions of their policy and what the future might hold, they would lapse the policy. They’d say goodbye and ask for the cash value,” Kaufman said. “I think the people who are healthy are more likely to lapse the policy than those who are unhealthy [who], let’s say, have a heart problem, diabetes or high blood pressure and have six or seven years to live. In that case, they would let their kids help them pay for it or try to sell it. They would do something to keep the policy, which means the insurance companies would be stuck with bad pools of business.”
As a consequence of holding large pools of high-risk policies, Kaufman theorized that insurers will start to raise the mortality charges that are inherent in universal policies and reduce the already-low dividends of participating policies.
“That would be devastating. It has really never happened before. It would be an event that would devastate many types of life insurance policies if that occurred. People don’t think that would happen but it could,” he said.
Kaufman has been sounding an alarm about trust-owned life insurance for a long time. His biggest worry is that more and more policyholders who purchased policies 10, 15 or 20 years ago are waking up to find that the policies in their trust have fallen apart because the premiums they are paying have not been sufficient to keep the policies in force. “They learn about it when it is too late,” he said.
Take for example, a universal life insurance purchased several decades ago. “Let’s say it was $1 million policy and you paid $30,000 premium for it based on projections when the interest rate was 6 percent. You may have continued to pay the $30,000 but what happens is, maybe 20 years out or 15 years out $30,000 is not enough to keep the policy in force. What might now be required is $100,000,” he said.
Kaufman said, in some cases, clients were told if they pay the premium for 10 years they wouldn’t have to pay in the 11th year. “When you look at the in-force ledgers you might find out that is not the truth about the policy. Unfortunately a lot of people buy a policy, they put it in a trust and nobody looks at it again. Then the policy falls apart,” he said.
Kaufman said people do not take these concerns very seriously – not even the attorneys who prepare the trusts.
“A few months ago, I visited with attorneys to educate them on this issue. When I explained that a lot of people are not aware of these problems, one attorney told me, ‘All I get paid to do is put it in the trust.’”
In other words, the attorneys preparing the trusts are not looking at the assets and the likelihood that they would perform as expected or last through the client’s lifetime. Most accountants also are not looking at the asset because, in an irrevocable trust, there is no tax form to sign every year.
“So it’s almost like an asset that is buried that nobody is looking at, even though they have a lot of money invested in. Eventually it’s not going to work for them. It doesn’t happen in every case, but in many cases these policies are going to fall apart," he said.
David Dankwa is a longtime business reporter with significant experience writing about the global insurance industry. Contact him at [email protected].
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