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June 1990

What criteria should an accountant use when asked about life insurance?

by Rubin, John

    Abstract- Accountants who focus on the use of insurance products and estate planning may be confronted with a variety of life insurance products and may not know how to differentiate between them. Techniques for analyzing competing products include determining: what interest rate a dividend is based on; what the investment yields are for the previous five year period; and whether a company is a 'direct recognition' company. It also is important to obtain competing quotes from various companies.

What do I pay? And what do I get?" The policy illustration that looks less expensive than a competitor's may be more expensive or represent tangibly more risk for your client. This article gives you, as a professional, the ability to analyze competing life insurance products.

How Should an Accountant Analyze an Insurance Illustration?

The best action is to find an insurance broker who is totally above reproach and has a working product knowledge. This may be difficult. Most agents are honest, but some are more trained in sales skills than product knowledge. As an alternative, for each quote you obtain ask the broker to answer several questions in writing:

1. What interest rate is your dividend based on? What yield is your company currently earning on its investments? Does the dividend assume future increases in yields?

2. What are the last five years' investment portfolio yields of the issuing company? Ask the broker to bring you a page from "Best's Insurance Report for Life and Health" to prove the yields.

3. Does the illustration contain a term insurance rider? These riders improve the performance of the illustration but add substantially to the product risk for your client. They are funded with projected dividends. If the actual dividends are less than projected, the face amount of the insurance can drop significantly and the number of premium payments (on limited pay policies) can increase. Also ask if the illustration has any policy loans. Again, they are designed to improve performance, but with risk.

4. Ask if the issuing company is a "Direct Recognition" company. This means that if your client borrows money from the policy in the future, the projected dividend scale is automatically lowered. If your client has to borrow from the cash values, this may be important. In addition, ask if the loan rate is variable," meaning the issuing company can change the loan interest rate annually. Oddly enough, a variable rate may de better because it allows the issuing company to maintain a higher yielding portfolio.

5. Ask the agent for the 1985 projected dividend scale and the actual dividends paid since then The agent may counter with a 20-year dividend history based on a 1969 dividend scale. The results of that are meaningless. In 1969, Moody's long term bond yield on AA bonds was only about 6%. Virtually every company that projected dividends based on a 1969 scale equalled or, in almost all cases, exceeded that scale. Only a five-year history is meaningful.

6. In the case of universal life rates; ask the broker to illustrate at lower interest rate assumptions, This will demonstrate the impact of lower actual interest credits on the cost of the product. on whole life products, some companies actually allow varying dividends (or credited interest) in illustrations. Lower yields in the dividends increase the number of payments on limited pay policies.

7. Ask if the illustration can be run with an "internal rate of return" column This tells you what rate of return the insurance company must earn on premiums to pay the death benefit based on projected life expectancy. if you see 14% compounded rates of return at life expectancy you know the illustration is aggressive.

8. Ask for the full three to four page insurance company synopsis in the AM. Best Guide. Best also rates companies; an A+ " rating is superior and is given to the top 20% of all companies. Other items include expenses and mortality costs as well as policy lapse ratios. These represent "overhead" and you want them to be "average" to "low."

9. Ask if they have reduced their dividend scale in the last five years and to give you the specifics The agent should request from the issuing company the interest rates on which the prior dividends were based.

10. Ask for the Standard and Poors or moody's claims paying rating of the issuing company. ideally, you want them to be at least "AA" in one or both. Many companies are not rated, for a variety of reasons, and this does not mean they are not good. If they are rated, though, you should find out what the rating is.

"Junk Bonds and Other Risks" in the Insurance Company Portfolio

The largest buyers of junk bonds in the U.S. are insurance companies and fund managers. About half the outstanding junk bonds have nothing to do with leveraged buyouts and are simply a vehicle for the issuing company to obtain extra leverage. Coca-Cola, Beatrice Foods, Union Carbide and Morgan Guaranty all have issued junk bonds. The risk premium on a junk bond (the interest spread between investment and non- investment grade debt) ideally covers the additional defaults expected. Through careful selection and wide diversification the risks may be minimized. Other risk investments which insurance companies acquire as part of an overall portfolio include private mortgages, private placements (ungraded bonds), common stocks, and BBB bonds (the lowest of investment grade bonds). An insurance company can obtain better yields and provide low cost insurance by investing carefully in these vehicles. You may wish to inquire from the presenting agent, however, how much of their portfolio is composed of these risks.

MSVR Reserve

State insurance departments realize that even if an insurance company had only "AAA" grade investments, market forces can make those investments worth less at a given point in time (i.e., general interest rates rise). To cover unrealized capital losses (which must be reported) insurance departments require a Mandatory Securities Valuation Reserve or MSVR. This is an additional reserve having nothing to do with death claims. Its sole purpose is to provide a stop gap against realized and unrealized portfolio losses. MSVR and capitalization, for most insurance companies, constitutes about 5% of total assets. This is low, unfortunately. Look for companies in the 7%-15% range. Both MSVR and capitalization are segregated on the balance sheets in the Best guide.


The fundamentals of an insurance company whose product is being illustrated must include high historical portfolio yields with acceptable risk, low mortality, and expense experience. Here's a selection of criteria based on the responses to the 10 questions previously asked.

1. Determine that the interest spread between current portfolio yields and the dividend interest rate (or credited interest rate in stock companies) is not more than 1 1/4 points to the negative (e.g., the dividend is based on 11.5% and the company is earning 9.5% on its portfolio).

2. Assuming you passed the "spread" test in 1., determine if there are "term" riders or policy loans" in the illustration; both add risk. If a client is over age 65 and needs a great deal of coverage at a low cost, opt for the term rider and accept the risk because of the life expectancy. Let the client know the risks. if the client is in his or her forties or fifties, avoid either of the above risks.

3. Review the issuing company's five-year portfolio yields. The industry average is about 9.3%. Remember, an insurance illustration is a projection. Because it takes 10 to 20 years to cycle a portfolio, it is extremely important that the current yields be respectable.

4. Be certain the company is A+ with A.M. Best and, hopefully, satisfactorily rated by a major credit rating service. You should also address "portfolio risk." if you are concerned with portfolio composition, go for a lower yield in the product. if you have a concern about the client's ability to pay the schedule premiums, then cash values, and particularly guaranteed cash values, may have weight in the decision. In addition, obtain competing quotes and give all the illustrations to the competing agents. Listen to their criticisms of the competitor's product and after all this, use good horse sense. The best insurance, when used in the context of an estate plan, is expensive no matter whose product you use. It typically finances something expensive like estate taxes, dependent living expenses or buy/sell agreements. Your obligation in learning about it is no less important to your client than learning how to interpret the trusts and documents that use it.


By Marc Haziza, CPA, Miller and Company, P.C

Qualified retirement plans became popular about 20 years ago when Congress enacted laws giving taxpayers an incentive to accumulate tax- deferred funds.

Today, however, an increasing number of plans are maturing, and Congress has imposed a bewildering number of requirements with respect to the timing of the distributions, the amount of benefits that must be distributed during the participant's life, the speed at which benefits must be distributed, and the penalties for premature distributions. An explanation of the various choices available to clients is appropriate when putting together a financial plan.

Distributions to Participant

Distributions of a participant's retirement benefit under a qualified plan (pension, profit-sharing, IRA, etc.) must generally begin not later than April 1 of the calendar year following the year in which the participant attains age 70 1/2. This date is referred to as the "required beginning date" Sec. 401(a)(9)(A)(i).

The benefit amount is also subject to minimum distribution rules that specify the periods over which retirement distributions must be taken from a plan and the minimum amounts that must be distributed each year. During the participant's life, distributions must be made over the life expectancy of the participant (or a shorter period), or the joint lives of the participant and a designated beneficiary (or a shorter period) Sec. 401(a)(9)(ii). Life expectancies are determined under Tables V and VI of Reg. Sec. 1.72-9, and are not necessarily actuarial lives in the case of joint life tables for non-spouses.

Distributions to Participant's Beneficiaries

when the participant dies, the beneficiary's option depends on two important issues: whether the participant died before or after the "minimum required distributions" MRDS) had begun and whether the beneficiary is the participant's surviving spouse.

If required distributions to the participant had begun during his or her lifetime, the remaining portion of interest must be distributed at least as rapidly as under the methods of distribution in effect at the time of the participant's death Sec. 401(a)(9) (B)(i).

If the participant dies before the MRDs were required to begin, his or her interest in the plan must be distributed in full by December 31 of the year that contains the fifth anniversary of the participant's death Sec. 401(a)(9)(B)(ii)). However, if the participant has designated a beneficiary with respect to his or her interest in the plan, the five year rule may be waived and distributions may be made over the life of the beneficiary (or over a period not extending beyond the life of the beneficiary); provided however, that such distributions must begin on or before December 31 of the calendar year that follows the year in which the participant dies Sec. 401(a)(9) (B)(iii); Prop. Sec. 1.401(a)(9)- 1,C-3.

Spousal Beneficiary

If the only designated beneficiary is the participant's spouse, then commencement of the distributions may be postponed until the year the deceased would have attained age 70 1/2, or December 31 of the year after the death year, whichever is later. Sec. 401(a)(9)(B)(iv); Prop. Reg. Sec. 1.401(a)(9)-1, C-3. Distributions would then be made over the life expectancy of the surviving spouse.

It should be noted that a surviving spouse may roll over or transfer the participant interest to his or her own IRA Sec. 402(a)(7). If this choice is made, the account must be rolled over or transferred by December 31 of the year following the year the participant dies.

Five Year Payout

If a plan does not have an optional provision specifying the method of distribution after the death of an employee, the distributions are to be made over the life expectancy of a spousal beneficiary. in the case of a nonspouse beneficiary, the distributions must default to a five-year payout Prop. Reg. Sec. 1.401(a)(9)-1,C-4.

On the other hand, a plan may adopt a provision that permits employees (or beneficiaries) to elect the five year rule and whether the designated beneficiary exception to that rule applies to distributions. Beneficiaries who are required under the plan to make such an election, must make it on a timely basis. For example, a non-spousal beneficiary who has elected to take a payout over his or her lifetime under the exception to the five year rule, must do so in writing by December 31 of the year following the participant's year of death. If no election has been made by either the employee or the beneficiary and the plan does not specify which rule applies, then the distributions must be based upon a maximum five-year payout Reg. Sec. 1.401(a)(9)-1,C-4.

The loss of the election can be avoided if the beneficiary is apprised of his or her responsibility and status under the plan. Once the beneficiary decides how he or she wants to receive the money, all transactions and reporting must be properly completed. Plan trustees and custodians must be notified of the selection in order to process and report distributions in compliance with IRS requirements.

A thorough understanding of the rules applicable to retirement payouts may save beneficiaries considerable effort and tax cost.

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