Single-Premium Whole Life Insurance: Module V-C

Single-Premium Whole Life insurance came into its own following the 1986 tax reform law. A number of investment strategies lost their attractiveness, including Individual Retirement Accounts, while Single-Premium Whole Life offers tax-deferred interest for investors, plus Life insurance. In some cases, interest from a Single-Premium Whole Life policy comes out tax-free.

You may have read that Single-Premium Whole Life policies pose potential tax problems-we'll tell you more about these problems in this section, so that you can decide for yourself how you wish to proceed. One thing is certain-there is a great public demand for the product, so it bears looking into. When you add Single-Premium Whole Life insurance to your Life arsenal, you're establishing your agency as up to date and knowledgeable in both financial services and Life insurance.

Single-Premium Whole Life insurance is exactly that: a Whole Life insurance policy paid for by a single premium. The lump-sum contribution ranges from a minimum of $5,000 on up. The average payment is $20,000 to $25,000, but recent studies show that the averages are increasing. Standard agency commission, which is premium-driven, ranges from 3% to 6%.

The Life insurance part of the policy works like a regular policy. The insured pays a one-time premium and earns interest on that premium, or investment. The policy's interest rate depends largely on the marketplace, but generally is guaranteed to be at least 4%. If the policy is left untouched, at death it will pay out, tax-free, the full face amount, which includes the premium plus accrued interest. And, like all Life insurance, Single-Premium Whole Life provides estate liquidity. Death benefits go directly to the beneficiary without any income tax liability and without going through probate.

However, the real benefit of Single-Premium Whole Life insurance is as a cash accumulation vehicle. There are few vehicles available today that allow an investor to put money in and draw money out without having to pay immediate taxes on it. Single-Premium Whole Life provides that advantage. The insured pays the lump sum, earning interest on that amount. The amount of interest earned each year may be borrowed, tax-deferred, usually with a zero interest spread. Because the interest rate charged on the loan is usually the same as the interest rate credited on that loan, it is 'interest-free.' The insured can continue to borrow the interest each year and, as long as he or she does not lapse the policy, at death the death benefit is paid out tax-free. The insured must be aware, however, that any borrowing from the policy reduces the net death benefit payable.

If the policy is completely liquidated, all the interest, borrowed and unborrowed, is subject to taxation. So, at the very least, Single-Premium Whole Life insurance is tax-deferred. The insured has had the money working for him or her for a period during which otherwise he or she would have had to pay a portion to the government.

Many Single-Premium Whole Life insurance companies offer one-year 'free looks.' An insured can decide at the end of the first year that he or she doesn't want to continue the policy. The carrier returns the entire premium amount, keeping only the interest, which, in effect, has become the surrender charge.

However, policies surrendered after the first year incur surrender charges starting around 7% to 10% and dropping 1/2% to 1% each year thereafter. Surrender charges generally are in place for 7 to 10 years.

Underwriting requirements vary. Some prospects may have to undergo a physical examination; selection is based on age, medical history, and policy size. Under no circumstances should gaps between coverage be allowed.

To summarize, Single-Premium Whole Life offers some clear-cut advantages:One Payment

• Single-Premium Whole Life requires only one premium payment. Life insurance is provided just like other Life insurance products, but no future premium payments need to be made.

Superior Investment Provided

• As an 'investment' vehicle, Single-Premium Whole Life insurance is in many cases a superior product to IRAs, annuities, CDs, and other investment strategies. Single-Premium Whole Life often pays a higher yield than other vehicles, plus it offers Life insurance.

Tax-Deferred Interest Accrues

• The interest borrowed from Single-Premium Whole Life's principal is tax-deferred. In fact, as long as the principal is not liquidated, borrowed earnings will not be taxed. Only when an insured borrows from his or her Single-Premium Whole Life policy and then liquidates the principal will the earnings and principal be taxed. (One important note about Single-Premium Whole Life prospects: This product is different-buyers are usually investment-oriented and not necessarily insurance-oriented. More sales are made by analyzing multi-year interest rate guarantees, bailout clauses, and guaranteed borrowing costs than with other types of policies.)

CONS

There are also disadvantages to Single-Premium Whole Life:

Substantial Premium Up Front

• Single-Premium Whole Life insurance requires a substantial up-front premium payment, which may limit your prospecting.

Taxable If Lapses

• If the insured continues to borrow from the policy, he or she must make sure the principal never reaches zero. Once that occurs, all the accumulated interest becomes taxable.
• Some consider the policy very inflexible-once the client has purchased one, getting out can be prohibitively expensive. The tax bill for the earnings build-up can be immense-and most companies charge a healthy surrender amount.

Laws May Change

• Many clients aren't buying Single-Premium Whole Life to reap the surrender value at its endowment, but some will live that long. And the policy may create a problem for policy holders who live to that age (often 95 years old). Based on the values of several such policies, it can be argued that if the policyholder lived to receive the surrender value, he or she would also receive an IRS 1099 form for taxes on the total of loans received, including the borrowed interest, creating an enormous tax liability.

HOW TO CHOOSE A SINGLE-PREMIUM WHOLE LIFE CARRIER

Of course, when selling any type of Life insurance, it's important to examine the stability of the carriers whose policies you're writing. But there are some areas that loom as critical in the capital intensive environment of Single-Premium Whole Life, where death benefits are a smaller consideration and investment solidarity, return, and liquidity are of greater importance.

For that reason, we present some information that may allow you to weed out companies that, for a number of reasons, might fail to perform adequately. By 'perform adequately,' we don't mean to alarm. According to authorities, there is no known case of a policyholder losing guaranteed cash values or guaranteed interest because of a Life company failure or bankruptcy. However, you do need to examine your companies to judge which may or may not maintain current interest rates and values. The elements you'll want to examine are listed below.

Here's the information you'll need:

1. First, obtain an annual statement for each carrier you're considering-these are filed with your state insurance department.
2. Also, obtain the larger Best's report or the condensed individual company Best's reports furnished by most companies.
3. Take advantage of any information offered by home offices or knowledgeable field representatives.

Now, the following are areas you'll want to explore:

Best's Rating: Try to use only companies that are rated 'A' (Excellent) or better.

Capital, Surplus, and MSVR: A high ratio of capital, surplus, and Mandatory Securities Valuation Reserve indicates financial ability to meet contingencies even in an adverse market.

Net Profit from Operations: This is an additional source of money to meet contingencies, and an important source of stability.

Net Return from Investments (Before Taxes): Compare the net return to what is being paid to policyholders on Single-Premium products, keeping in mind that the company needs a 1.5% to 2% spread to remain profitable. If the spread is narrower, there may be a shortfall in the future.

Corporate Parents: The history and attitude of the parent company toward an insurer can be very important. Any recent change in ownership should be carefully weighed. Examine the recent direction of insurer investments, loans, transfers, and so on.

Healthy Growth: Level or falling sales are rarely healthy, but sales must not exceed company's capacity to meet surplus strain, either. Net profits and capital raised should be able to cover surplus strain from new business.

Capital Raising Ability: Does the company have the ability to raise additional capital to fund growth or meet contingencies?

Accurate Matching of Assets and Liabilities: The investments made by the carriers you choose should correspond to the length of time the average client invests in the product. Investments in common stock or other non-fixed income investments is a major mismatching (in most cases) of Single-Premium Whole Life liability with the assets backing it. Longer-term bonds have substantial interest rate risk. A rising interest rate environment is especially dangerous to long-duration bond portfolios because depressed bond values make the bonds very illiquid just at the time when cash outflows may be highest.

Investment Guidelines: It's up to you to judge the viability of a company's investment philosophy as defined in its investment guidelines. Consider risk in the light of available margins to meet contingencies.

Forward Commitments: Companies with large forward commitments in a rising interest rate market can experience severe problems.

Separate or Segregated Custodial Accounts for Single-Premium Funds: This is a plus in asset/liability matching and in monitoring investment results.

Independent Investment Advisers: Outside expertise may be a plus, especially for companies in which size does not justify a well-staffed, highly professional investment department.

Other Business Lines: Avoid companies with trouble in other business lines, as this could spill over and limit performance of their Single-Premium Whole Life products.

Renewal Rate Histories: Review of this area can be enlightening relative to a company's abilities and character.

Preponderance of Business from Stockbrokers: A company that receives most of its premium from stockbrokers may be handling too high a percentage of 'hot money.'

Brokerage: Some financial advisers believe that it's better to go with companies that are either very heavily or exclusively involved in brokerages, on the theory that they are more likely to be focused on meeting the needs of their brokers. That might prove important if you are brokering Single-Premium Whole Life products.

This list is by no means all-inclusive, but it is a good summary of the factors you need to examine when you analyze the companies you'll use to write a product like Single-Premium Whole Life insurance.

Single-Premium Whole Life insurance appeals to a variety of prospects. All must have a large sum of money readily available in some form or other, but as we will outline, there is a surprising number of such prospects. Keep in mind that you can't convince a prospect to buy a Single-Premium Whole Life policy unless he or she already has the money.

Prospects range in age and income level, but all need some type of investment vehicle. A Single-Premium Whole Life prospect could be new parents with hopes of college for their children; someone who wants a strong, safe investment-plus Life insurance; or a person nearing retirement age who wants financial security for the retirement years.

Here are some of the individuals who may be interested in Single-Premium Whole Life:

1. Existing P/C clients: Many of your clients probably are not aware that you offer Life insurance, much less that you can provide them with such an advantageous investment opportunity.
2. Existing Life clients: Take a look at your present clients to see if there are individuals who have outgrown their present policies. You may have some good prospects for a rollover into a Single-Premium Whole Life policy.
3. Existing Prospects: The magic word is prequalify. To invest in a Single-Premium Whole Life policy, prospects must have a significant sum of money saved. If the prospects don't have the lump sum, there's no use explaining the benefits of the policy to them. But again, be sure they realize that this sum may be generated by cashing in their present Life policies.
4. Standard-vehicle investors: Over $1 trillion is invested right now in standard vehicles such as Certificates of Deposit, passbook savings accounts, money market accounts, and treasury bills. About 75% of your clients and prospects have one of these investments.
5. Municipal bond holders: A substantial number of your clients and prospects invest in municipal bonds-the municipal bond market amounted to $97 billion in 1986. What are the drawbacks? The rate of return is locked in for five to 30 years. The bond may decline in market value and the interest must be reinvested as it is received. Retirees must consider this interest income in determining their income for the year. If they have earned more than the law allows, some Social Security benefits probably will have to be repaid to the government.
6. Clients with IRAs: Approximately 80% of your clients have IRAs-show them how to continue receiving tax-advantaged treatment with this Life policy.
7. Commercial Lines clients and prospects: Don't forget to market the policy to businessowners. Businesses can use Single-Premium Whole Life to meet a variety of insurance and financing needs. It provides lowcost, flexible Key-person insurance; can fund a buy-sell or deferred-compensation agreement; and can reduce accumulated earnings to safe levels.
8. Older prospects: Those within 10 years of retirement who have a healthy income are prime candidates for Single-Premium Whole Life.
9. Annuity holders: Although not a tax-free transaction, Single-Premium Annuities can be exchanged for Single-Premium Whole Life insurance. Cash accumulations from an annuity must be taxed eventually, unlike Single-Premium Whole Life accumulations.
10. Charity supporters: Target wealthy individuals who donate large sums of money to charity. They would be responsive to a Life insurance plan that would allow them to give more money to their favorite charity and, at the same time, earn more money each year.

The following ideas should help you target Single-Premium Whole Life insurance to the above-mentioned prospects: