I recently received another communication from a life insurance company seeking to buy back from the policy owner a life insurance policy issued years earlier. Deals like this happen periodically, but this is the first time I’ve seen it from this carrier.
In these situations, the insurance company offers the policy owner more money than the current cash value to redeem the policy. This approach often takes the policy owner by surprise and they start asking questions. The first is “Why would they do that?”
These situations usually involve Guaranteed Universal Life (GUL) policies. GUL policies have a guaranteed premium and a guaranteed death benefit and often have little or no cash value, especially compared to more traditional policies. I would imagine that if a given policy owner had, say, a more traditional $1 million policy with a cash value of $300,000, they would be more likely to think about surrendering it to use the cash value at other purposes than if it were a $1 million policy. GUL policy with $50,000 cash value. A GUL with no cash value offers no incentive to redeem except the promise not to pay future premiums.
Benefit for the carrier
It’s a matter of economics and what would be in the best interest of the financial position of the insurance company. Some of the policies they have issued over the past year have proven to be “too good of a deal” for clients. Let’s say there is a $5 million life insurance policy with a cash value of $300,000. Given the age of the insured, regulations regarding the amount of money the insurance company has to cover claims, and other factors, the company would like the customer to buy out the policy for the $300,000. , as this would be far less than the future liability funding of $5 million. But the customer doesn’t want to surrender, so he offers more than cash value as an incentive. Economically, it is simply better for the insurance company to try to get that liability off the books.
If economics dictates that it is better for the carrier to buy out the risk and the obligation, it seems that the target policies might be ones that it would also be in the policyholders’ interest to maintain. I’ve seen offers on quite disparate GUL policies, but when you calculate the internal rate of return (IRR) on the current cash value and the continuing premium on future death benefits, the lower the cash value, the higher the IRR. This comparison does not necessarily make the IRR better across the entire transaction, from policy issuance to death benefit payment, but from a midpoint to the end, a lower cash value GUL policy generally provides a higher IRR than a traditional higher cash value policy.
When evaluating the offer, the policy owner should reconsider the original purpose of the policy. Do they still need it? Is the reason they originally purchased life insurance still valid or, if things have changed, is there another current need? If they decide to take advantage of the offer, it is important that they understand the potential tax consequences of surrendering the policy. An attractive offer may result in a gain that would be taxable upon redemption.
Rules of life?
The first thing I would advise a client who receives such an offer is to think about it: “If the insurance company wants it because it’s a better deal for them to buy back the death benefit today today, maybe someone else would be interested as well.”
I’ve already done it. In a few cases, it turned out that the life insurance market ended up thinking the policy was also attractive. In fact, they felt it was more attractive than the insurance company and ended up making a higher offer. In the end, the policy owner was left with more, a third party got the deal they wanted, and the insurance company was left with the policy remaining on the books.
Bill Boersma is CLU, AEP and Chartered Insurance Advisor. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.com or by e-mail at [email protected] call 616-456-1000.