By Norman A. Pappas
Jan. 7, 2010
If you own a business, chances are you also own life insurance. The most common reason for owning insurance is also the most obvious: death benefit protection. This can mean anything from providing income for your family, to protecting your business from creditors, or providing funds for the all important buy/sell agreement.
As a good business owner, you have planned for these contingencies and backed up your plan with life insurance. So your job is finished and you can move on, confident that this is taken care of and requires no more attention, right? Unfortunately, that’s wrong. In most cases, modern life insurance policies include non-guaranteed elements that can result in your losing the protection your family and business are relying on. This is the land mine that could explode, jeopardizing the most carefully laid plans.
A brief history of life insurance will help explain. Prior to the 1980s, whole life policies had guaranteed death benefits and guaranteed premiums that you paid forever. They returned low interest rates, but provided certainty, and built cash values that could be accessed during life for emergencies.
Then came the 1980s with its high interest rates and inflation. Life insurance consumers were no longer content with the low returns of whole life. Insurance companies responded by creating policies that were built on current, non-guaranteed, interest rates. Called Universal Life, these policies provided permanent insurance at a lower cost than had previously been available, with premiums based on interest rates of 10 percent or more. As rates dropped (today they are 4 to 5 percent, or less), the original pricing assumptions did not hold up. The result was premiums that had to be paid longer than expected or, in many cases, had to be increased. Failure to monitor the policies and make necessary adjustments could result in the loss of coverage.
Then came the 1990s, with its high stock market returns. Now consumers were no longer satisfied with fixed interest rates. Insurance companies responded by creating policies that accessed the equity markets for policy returns. This again provided genuine value to buyers for a long time. But as market returns went south, so did policy performance. The result was the same as in the previous generation of products: costs were increased, and failure to monitor and adjust put benefits at risk.
The latest generation of permanent insurance policies, called No Lapse Guarantee Universal Life, guarantees the death benefit, the premium, and the years to pay. It sounds like whole life, but it’s different. The costs are generally lower, and there is less cash value. Nonetheless, it offers another valuable alternative to the insurance consumer.
The point is that all policies require auditing for changing times and circumstances. If performance has fallen behind expectations, the sooner corrective action is taken, the better. There are many rescue plans available for underperforming policies.
There are other reasons that insurance policies should be reviewed on a regular basis, including ownership structure, tax status, insurability, the need for cash value, and the amount of insurance needed. (If policies are not needed, secondary markets can buy policies for a nice profit for the owner.)
Objectives change throughout the years, and serious money can be lost by not reviewing your policies. In these tough economic times, it is especially important to plan wisely for the needs of your family and business. Just as the policies are an important part of your financial picture, ongoing policy audits should be a routine part of your financial life. This is the only way to avoid future land mines.
Norman Pappas is president and founder of Pappas Financial and the author of several articles on business and estate planning topics. His book, Passing the Bucks, is a guide to business succession and wealth transfer planning. He can be reached at [email protected].