Sales may be down, but advisors are still using survivorship insurance.

Insurance companies expected the Economic Growth and Tax Relief Reconciliation Act of 2001 to hurt sales of survivorship policies, and they were right. Research by LIMRA International, the life industry's trade association, shows that 20% fewer policies were written in 2002 than in 2001, with sales for the first half of this year off 14% from the same period last year. Total premium dollars also have declined.

Although it has come to be used in many ways, carriers originally designed survivorship coverage to provide funds for paying a couple's federal estate tax, a bill that is generally triggered at the death of the surviving spouse-hence the alternative moniker, second-to-die insurance. EGTRRA repeals the tax in 2010, after raising the estate-tax-free amount from $1.5 million (effective January 1, 2004) to $3.5 million per individual. But thanks to what is arguably the most second-guessed tax-code provision in history, the law reinstates the levy in 2011 for those whose net worth tops $1 million.

The loop-de-loop makes it impossible to know what the client's tax toll will be, bringing uncertainty to the insurance-planning table. It's tough enough trying to get clients to do estate planning. "When you throw in the uncertainty, that leads people, in a lot of cases, not to act" and slowing sales, says Les Lovier, life-marketing vice president at AXA Financial in New York City. The industry's lone (but smart) response in product design has been to waive policy surrender charges in years when there is no estate tax, to mitigate customer cost in the event that the insurance isn't needed for its ostensible purpose.

In financial planning circles, meanwhile, survivorship insurance has become something of a hot-button topic. The fee-only crowd will tell you that the policies are oversold by insurance agents in search of lucrative commissions. As with any life policy, there are loud, opposing opinions about the wisdom of utilizing variable products, which let clients subject the cash value to the vagaries of the financial markets. Regardless of your stand, advising clients about survivorship insurance today is different than it was before EGTRRA, starting with the educational initiatives. "I haven't necessarily altered how I use the product, but a standard communication to clients now is that the laws are going to be continually changing, and therefore we need to really understand why we're using the product," says advisor Saul Simon, president of Simon Financial Group in Piscataway, N.J.

Taxes Don't Go Away

Inform clients about the carryover-basis regime that replaces the federal death tax in 2010 and which, conceivably, would take effect under a final repeal of the tax. In this paradigm, assets pass to heirs with the decedent's basis-no step-up to the value at death as current rules provide. When the property is sold, therefore, the heirs will owe capital gains tax on all the growth. "Even if the client has a modest asset base that has appreciated, you're still talking about a tax of 20% (after 2008) plus inheritance tax, depending on the state," says Ellen Fairbanks, a certified financial planner licensee with MD&A Financial Management Co. in Pittsburgh.

Similarly, clients planning to pass large retirement plan balances to heirs should be reminded that the future portends significant income tax-forget death tax. Heirs' withdrawals from tax-deferred accounts are ordinary income. "The notion of stretch IRA, which all of us preach, presumes that the kids are more interested in saving taxes than in benefiting from the money in the account," says Herb Daroff, a planner with Boston's Baystate Financial Services. "I don't know about anyone else's kids, but mine want to go after the cookie jar. A second-to-die policy gives them the freedom to access the funds without losing 35% or more to federal and state income taxes," Daroff says.

These are not necessarily problems for smaller estates, of course, and some are letting their survivorship policies lapse. "I'm letting a couple of them die right now for clients with less than $2 million," says John Henry McDonald, president of Austin Asset Management Co. in Austin, Texas.

Another way out of a policy that is no longer deemed necessary is to sell it to a life settlement company, says Diane Pearson, director of financial planning at Legend Financial Advisors Inc., in Pittsburgh. One couple had purchased coverage five years ago, based on their net worth at the time. Since then, the estate-tax exclusion has escalated above their wealth while their variable policy's cash value fell to $35,000 in the bear market, after $75,000 of premiums had been paid. "So we went to a life settlement company that purchased the policy from them for $58,000," Pearson says, explaining that the company will receive the payout at the second death. "It's terrible to say, but the clients might have gotten more money for the policy if the wife, who is 82, had not been so healthy," Pearson says. It's the opposite of buying life insurance, where good health helps.

For many clients, however, the risk of taxes ruining their legacies is too great to ignore. This is particularly true in cases where wealth is concentrated in illiquid assets. "Survivorship insurance still makes sense for small-business owners, as well as for people who own real estate," Pearson says. Passing away with no provision for whatever taxes may be due could force disposal of the illiquids at fire-sale prices-not an optimal solution for the individuals you undoubtedly hope to inherit as clients.

Some who continue to use the coverage take a flexible approach to manage the tax uncertainty. "We will build a formula into the estate planning documents that says, 'If I have an estate tax liability, then X occurs. If I don't, then give some or all of (the survivorship policy proceeds) to my private foundation or favorite charity,'" says estate planning attorney John Jeffrey Scroggin, of Roswell, Ga. "It's comforting for clients to be able to say, 'If the law goes against me, I've got the policy for estate tax liquidity. If the law goes with me, I've got that covered, too.'"

Greater Interest In Alternate Uses

With the tax picture fuzzy, second-to-die's other benefits have become more salient, since those may be the only ones that the client will ultimately enjoy. "We are seeing a whole lot more discussion about the non-tax purposes" of survivorship insurance, Scroggin says. Consider the small-business owner who anticipates that at least one child will work in the enterprise but not all will. Those who won't should not inherit business-ownership interests, Scroggin asserts. If they do, "you've tied (all the heirs) together financially, and as time goes on, that creates conflicts in the family," he says. But when the private company is the lion's share of the owner's net worth-which it often is-cash is needed to pay off those who do not inherit it. "We use a second-to-die policy as a funding vehicle to equalize the estate at Mom's death, since in most cases we want to give her an income stream from the business until she dies. The insurance fits well in that context," Scroggin says.

For the philanthropic client, survivorship coverage can offer simplicity plus wealth replacement. "We have clients who say, 'I don't want to have this trust or that trust. Everything goes to charity,'" says Daroff. That entitles the estate to a charitable deduction for its total value. "So there's zero estate tax, with or without repeal," Daroff says. The second-to-die policy supplies the kids' inheritance.

A special-needs child who cannot work to support himself can benefit from survivorship coverage, says AXA Financial's Lovier. "You worry that if both working parents die, who will take care of the child? We see survivorship insurance used to meet that need."

Product Features To Pursue

When utilizing second-to-die insurance, be sure to get policies carrying the latest options, especially split coverage, a feature introduced prior to EGTRRA that has bloomed in popularity post-enactment. The couple can split the joint coverage into individual policies if the estate tax is repealed or if there is a divorce, says life insurance consultant David K. Bohannon of Consultants Corner Inc., in Louisville, Ky. That could be useful, for example, if circumstances change and one spouse will need income should the other perish. "A couple with a $5 million policy and the split option may have enough in the contract to fund a $2.5 million individual policy without the need for any additional premiums," Bohannon says. The cost is minimal-some companies charge nothing-but the real boon could be that many carriers will let you divide the coverage without proving insurability.

Regarding the surrender-charge waiver mentioned earlier, be sure to read the fine print before buying. Equitable, for instance, waives the charge on either a policy surrender or reduction in face amount (should the client need less coverage than originally anticipated), but other carriers dispatch with the fee only on full surrender.

You should also be aware that many traditional universal-life products now come with a guarantee, a wrinkle instituted by the industry not because of EGTRRA but due to the havoc wreaked on variable policies by the bear market. Under the guarantee, when the client makes timely payment of the premium and avoids policy loans and withdrawals, the insurance company warrants that the policy will be fully paid regardless of changes in interest rates, Lovier says. "There may be no cash value in the product at some point, but the policy won't ever lapse. The insurance will be there."

If the industry's product-development response to the 2001 act seems languid, it is also calculated. Carriers are merely biding their time, according to one insider, hoping that eventually Congress will vote against total repeal of the death tax. But regardless of which way the ax falls on that issue, once the element of uncertainty is erased insurers expect survivorship policies to gain favor-and we know how their last prediction turned out.