January 24, 2004

Mr. Fred Client
140 Yellowbrick Road
Anytown, USA 12345

Re: Acme Mutual Policy #1234567890

Dear Fred:

You have retained my services to review your life insurance planning and policies. This reports on my review of the Acme Mutual survivorship policy. Please refer to the accompanying Policy Informations for specific data about this policy.

Overview

This policy replaced two survivorship universal life policies acquired by the Trust in 1993. The UL policies' had a defined-contribution design with low initial death benefits that increased. Your Trustee, ABC Bank, convinced you to replace your UL policies so they could sell you this Acme Mutual policy with a defined-benefit design that has level-to-maturity death benefits. It is not my position that either of these death benefit designs are better than the other. They are different and one or the other will provide more benefits at different times. ABC Bank didn't discuss these concepts with you and you had forgotten that you went through these alternatives in 1993 before the Trust purchased the UL policies. ABC Bank also didn't discuss with you the alternative of using a static-priced policy instead of this market-priced policy. Finally, it appears that ABC Bank is using a flawed policy funding goal that would have had you dramatically overpaying for this coverage. We considered your options regarding possible legal action against ABC Bank, who may not have fulfilled its fiduciary responsibilities very well. I recommended against pursuing any legal strategy against ABC for reasons detailed in this report.

Defined-Contribution / Defined-Benefit Designs

The UL policies had increasing death benefits in 2002 of around $1,400,000. If you or Ethel lived to joint life expectancy it is likely that the death benefits could exceed $3,000,000. However, as noted the defined-benefit ($3,000,000 level death benefits) is also an appropriate design and no legal case should be made against ABC Bank because you may have continued to prefer one over the other if presented with the alternative as you were in 1993. An issue I haven't and won't research is whether Acme Mutual's better embedded pricing than UL (because it is an later designed universal life policy) can offset the additional acquisition costs of about $110,000. This pricing differential is another reason to not rush to the courthouse.

Market-Pricing / Static-Pricing

Up until a couple of years ago the only permanent life insurance choice since around 1980 was market-pricing, which means future interest rates and to some extent mortality will change policy pricing over time. A couple of years ago universal life policies with exaggerated premium guarantees were developed. I refer to these policies as static-priced. They are basically term-for-life because the premiums are guaranteed and there is little (even zero) cash value compared with a market-priced policy. The Acme Mutual policy the Trust purchased is market-priced and the premiums will fluctuate based on future interest rates. ABC Bank established a target premium of $40,000 a year after $600,000 was transferred from the UL policies. This target premium was established to generate a cash value at policy maturity (25th year) of $3,000,000. The interest crediting rate dropped in 2003 from 6.4% to 5.45%, which would necessitate an increase in the target premium to around $46,000 to meet the $3,000,000 cash value goal. Research I did indicated that a Acme Mutual static-priced policy ABC Bank could have sold - and bought as Trustee - could have provided $3,500,000 guaranteed death benefits with a guaranteed premium of $42,000. ABC Bank apparently didn't think of this as an option and you were completely unaware of it.

Policy Funding Requirements

Until a few years ago permanent policies matured at either insured's age 95 or 100. Universal life allows for premium flexibility so it is up to the policyowner to figure out what the funding goal should be and how to manage this with market-priced universal life policies. At maturity (meaning the insured has lived to 95 or 100) policies become paid-up for their cash values. Most companies extend matured policies as life insurance until the insured dies to preserve the policy's tax-free benefits. If a policy had a death benefit of $3,000,000 but a $100,000 cash value at maturity it became paid-up for $100,000. However, life insurance companies have become very creative (so did Enron, so hold the applause for actuaries for a while). They have created lifetime extensions on policies and only require that the policy be in force at maturity, 25th year for this Acme Mutual policy. Being in force means having at least $1 of cash value on September 28, 2027. Beyond the 25th policy year the policy will stay in force for $3,000,000 without any premiums. Apparently ABC Bank didn't get the memo because they established target premiums (originally $42,000 that I calculate should now increase to $46,000) to generate a cash value of $3,000,000 in the 25th year. But this isn't necessary, we only need $1. I had Acme Mutual run an in-force illustration to generate a $1,000 cash value in the 25th policy year, showing the target premium for this funding. The target premium is $18,101 instead of $46,000. Your joint life expectancy is around 20 years, meaning based on current pricing we can expect a present value savings in target premiums of around $342,500 (discounted at 5%) for 18 more premiums.

I recommend you gift to your Trust only $18,100 annually until I review this situation in two years when we will adjust the premiums if necessary. Because this market-priced policy only needs $1 of cash value in the 25th year we dropped thoughts of possible legal action.

Premium Management

The goal of keeping the policy in force to the 25th policy year is appropriate as long as you or Ethel are still in good health with the possibility of living that long. However, if one of you have passed and the other is in very poor health, such that it is nearly conclusive survival for, say, five years is very unlikely, and the policy has enough cash value to stay in force for those five years, I would recommend that no more gifts be made to the Trust because no more premiums are needed. That is, the policy will pay its death benefits of $3,000,000 regardless of how much cash value there is. I don't mean to be morbid about these things but proper management can save huge amounts of unnecessary premiums.

But except for having knowledge of the likelihood of the second death within some specified period we need to manage the premiums for at least $1 of cash value in year 25. I do expect interest rates to decline on this policy in the short- and medium-term and this will increase the target premium. For example, if the crediting rate is 4.6% the target premium would have to go up to $26,000 this year. But if the funding goal had continued to be $3,000,000 of cash value the target premium would have to be $55,000.

Please review and give me a call to discuss.

Very truly yours,

Peter Katt, CFP, LIC

Enclosures