In today’s rapidly evolving life insurance market, to fully protect their clients advisors should understand how life insurance companies are rapidly rewriting the rules. Selecting the right policy is essential to any financial plan whose goal is to protect the financial future of high-net-worth individuals and their families.
Most breadwinners under the age of 40 should be advised to carry large amounts of relatively low-cost term insurance to protect their loved ones. An informed advisor has rarely been more important since the term insurance market has turned into a veritable obstacle course.
The good news is that your clients continue to benefit from highly attractive term insurance rates. For example, a 40-year-old male in excellent health need spend roughly only about $600 annually for every $1 million in coverage and get that rate guaranteed for 20 years.
The problem is that during our prolonged low-interest rate economy, insurance companies have struggled to make a sufficient return on their investment. Compounding the issue are conversions that don’t require any additional underwriting. Because most people convert their policies due to a decline in their health, mortality rates rise significantly for policy holders after the initial period after conversion, according to a 2016 study by the Society of Actuaries. As a result, conversions are costly for insurance companies.
Restrictions on Conversions
Rather than raise rates and risk losing market share, insurance companies have added restrictions on conversions to maintain profitability. Yet, as our clients live increasingly longer lives, the consequences can be high if we fail to plan to ensure access to affordable life insurance for the long term.
Buyers of term insurance will discover that fewer policies provide full conversion rights and most now restrict when they can convert and which permanent policies are open to conversion. As a result, choosing the right term insurance policy can mean the difference between staying protected for as long as your client needs it and losing coverage down the road. The best products should provide policy owners the most choice over the longest time frame.
Need for Ability to Convert
As we all know, various changes or unforeseen events in life can impact one’s need for insurance. When young adults shop for life insurance, their goal is to protect their family’s standard of living and future life choices. In today’s marketplace, their best option is to buy term insurance because it’s the most competitive and well-priced policy to fully protect the security of the family for a specified time.
When the insured couple’s children grow up, the couple often reevaluate their insurance needs, and many find they don’t need insurance any longer. Or 20 years down the line, the insured may find new reasons to wish to continue to carry life insurance. These reasons may include an adverse health event or a new family with dependent children to protect. Maybe they’re supporting parents, siblings or a surviving spouse or perhaps they’ve taken up a dangerous hobby.
Another reason may be that their income and net worth have risen dramatically, and they may need insurance to help finance estate taxes or equalize inheritances. If they don’t have the ability to convert the term insurance, they would need a new physical examination and may not be eligible for the preferred pricing category they obtained two decades earlier—or no longer be insurable.
Maybe they’re still in excellent health, and buying new insurance will be easy and affordable, but maybe they’re not, which means buying a new policy will be a far more difficult and expensive transaction.
Keep Options Open
While most term policyholders ultimately don’t convert to permanent policies, wise planning will keep your clients’ options open. Because advisors have no idea what life conditions their clients might face in 10 or more years, our job as professionals is to advise them to hedge their bets just as insurance companies do when underwriting potential clients.
For some clients, it may be worth paying a little extra to keep the full conversion option through the life of the term policy or to the maximum conversion age, typically aged 70.
One option that isn’t feasible is to continue the term policy beyond the initial term period. At the end of the term, premiums either skyrocket, or with some carriers, the death benefit may be automatically reduced. In either case, without conversion, the coverage will be lost.
The renewal rate for a $10 million 20-year term for a once-healthy 50 year old, who had a rate of $16,000, jumps at aged 70 to $500,000 and, by 80, to $1.75 million a year. The only people who would continue a nonconvertible policy after the term period are those who, due to poor health, can’t acquire a replacement policy and whose life expectancy is short.
The upshot: Clients should buy term with the most favorable conversion rules possible. Think of the conversion option as insuring your insurance.
How clients purchase life insurance can be just as important as which insurance they buy. Term insurance consumers should consider working with a service-oriented firm that will keep them informed of industry and policy changes, as well as offer advice on evaluating their insurance coverage. Most life insurance companies don’t provide much notice to fully assess whether conversion makes sense, and internet providers typically offer no agent or ongoing service.
In contrast, service-oriented firms will keep track of deadlines and conversion options and alert clients when carriers suddenly change the rules, such as limiting which permanent policies are available for conversion. If the insured or third-party owner isn’t paying attention, the conversion period could pass, and, at the end of the term period, if that person still has a need for insurance coverage, he could lose valuable protection.
If the need for insurance disappears, a client in poor health may not want to convert but might be thrilled to sell the policy in the settlement market and possibly have a windfall or recover all or a portion of the paid premiums. Without the conversion option, the policy’s value in the settlement market would be close to zero. A good advisor can be indispensable when making these decisions that can have such a long-term impact on clients’ financial well-being.
New Restrictions on Term
While it was once standard for an individual term policy to be fully convertible to all products offered for sale by the carrier, the life insurance industry has over the last few years instituted a range of restrictions or limited flexibility for converting term policies to permanent insurance. These include:
- Limiting the conversion period. Typically, for a 10- or 20-year plan, an individual can convert to any permanent policy prior to the fifth anniversary of the contract. Many offer conversions on 20-year policies only up to the 10th anniversary.
- Increasing minimum face amounts of insurance to be eligible for conversion.
- Preventing or restricting a healthy insured in the early years of a term policy from reducing the face value of the policy.
- Restricting individual term policies from being fully combined when converting to a new second-to-die policy.
- Reducing the maximum age for conversion, now as low as 65.
- Automatically reducing the face amount at the end of the term period.
From my perspective, the long-term outlook for life insurance companies still looks excellent. People are living longer, and insurance companies will continue to profit from mortality improvements, especially with the more restrictive conversion options in place.
If, like many, your clients take their health for granted and expect to live in good health well into the future, they should be smart investors and take some insurance out on that. In this competitive market, we think young clients should be buying as much term life insurance as they can. And the best deals must include full conversion options.