Vol 11 No 5		MAY 2009

Katt & Company is a national fee-only life insurance advising firm. The June 2002 Forbes magazine, and a July 16, 2003 Wall Street Journal article, name Peter Katt as one of only four nationally recognized advisors. The Forbes article states that, "…advisers are well worth the money… These savants are working for no one but you…" For references please contact us.

Replace This

"With all policy replacements there may not be right or wrong decisions, but an objective analysis is needed so clients can make more informed choices that are compatible with what they perceive to be in their best interests."

Several weeks ago I was retained by Conner Client to review and begin managing his life insurance portfolio. To his chagrin, the year before he had been talked into replacing his Excellent Mutual (not the real name) with a Shadow Life (not real name) no lapse UL policy because more death benefits could be purchased for the same premiums. He didn't notice that EM was illustrated to have much more death benefits by life expectancy. Conner transferred $205,000 from EM to SL. After the transaction SL's cash values were $91,000. Whereas EM's financial strength ratings were and are exceptional, SL's have been slipping and it makes about a weekly appearance in the financial press with stories of its weakening financial condition. Conner would like to unload the SL policy. He now questions whether he needs this life insurance anyway, since he has $3,000,000 of term and another $2,000,000 with EM. The option that Conner decided upon was to transfer the $91,000 to a deferred fixed annuity in order to also transfer the much higher cost basis that will make the annuity much more tax effective if he converts it into an income annuity at retirement. Conner wishes he had contacted me before making the jump.

About a week later John Agent hired me to comment on an attempted replacement of an EM policy he had sold. To follow is my memo to John. With all replacements there may not be right or wrong decisions, but an objective analysis is needed so clients can make more informed choices that are compatible with what they perceive to be in their best interests.

To: John Agent

From: Peter Katt

Re: Acme Life (AC) Replacement of Excellent Mutual Joint Life Policy

You asked me to review and comment on the possible replacement of an EM joint life policy with an AL UL having a no lapse rider. To follow are my comments.

1. AL is a static-priced policy. The $84,000 premiums and $5,650,000 death benefits are guaranteed. Static-pricing is very much like term insurance for life. There will be low to zero cash values. EM is market-priced. The premiums to fund $5,650,000 death benefit will need to be adjusted as the dividend rate changes. The rate is currently 6.5% and the target premium is currently $95,000. The EM policy has robust cash values. If we have a sustained deflationary era these EM premiums will need to go up. If we have a sustained inflationary period the premiums will be able to come down. The EM target premium could fall below the AL guaranteed premiums if the dividend rate were to rise to 8.5% and remain at least this high.

2. EM has the highest rating from S & P, Moody's and Fitch. AL ratings are: S & P - AA+ (2nd); Moody's - Aa3 (4th); and Fitch - AA (3rd). In this era at least, I believe mutual companies have the potential to be safer because they can conserve capital by drastically reducing dividends if needed. In my experience AL has exhibited very aggressive underwriting decisions. AL has some of the most aggressive static-pricing. For a large block of AL policies there is no break, they have to meet the guarantees. AL can't conserve capital like an EM. Also note that EM has sold no static-priced policies.

3. If we continue to experience financial problems that feature debt defaults and deflation I believe AL has considerably more risk than EM for the reasons noted in #2. If we are headed for an era of inflation to a point that EM's dividend averages 8.5% or higher, it will likely be a better value than AL.

4. AL will have low to zero cash values compared with very robust cash values for EM. Having liquidity in a life insurance policy is important for two reasons. It can provide an emergency source of funds (although less flexible being owned by an ILIT), and allows the ILIT to miss premiums for an extended period if necessary due to extraordinary financial problems. The AL policy has little leeway for missed premium payments. I believe that missing even several premiums could cause the AL policy to terminate.

5. Under the correct conditions AL may be the better choice. Under other conditions EM will be a better value. Using its best critical thinking, the ILIT should consider which conditions are more likely for the future. One option for the ILIT is to consider diversifying the life insurance asset.