Vol 8 No 5		August 2006

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.

Professional Curiosity

Given a unique set of circumstances, our firm recognized a creative alternative to using dividends to offset policy premiums. Upon further analysis this alternative proved to be correct with a 15% increase in death benefits at life expectancy. The point of this Perspectives is to encourage examining various approaches, even when there is a tried-and-true obvious route.

Maintaining an active intellectual and professional curiosity will benefit clients. We were recently retained to review and begin managing a very large amount of joint whole life insurance owned by an irrevocable trust. The policies, insuring spouses with a 20 year age difference, were purchased between 1991 and 1995 with the intention of having the premiums offset via dividend values as soon as possible. The Trust had expected the dividend values to begin paying all premiums starting several years ago, but only 10 of the 17 policies are now entering this status with the remaining seven policies needing premiums for up to five more years. This delay in expected premium offsets is due to the decrease in dividend-interest-rates since the policies were purchased. The higher the rate, the fewer years out-of-pocket premiums are needed and vice versa. Aside from the expectations created, the Trust was anxious for the premiums to cease because of the large gift taxes associated with the premium payments.

Because of unique circumstances associated with this case, we recognized a possible creative alternative that would allow us to immediately eliminate premiums for all 17 policies. This possible alternative for eliminating premiums is not commonly considered, and we ran into resistance from the life insurance companies in even obtaining the data we needed to test our hypothesis. This alternative method proved to be correct, with a 15% increase in death benefits by life expectancy compared to slogging along the conventional premium offset path.

The method we designed was specific to the unique circumstances of this case and would not necessarily be appropriate for other situations. The point of this Perspectives is to encourage examining various approaches, even when there is a tried-and-true obvious route. The only problem with this approach, for advisors charging by the hour, is the occasional grousing about why an analysis takes so long. To follow are the details for those interested in the exoteric details.

Participating whole life policies have contract premiums that must be paid every year. After a sufficient number of premiums have been paid by the policyowner, subsequent premiums can be paid from policy values.

There are two methods for using policy values to pay premiums and they need to be tested and compared so clients can decide which is best for them. One method is premium offset. It uses a combination of accumulated dividend values and each year's dividend distribution to completely offset the contract premiums. If the value of distributed dividends declines in a future year, a new projection may show that out-of-pocket premiums must resume before the policy can then go back on premium offset. When dividends are used to pay premiums, the additional benefits they could have purchased are lost. The loss isn't dollar-for-dollar because a dollar of dividend will purchase, let's say, $1.30 of additional death benefits and create $.60 of additional cash values.

The other method to pay premiums from policy values is to use loans. Usually loans are not part of a premium design, but occur from neglect. Loans reduce values on a dollar-for-dollar basis. Typically, loans produce a better result in the short-term compared to premium offset, but in the long-term the loan interest due on the loans eat into this advantage. Generally, premium offset produces death benefits around life expectancy that are 20% to 30% greater than if loans are used to pay premiums. Therefore, the default assumption to permanently eliminate premiums is to use premium offset.

Our case was very different than the typical situation because the wife, who was 20 years younger than her spouse, had already passed away. All of the joint life policies in this case have joint mortality, with no change in pricing at the first death. This means that the surviving insured, a 75 year old male, has policies that are priced as if he were a 55 year old female. Because of this mortality anomaly, the value of continuing to buy paid-up-additions with the dividends is very significant. Realizing this, we believed there would be a large difference between using loans to pay premiums instead of premium offset. We found that because the 75 year old male has pricing for a 55 year old female, loans provide much greater death benefits even if he lives past 100. This would not be the case if the wife had survived our client. In that situation premium offset would be the better design.

By questioning conventional thinking about eliminating the premiums because of this case's unique facts, we examined the loan alternative and proved our theory that this would be the superior approach.