Vol 3 No 4		December 2001

Katt & Company is a fee-only life insurance advising firm. We work with clients throughout the U.S. - primarily by phone, mail, email and telecopy. Typically, we assist clients buying life insurance, those who need existing policies reviewed and managed, and in support of litigation. For references please contact us.

Alert and Information

The stock market free-fall the week following the September 11 massacre was probably an acceleration of the correction that had begun a year-and-a-half before. Plunging equity values can cause damage much beyond the erosion of one's net worth. Most dramatically a collapsing stock portfolio can trigger margin calls that require forced asset sales to obtain liquidity. Less dramatic, tumbling stock values can cause poorly designed variable life (VL) policies to become so underfunded that they require the equivalent of a margin call. A defined-benefit policy type is a very poor VL design. Defined-benefit type policies have level-to-maturity death benefits that purport to also define the premium costs via comforting pre-sale and in-force illustrations. But these illustrations are an illusion because they are based on assuming a constant investment yield that in reality will be very volatile, unpredictable and subject to occasional plunges as we have recently experienced. The fact is a defined-benefit policy's premiums cannot be known in advance and will need to be managed to avoid overfunding and underfunding. Knowledge that VL policies invested in equities are affected by stock market volatility isn't new; it is just sensationally reinforced by the September 11 events. Defined-benefit VL policies either need to be changed to defined-contribution designs that feature robust premium payments relative to very low initial death benefits that are almost certain to increase significantly without any changes to the premium payments or changed to a special premium management system that this firm has developed.

You should contact your clients to inquire whether they have VL policies and if they do obtain in-force illustrations to determine whether they are defined-benefit or defined-contribution type policy designs. For defined-benefit type VL policies your clients have two choices: 1) pretend the problem doesn't exist and call on divine intervention to avoid the certain problems of overfunding and underfunding. This head-in-the-sand approach is dangerous because 1,000 simulations in which the actual average yield matches the assumed yield with a 15 percent variation in year-to-year yields shows that half of the time such a VL policy will terminate because the cash values have run to zero; or 2) call in professionals who know what the hell they are doing.

July 1999 AAII Journal and November 2001 AAII Journal columns address this VL problem. They can be found at www.peterkatt.com under the Articles section. Included with the November 2001 column is a detailed explanation of a unique premium management system that will allow clients to retain defined-benefit type designs without the problems identified.

Tip

The very low (and perhaps going lower) interest rates are reducing the IRC 7520 interest rate that is used to calculate values for such estate planning techniques as GRATs, CLATs and simple Private Annuities. Clients that have been uncertain about these planning techniques may now be encouraged to implement them.