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Journal of Financial Planning - April 2001 When it comes to life insurance planning, obtaining detailed knowledge of a client's health history is as important as knowing the details of their assets. But don't take your client's word for it either. Taking a Healthy Look at Life Insuranceby Peter Katt, CFP, LIC Detailed knowledge of clients’ health histories at the onset of my work is one of the most important pieces of information I can have. This column presents a potpourri of planning issues relating to the astute use of clients’ health histories. During my initial data-gathering conference with a client, I ask very detailed health history questions, going so far as to get medical reports when I know such detail will be needed. If there is some concern about the kind of rating a client may earn (that is, preferred, standard or a sub-class rating), I obtain an estimate of the underwriting result we might expect. This usually is done by sending anonymous information to an insurance agent, who discusses it with insurance company underwriters. Having this information will allow you to perform your analysis based on a good estimate of the rating any particular client might expect. If there is some question about the rating, you will find it useful to use several assumed ratings for the analysis. Having an accurate estimate will significantly reduce the chance of doing complicated and time-consuming reports based on insurance policy rating assumptions that turn out to be incorrect. A cautionary note: It often does little good to settle for clients’ casual characterizations about their health; their impressions can be very misleading. While beginning a review for an existing client two years ago, he told me his health was still excellent. But being wary of such a claim, I asked more precise questions that resulted in learning that two years before, this 62-year-old had suffered two heart attacks. His view of being in excellent health, for my purposes, was very misleading. Insurance Application First—Purchase Decision Later Some insurance agents convince potential buyers to submit an insurance application and have the underwriting process (including the insurance exam) completed before the prospect has decided to buy anything. This, they claim, is done to make sure the prospect can qualify for the purchase the agent has recommended—or shortly will. But completing the underwriting prematurely creates a deadline for the prospect to make a decision about the insurance buy. This deadline can end up with the prospect making a purchase decision out of fear of losing his or her coverage rather than on the merits of the planning. I work with five to ten clients each year who come to me with a contrived purchase-decision deadline due to having been convinced to apply for the coverage before any rationale for the purchase has even been discussed. Therefore, my first work with this kind of client is for them to make an informed decision about whether they need to buy a policy on this kind of deadline. It would be unwise to reject such a purchase out-of-hand for fear you would be held liable for the very rare situation of a client being healthy this month and unhealthy next month. For clients who wish to act on protecting against this rarity, we have them put the approved policy in force on a monthly basis, and we do their planning on a rush basis. The fact is, almost all medical underwriting issues are known before the application process begins. That is, it is very rare for the insurance exam itself to turn up any disqualifying health issues. Almost all of the underwriter’s work is in obtaining and evaluating attending physician statements about the client’s health history. Therefore, obtaining a detailed health history from clients will certainly inform you if they will qualify for coverage at all; more precisely, it will usually provide you with knowledge of what rating is likely before reports are done. And becoming less healthy between the time the planning begins and decisions are made is also rare and would seem to be a risk we all live with every day. I certainly don’t recommend every few months we apply for insurance (but don’t actually buy it) just to constantly maintain access to the best rating possible. Mr. Brown, the 62-year-old client with the two heart attacks, referred to above, had a $1 million ten-year level term policy, with a preferred rating, that was owned by his construction company. This policy, whose ten-year level premium period was about to expire, had been used as collateral for a bank line of credit. The line of credit was no longer being used, so Mr. Brown’s CPA recommended that the policy be allowed to lapse. This CPA worked closely enough with Mr. Brown to know he had suffered two heart attacks two years before. The CPA also was fully aware that Mr. Brown had a very significant estate liquidity problem because most of his estate value was in his company. The CPA’s recommendation to allow the term policy to lapse was professionally reckless. It could have resulted in litigation against the CPA if, after the policy had lapsed, Mr. Brown had been unable to obtain other coverage at all, or only with a very sub-standard rating, and died quite prematurely. Fortunately, we had Mr. Brown transfer the policy to himself, then to an irrevocable trust, where it was converted to a preferred rated universal life policy that was available for conversion. Poor Health or Terminal Several years ago, Mr. Green, whose boss I had previously worked for, contacted me. Mr. Green had been diagnosed with a very aggressive form of leukemia. He had an annual renewal term (ART) policy for $300,000 with a current premium of $2,600. This ART policy could be maintained for another seven years before it would terminate. It could be converted to whole life anytime during the remaining seven years. His insurance agent, upon learning of Mr. Green’s leukemia, recommend that he convert his term policy to whole life with an annual premium of $13,750. However, Mr. Green’s situation was completely different. Conversion from term to permanent is probably a good idea when an insured’s health has deteriorated but isn’t terminal (the case with Mr. Brown), or when the term policy will expire without conversion, or its premium rate will skyrocket (also the case with Mr. Brown). Mr. Green’s health situation was terminal (conclusive he wouldn’t live another two years) and his ART policy wasn’t about to expire. Because the death benefit of the whole life policy would remain level at $300,000 for several years after conversion, paying the far more expensive whole life premium ($13,750 versus $2,600, $3,000, $3,400 and so on) would have been a mistake. Mr. Green continued his term policy. He died 14 months later, saving his family at least $12,000 in unneeded whole life premiums. ‘My Mother and Father Are Both 98’ In contrast to ignoring the insurance planning importance of deteriorating health is having a cavalier attitude about perfect health (especially with very old parents). Take the situation of two 70-year-olds, Mr. and Mrs. Black, who have several permanent survivorship life insurance policies being used for estate planning. Both policies were underfunded; that is, based on current pricing, the premiums project that the policies would expire between ages 93 and 96. There is a 46 percent probability that at least one of them will be alive at age 96. Mr. Black seems to think that funding beyond ages 93 and 96 is a waste of his money even though his parents are alive at 98. Increasing the premiums so the policies are on track to endow at age 100 provides considerably more tax leverage than intentionally underfunding these policies. (For additional information about premium management of permanent policies, see my November 1999 AAII Journal column at www.peterkatt.com.) Conclusion Detailed knowledge of clients’ health histories can be as important as knowing the details of their assets when it comes to life insurance planning. Don’t shy away from asking very detailed questions and obtaining medical reports, if necessary, and using this information to better serve your clients. Reprinted with permission by the Financial Planning Association, Journal of Financial Planning, Volume 15, Issue 3, March 2002.
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