In our last Blog post, we recapped the year in Trust Owned Life Insurance (TOLI) for 2015 (see: The Year in TOLI – 2015 Edition). As one of the pioneers of life insurance policy management in the United States, ITM TwentyFirst has the unique ability to participate in and track trends in the TOLI industry. Almost a decade ago, we surveyed our TOLI portfolio. In 2015, we updated that survey and the results clearly reveal changes – many of which will lead to additional challenges for those of us who manage life insurance policies.
The population in our TOLI portfolio is aging. As you can see in the chart to the right, a decade ago the greatest number of insureds were in the 40-to-59 age group, which has experienced the biggest drop in the last decade. As that group’s members age, younger people are not replacing them. This is probably because the changes in estate tax laws have made it less compelling for younger individuals to place life insurance in a trust. Many of the policies in force a decade ago were placed by grantors when the federal estate tax kicked in for individuals at $1M or less. Today, estate taxes begin at $5.45M, and the need for life insurance to pay estate taxes has decreased.
Though those in the accumulation phase may not be using Irrevocable Life Insurance Trusts (ILITs) as often as their elders, this does not mean that those in the preservation phase are clamoring to drop their life insurance. The greatest jump in age groups in the last decade was the 80 – 90 and 90-plus groups. The combination of these groups makes up almost 25% of our portfolio. Like society in general, our TOLI population is aging, and this causes certain issues. Life insurance costs generally increase with age, and this increase often creates tough decisions when dealing with policies, especially those that might be underfunded. Health deterioration combined with policy failure makes policy management choices harder. Using a Life Expectancy (LE) Report as another data point when making these policy decisions will become a vital management tool as we move forward. Obtaining an LE Report may prove you took the steps to make a prudent decision even when the decision turns out to be “wrong” (see: How Using a Life Expectancy Report to Manage a Life Insurance Policy Helped Save Our Trustee.)
While life insurance policy types have not changed much over the last decade, the specific types that life insurance advisors favor have changed. When we conducted the initial ITM TwentyFirst survey almost a decade ago, the predominant policy type held in trust was Whole Life. The combination of base and blended Whole Life made up just over 40% of our portfolio. Today, that combination has dropped to just over 30%. Whole Life typically has significant cash value build-up, but some advisors think it is too expensive. After all, unless necessary for specific trust goals, the cash value in the policy is an unneeded (and perhaps costly) asset of the trust. The key to maximizing the beneficiary benefit is creating the highest internal rate-of-return on the death benefit paid on the policy, which comes from minimizing premium payments.
Term policy usage has dropped slightly, from just under 17% to just under 13% today. Most Term policies held in trusts are used for short-term needs and are either converted to permanent polices or dropped after the short-term need for the coverage is gone.
Universal Life (UL) has surged almost 50% from just under 30% of the portfolio to almost 44% today. Guaranteed death benefit UL products now make up a higher percentage of the portfolio than they did a decade ago. These come with required premiums that must be paid in full and on time which creates a tracking and administration challenge for trustees – one that comes with liability. Equity-indexed products, some with unreasonable investment expectations (see: Actuarial Guideline XLIX Will Mandate More Realistic Assumptions for Index-Based Life Insurance Policies), have increased in popularity. Variable Life has seen a slight decrease in usage. Variable Life is the only policy type that requires the policy owner to make the cash value investment selection and happens to be the only policy type that can experience a cash value investment loss. The volatility in the equity markets we are experiencing lately accentuates the special care required, care some trustees cannot provide. Today we are seeing Current Assumption Universal Life (CAUL) policies, which have been the backbone of the industry, subject to cost-of-insurance increases that threaten policy health. These cost increases, unheard of only a few years ago, have increased the premium needs on some policies by 200% or more (see: Transamerica Cost Increase Causes Premium to Maturity to Jump Over 200%: A Case Study for TOLI Trustees). Challenges abound from all of these various UL products.
Those CAUL cost increases are in part due to the historically low interest rates being paid on fixed investments, which have put pressure on life insurance carriers. A CAUL policy has a current rate being credited, a minimum rate that is guaranteed, and a projected rate at issue. It is no surprise that these rates have dropped over the last decade.
As can be seen in the chart to the right, ten years ago the average interest rate credited at policy issue was 6.19%. Today it is less than 5%. The average rate being credited currently has dropped also, by almost a full percentage point. The average guaranteed rate has dropped about .5%, and many policies currently marketed today have guaranteed rates of only 2%. Times have changed – and for those insurance products relying on fixed investments – not for the better.
As life insurance trusts age, the issues around them tend to increase. As we mentioned, over the last decade dividends and crediting rates have dropped, and the older policies tend to be more negatively affected. In addition, as trust goals change over time, policies may need to be adjusted. In short, as your portfolio ages, your risks and work will tend to increase. In the current survey, 30% of the policies were over 20 years old, and 10% were over 30 years old. Ten years ago, the number of policies with a duration above 20 years was significantly less – trustee risk has increased.
One bit of good news that we found in the newest survey was the increase in highly rated policies. ITM TwentyFirst uses a proprietary rating system that measures risk to the trustee. The current 55% of “A” rated policies represents low-risk policies expected to run to contractual maturity and pay full death benefits. This percentage has grown by almost 30% over the last ten years and represents the hard work of our clients in managing their policies. “D-“ and “F” rated policies, representing the greatest risk to the trustee because they are projected to lapse prior to maturity or life expectancy, dropped dramatically and represents less than 20% of the portfolio. While these policies represent risk to the trustee, that risk can be mitigated through remediation and documentation efforts of the trustee. For our Managed Solution clients, remediation and documentation services are included as part of the offering. A “U” designation represents unrated policies, typically group policies with limited information or policies we are in the process of rating.
Challenges for TOLI Trustees have changed over the last decade as insureds aged, products changed and interest rates have fallen. However, insurance remains a critical component of many estate plans and we’ve seen the value insurance plays in the life of beneficiaries. So the key is for TOLI trustees to make sure they are prudently managing the policies for the beneficiaries. Although life insurance is a peculiar financial instrument and the decisions that must be made around policy management are rarely black or white, having the appropriate processes, procedures, policy information, policy reviews and remediation expertise can really help trustees mitigate liability and deliver results for the client.