The economic and financial impact of COVID-19 was the theme of the year for 2022. For the first time in decades, the country – and central bank – had to address inflation pressures. Possible rewording: rising interest rates has led to an inverted yield curve and negative returns in fixed-income, a significant equity market pullback, and the threat of a recession. The threat of a recession or stagflation leads us into an uncertain 2023. Politically, the Republican party was able to narrowly take control of the House of Representatives leaving us with a split government.
Life insurance will continue to be an important asset class that can be designed and implemented to fit a number of objectives. The industry has adapted and changed coming out of the peak of the pandemic, creating more efficiencies in underwriting and providing new product features to allow life insurance to be incorporated into more planning objectives.
Themes for 2023
Looking into the future, here are the concepts, insurance designs and industry trends we anticipate for 2023.
Higher interest rate environment won’t immediately pass through to higher crediting rates on Current Assumption or Whole Life (dividend rates). The General Accounts of life insurance carriers are segmented and invested with a consideration on liabilities and duration; this leads to a mix of 10 and 30-year highly rated bonds as the primary investment vehicles. Carrier’s Net Investment Earned Rate (NIER) will lag the Federal Funds rate significantly due to reinvestment on portfolio turnover.
One immediate effect of rising rates will be carriers are willing to raise maximum premium thresholds
Annuity products will react much quicker to rising rates. Unlike the longer duration asset-liability match on insurance products, annuities have and will continue to reprice much quicker to keep in line with fixed income alternatives. For the first time in several years, we expect to see a continued ramp on Single Premium Immediate Annuity (SPIA) payout rates, increases to fixed deferred annuity rates (particularly on shorter guaranteed rates) and guaranteed growth and income riders for lifetime income.
Life insurance products are being revamped to add increased versatility in the underlying crediting mechanism. While Indexed Universal Life (IUL) continues to be the permanent product in the marketplace, many providers are adapting their Variable Universal Life (VUL) chassis to include index options along with a fixed account, which essentially creates the ability to use one policy with access to the full suite of universal life crediting mechanisms.
The traditional Guaranteed Universal Life (GUL) marketplace will continue to be limited. As an alternative, current assumption products will include options to “dial” a secondary guarantee to life expectancy or longer.
There will be further delineation between protection, accumulation and legacy planning and the product designs. Determining the proper product for the ultimate objective for the coverage will be increasingly important as different pricing structures become available from the same providers.
Protection: Term insurance and emphasis is on lower cost, low cash value permanent designs. Permanent policies can be paired with Long Term Care Rider riders for increased portfolio protection.
Accumulation: Focus on higher cash values, usually with a design to ‘monetize’ tax-free income.
Legacy: Focus is on tax-adjusted IRR at expected mortality for perpetuating wealth to next generation.
DESIGNS AND CONCEPTS
Repositioning the cash value of existing permanent policies can improve money already dedicated to insurance to current needs. A change in objective between protection, accumulation and legacy objectives should be evaluated to determine if a more tailored product and insurance design is warranted. It is important to understand moving into a new product may create new surrender periods, create a taxable event and/or introduce higher fees.
Adjusting Risk Tolerance – After several years of robust equity performance, Variable Universal Life policies should be analyzed to determine if asset mix matches long-term risk tolerance and time horizon. For contracts where funding was paused or eliminated, review to make sure cash values are sufficient to support the policy going forward.
For “outside” assets, e.g., a managed portfolio, adding permanent insurance as an asset class may significantly improve the tax-adjusted expected return with a lower expected risk (standard deviation of returns prior to, at and after Life Expectancy)
IRA Reallocation will continue to be an attractive alternative to inherited IRAs under the SECURE Act.
Adapt the “Wait-and-See” Design to fund the contract at earlier ages with better insurability using current cash flow or existing assets with intent to switch funding from after-tax RMDs.
Combine guaranteed income solutions (such as SPIAs or annuities with guaranteed lifetime income) or 10% free withdrawal feature of Fixed Indexed Annuity (FIA) to match a funding source to the premiums required. Depending on the design, this provides full principal protection with upside potential.
For those that inherit an IRA and are subject to the 10-year rule, analyze the benefit of using annual distributions from the inherited IRA to fund an accumulation-design insurance strategy that can be monetized in the future to establish a tax-free income source.
ROTH conversions provide a solution for income tax treatment, but do no address moving the after-tax assets outside of the estate.
Estate Tax Planning – The increased lifetime exemption provided by the Tax Cuts and Jobs Act (TCJA) is set to “sunset” on December 31, 2025 with lifetime exemptions set to revert to 2016 levels ($5MM per person) indexed for inflation. This is a significant reduction from current levels. When life insurance is owned by an Irrevocable Life Insurance Trust (ILIT), the death benefit proceeds are typically paid income tax-free to the beneficiary (the Trust) and death benefit proceeds may avoid estate taxes; therefore, the death benefit proceeds can be considered double tax-free assets. The economic value of life insurance is the income and estate tax-equivalent IRR at expected mortality.
In states with an inheritance tax (e.g., New Jersey), non-“Class A” beneficiaries (spouses, children, parents) are subject to additional taxation. Life insurance proceeds are exempt and therefore a tax-efficient vehicle to transfer assets to extended family and unrelated beneficiaries.
Medical and financial underwriting is the ultimate determinate of the price and availability of life insurance. Proposed solutions are generally based off hypothetical underwriting classifications. The informal underwriting process allows clients and their advisors to survey the marketplace to investigate insurability and pricing, generally through a review of a clients’ existing medical records. The informal process is non-binding and at no cost to the proposed insured and should be the first action item after a solution has been determined.
The industry continues to move towards accelerated underwriting. More providers are offering and/or expanding their capabilities in providing accelerated, electronic and/or fluid-free (no medical exam) underwriting process. While this leads to a more streamlined and efficient process for healthy individuals, it can create additional steps for proposed insureds with complex medical histories and should be deployed tactically.
COVID-19 related restrictions are easing; however, the social and behavioral impacts of the pandemic are still important for the medical underwriting process. The pandemic saw an increase in the use of recreational and medical cannabis, social drinking and a greater emphasis on mental health. Providing detailed, accurate information is important to achieve the best rating without a last-minute adjustment to rate class and pricing.
THE TAKE AWAYS
In an evolving economic, financial and tax atmosphere, a properly designed, implemented and monitored life insurance strategy can provide significant advantages to a financial plan.
Existing life insurance policies will continue to react to changes in the equity and interest rate environments and need to continually be reviewed to evaluate whether the coverage is still meeting the objective in the most efficient way. This is especially true of insurance solutions that used financing or leverage as the primary funding source.
While medical underwriting is becoming more user-friendly, it is still a complex and nuanced process that can take several weeks or months to reach optimal conclusion. Understanding insurability and how that relates to pricing is the usually the most important factor in determining the viability and competitiveness of a solution.
Designing a strategy that can work in and through multiple environments is critical. Understanding the downside risk and upside potential of an insurance solution is essential when comparing a life insurance proposal to other alternatives.
Life insurance is more than just protection tool used to replace lost income or match a specific liability. The tax characteristics, anticipated risk and return of life insurance should be evaluated not only in isolation, but also as a component within an overall portfolio.
The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Before implementing a strategy involving life insurance, it would be prudent to make sure you are insurable. As with most financial decisions, there are expenses associated with the purchase of life insurance. Policies commonly have mortality and expense charges; if a policy is surrendered prematurely, there may be surrender charges and income tax implications.
Annuities are insurance contracts that pay a lump sum or an income stream over a certain period of time. Generally, annuities have mortality and expense charges, account fees, investment management fees, administrative fees, and possible surrender charges during the early years of the contract. Withdrawals prior to age 59½ may be subject to a 10% tax penalty. The earnings portion of annuity withdrawals is taxed as ordinary income. Any guarantees are contingent on the financial strength and claims-paying ability of the issuing insurance company.