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Jan 1991

Are the economics and flexibility of your joint and survivor life insurance realistic? (Personal Financial Planning)

by Rubin, John

    Abstract- People considering the purchase of a joint and survivorship insurance policy, in which benefits are only paid after the death of both spouses, should examine the policy closely to determine whether the economics and flexibility offered by the policy are realistic. A break-even test should be performed to calculate the economics of the policy: there should be an approximate 19-year break-even mark for policies for 65 year olds. The policy should be checked for term insurance riders which make the break-even years unrealistic. Another factor to consider is how the mortality costs are calculated. When analyzing the flexibility of joint polices, the ability to break the joint and survivor policy into separate policies and the ability to switch between whole or universal life contracts should be checked.

This seemed very aggressive so I did a break even analysis to determine how many years you would have to invest $8,983, at say 8-1/2% interest, to hypothetically produce the $1 million death reserve in which to pay the claim. The answer was 29 years. If the wife were the survivor she would have to live to age 94 for the insurance company to break even. Since this $8,983 was not a guaranteed rate, and inordinately large rate increases could be expected in the future. Even well-known life insurance brokers may prepare comparably aggressive projections.

In addition to the issue of economics, there is the issue of flexibility. Joint and survivorship insurance is based on the assumption that estate taxes are, and will always be, due and payable on the death of the last surviving spouse. It also assumes both spouses stay married till death do they part. On large policies, it may also be dependent on current gift tax laws for funding. Since any of these laws or your clients marital status may change, how flexible is their insurance?

Rely on Your Basic Sensibility--The Economics

With advances in modern medicine it's certainly true that people are living longer. This, however, shouldn't skew your basic sensibilities on joint life expectancy in the future. You want your insurance company to err conservatively if they err at all. Virtually no policy illustration has guaranteed everything. The first test on an illustration is the aforementioned break even test. You'll need a programmable calculator, or ask the life insurance broker to perform it. Use an 8-1/2% credited interest rate for the analysis. Normally insurance companies earn more than 8-1/2% on invested funds, but they still have expenses, including commissions and overhead with a profit to make.

What should you be looking for in terms of results? in the case of two 65-year-olds (male and female) you want to see approximately a 19-year break even; on two 70-year-olds, you want to see a 16-year break even, all based on life expectancy tables. Ask the life insurance broker to prepare break even calculations for other ages using these guidelines. In cases where the insurance company has illustrated a "limited pay" policy (i.e., eight years) it may be more difficult to calculate. What you do is enter the premium for seven years and then determine the number of years to break even. If the break even years exceed the guidelines, either the premium is likely go up, the face amount go down or the number of payments on a limited pay policy increase sometime in the future.

Look For the Term Rider

The second thing to look for in an illustration is term insurance riders which make break-even years seem unrealistic. Find them by looking at the top of the illustration. Normally, when these riders are used, insurance companies will divide the death benefit at the top of the illustration into two parts, base and target term rider (TTR). A $1 million face amount might be $300,000 base and $700,000 TTR. The TTR is term insurance which is supported by dividends. If the dividends are unrealistic, a drop in the dividends will either create a permanent drop in the face amount or a substantial increase in the premiums. Why is this the case? Term insurance costs go up each year relative to the insured's new attained age. The projected increasing dividends are supposed to pay the increased costs. If, however, the dividends are less than projected, the policy owner pays these increased costs.

Mortality Costs

The third factor that affects the pricing structure on joint and survivorship policies is how the mortality costs are calculated within the policy. Since the insurance company pays a death benefit only after the second to die, the benefits paid in early contract years may be low. When one insured dies then logically the individual mortality rates should apply. In many cases, the illustrations do not reflect this nor does the insurance company pricing strategy. Ask the presenting agent, "what happens to the cost of this insurance when one of the insureds dies?" If nothing happens it's an aggressive posture or the insurance company may have built a cushion by initially charging higher mortality in the annual premium. Determine if there will be an increase in the rate at the first death. A widow should not be left with a burdensome insurance premium when her spouse dies.

Can You Disjoin?

The first issue to address when reviewing the flexibility, of joint policies is the ability to disjoin" them, breaking the joint and survivor policy into two distinct individual policies. Some companies do not permit disjoining, some offer it as an option at the time of the original purchase, while others include this ability at no charge. A few companies require evidence of insurability. Some actually create a special "conversion" policy that pays full commission to the agent at the time of the split while adversely impacting the cash values of the new split contracts. This is especially harmful in periods of falling dividends.

Policy splitting is an important feature because your client may be divorced or tax laws may change. Splitting allows for change.

Whole or Universal?

The second issue of flexibility has to do with the type of joint and survivorship contract--whole or universal life. In a whole life contract, you have a maximum premium but limited flexibility to after face amount without some adverse economics. This ability to change face means a great deal if dividends have fallen and the husband dies leaving the wife to gift premiums to her children or a trust. At the death of the first spouse the maximum annual exclusion gift falls from $20,000 to $10,000 per individual. Changing face amount may be the only way to deal with keeping within the exclusion limits. It is easier with universal life to change face, but the nature of the product is also riskier than whole life. Ask the presenting agent questions on both the ability to disjoin the policy and the ability to lower the face amount. Also, the agent should provide the costs associated with each.

Closing Thoughts

The ideal joint and survivorship insurance product is one that is priced appropriately and is not overly interest sensitive. It permits disjoining and is issued by a reputable company. Can you find all the above? This is a difficult task since complying with the ground rules could produce an expensive product. However, even a good joint and survivor contract will be quite a bit less expensive than individual contracts.

If insurance is to perform according to the original plan instead of providing future shock, your client should seek reasonable assumptions on mortality and interest, and reasonable product flexibility.

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