Life insurance can be a very useful tool for the wealthy, one that plays an instrumental role in wealth planning, especially in the hands of talented life insurance agents. Yet sometimes the insurance policies, which might have been purchased to address a particular set of needs, have outlived their usefulness.

Thus, a meaningful percentage of wealthy individuals and families are discovering they have more—sometimes a great deal more—life insurance than they need. Sometimes it’s because their lives have changed, and sometimes it’s because they have discovered that too much was sold to them in the first place.

Clients might have purchased life insurance exclusively or primarily for the death benefit or built up large cash values in the policies. And it might well be time for them to re-evaluate those needs, examine the policies they currently own, and decide if they are still necessary.

Is their death benefit enough? Too much? These questions have become even more pressing with the passage of the Tax Cuts and Jobs Act.

Consider a scenario in which life insurance agents project the size of somebody’s estate. They might come up with a plausible growth rate for it, but there are times they don’t. It’s potentially unrealistic to set a compound growth rate and project years, and sometimes decades, forward.

If the wealthy indeed have too much life insurance for their needs, there are a number of things they can do to correct this, and one of those things is to convert the insurance into investable assets.

Situation Analysis

To analyze the situation, there are three things advisors must do with their clients (in order of complexity):

• Life insurance product analysis: First, they must understand how the policies are performing and determine whether they are doing what they are supposed to. Wealth advisors must also identify the cost of the present structure. This is a very easy step, since all that is required are in-force illustrations.

• Life insurance strategy analysis: This is not always necessary, because many times the life insurance is paid for directly. However, other times the insurance was purchased as part of a financial or legal strategy.

For example, if the premiums have been financed, not only do the policies need to be assessed, but also the underlying financing assumptions—the collateral requirements and so forth. In many of these cases, even slight underperformance in the policies, compared with what was presumed, can have a very dramatic impact on results. The different financing and interest payment requirements can make matters even more problematic.

• Needs and wants analysis: The most complicated aspect of the analysis is the needs/uses analysis. Here, the buyer must specify and evaluate the logic behind the original purchase of the life insurance. Remember, the insurance is just a means to an end, and it’s essential to explain just why the policies were bought. Why did the individual or family need the death benefit?

Sometimes, the use of life insurance changes as a person’s circumstances change. Consider, for instance, a start-up entrepreneur buying life insurance to create an estate so his spouse and children are taken care of. The idea is that he or she will subsequently use the insurance (possibly including the policies originally purchased) to pay estate taxes after becoming successful.

Still, no matter what the original reason for the purchase was, the major considerations are the client’s current needs and wants. So a number of questions must be answered:

• Does he or she currently need the death benefit?

• What current concerns are being addressed by the life insurance?

• Is the amount sufficient or is there too much or too little insurance?

• What current concerns can the insurance potentially address?

• How much insurance would be required to address current concerns?

As clients re-evaluate the need for their insurance, one of the things they must take into consideration is the increase in the federal estate exemption, which has risen to about $11 million for individuals and about $22 million for couples. Recent research suggests that those families who are no longer subject to the federal estate tax are significantly dropping, lowering or converting their life insurance coverage. 

Some individuals and families will keep the life policies in place anyway, even if they no longer need them to pay the taxes. But more often than not, they will likely want to drop or modify the policies, and the result will be money they need to have professionally managed.

In our experience, the needs and wants analysis can often take a good amount of time. It becomes a process of thinking through an array of issues, life insurance being just one component.

Comparative Analysis

We’re making the situation and comparative analyses different for pedagogical reasons. In reality, they overlap.

A comparative analysis takes into account the goals and objectives of the family or individual. There are three choices to make:

• Keep the status quo: In this case, a client can keep the existing policies as they are, and, if necessary, continue paying the premiums. Very often this is not the preferred choice, but it’s sometimes necessary because other factors come into play, such as the back-end charges clients might have to pay for leaving policies behind.

• Exit the policies: A client can surrender his or her life insurance policies and take the cash value. Some clients can also pursue a life settlement agreement, in which they sell a policy to a third party.

• Restructure the life insurance policies: At times, the best answer for clients is to take an existing policy and lower the death benefit while making sure it is all paid up. Other times, it is wise to convert the current policies into other types of policies. These days, private placement life insurance and private placement variable annuities are extremely attractive alternatives for wealthy clients.

By showing clients the different scenarios, you can help them make well-informed decisions about what to do with unneeded life insurance. The final step is taking action.

Taking Action

At this point, everything is fairly mechanical. The difficult aspects were thinking through why a death benefit was still needed and how much of it was. Other decisions flow from those questions. Once those decisions have been made, capable professionals can readily implement them.

More Investable Assets

While the federal estate tax might change again, ensnaring families that have estates of less than $22 million, the wealthy are increasingly willing to take that risk if it means not having to pay more premiums or take certain risks associated with financing them. At the same time, it is clear that many wealthy families have more death benefit than they need, regardless of what the estate taxes are. In these situations, most families regularly decide to either exit or restructure their life insurance policies, if they can.

Such restructurings will sometimes leave them with additional money to invest—say, if they are entering a life settlement agreement and they put the proceeds from the policy sale into an investment account. Some wealthy families might choose to convert existing traditional policies into private placement life insurance or private placement variable annuities. The continued tax-free buildup of value, coupled with the investment expertise of financial advisors in whom they are confident, makes these alternatives very attractive. 

Russ Alan Prince is president of R.A. Prince & Associates.

Pat Rufolo is a partner at Stern, Kilcullen & Rufolo. Frank Seneco is president of Seneco & Associates.