Bill Clooney is an 87-year old family patriarch who has planned extensively for his retirement and for his family’s future. With his good health and lifestyle, he has had few concerns. As Bill and his wife Martha take a leisurely stroll on a sunny Tuesday afternoon, he is thinking that his life is close to perfect. He has always been a strong planner, and it has served him well in his life and his business.
Bill planned carefully for his retirement. He had investments and cash that he expected would take care of him and Martha comfortably in their sunset years. Their son and daughter, now grown with families of their own, have stayed close to their parents. Their daughter Janice owns and runs the family business. Bill’s original plan was to pass the business on to both children, but his son James had other ideas for his life. When Bill retired, Janice got the business, and James was given a promissory note for $500,000. A $1 million insurance contract was purchased on the life of Bill to protect Martha and the business and to pay off the note to James and his family were something to happen to Bill… A perfect plan.
Even in 2007 when the economy plummeted and the business needed cash, Bill had the means to loan the business $1 million to keep it solvent. By doing so, however, he was substantially jeopardizing his retirement income.
Suddenly Bill receives a wake-up call from his trustee. It seems that Bill, like most others in our country, really hadn’t planned for the weak and fragile economy. In spite of the $527,000 Bill has already paid in premiums, his insurance contract will lapse in just four short years. The economy has kept the interest rates at a very low 4% (much lower than the projected 10% when this policy was written).
It seems that rather than a ‘perfect plan’, conditions may be brewing for the ‘perfect storm’.His estate plan is not going to work if the life insurance contract is no longer in-force! How will the business pay the note to James and his family? How will the business repay the 2007 cash loan? And if the business is unable to repay the loans, will there be enough money to provide for Bill and Martha for the remainder of their lives?
Of course, Bill has a lot of questions. Where did his plan go wrong? Can his initial plan be salvaged? How much can he now afford to spend on insurance? Should he look for a new policy or find another solution? Bill’s trustee, an attorney, doesn’t have good answers and is starting to really worry. In fact, without a solution, the trustee is thinking of resigning rather than face potential fiduciary liability issues.
So what can be done about the failing life insurance contract and the approaching storm? The attorney reached out to Insurance Analytic, a member of the Wealth Legacy Family of Companies to see what could be done.
And although the hole is very black, we have been able to shine some light and provide the following options:
1. Bill could die early – clearly not a popular option for Bill or his family! Kidding aside, his children think that Bill will likely be vibrant and active for ten years or more, despite his actuarially projected life expectancy of five years. They fully expect him to live well beyond that five-year projection.
2. Continue to pay the current premium. Given present interest rates of return, the contract will expire in four years. Given the children’s expectations that Bill will live for at least ten more years, having the life insurance contract “expire” is not acceptable.
3. Increase the premium to keep the contract in effect to age 100. Unfortunately, the new premium would be nearly $90,000 per year – almost twice the current premium. By age 100 this would be nearly $1.7 million in premium… for a $1.0 million contract.
4. Borrow premiums at attractive loan rates available today. If we borrowed $2 million and paid 3% per year, the $60,000 of interest would be less than the $90,000 per year to keep the contract to age 100. That 3%, however, would not be a fixed rate, and interest rates would likely increase over his expected life-span. Further, even with a $2 million “dump-in” to the contract, the numbers after repaying the loan simply do not work out.
5. Purchase new insurance. Despite Bill being in excellent health, at age 87 the options for new insurance are limited and the premiums greater than simply modifying his existing contract.
6. Sell his contract on the “secondary” life insurance market. There are pools of investor money looking for alternative places to invest their money. Life insurance is one such option. However, in looking at the cost to carry to age 100, at 9% per year, the secondary market is not interested. Their necessary rates of return do not come even close to making this work.
7. Consider international markets and a tool referred to as “Private Placement Variable Life Insurance.” The premiums for this type of insurance can actually be stocks, bonds, mutual funds, real estate, etc. in addition to or as an alternative to using cash. These products also have very low costs of mortality, premium taxes and administrative charges in comparison to “retail priced”, domestic insurance contracts like Bill’s current coverage. Unfortunately, however, this option is not viable given Bill’s age.
8. Keep the current contract, continue the premium of $48,000 per year, but reduce the amount of insurance to $565,000 – an amount that will keep the contract in effect until age 100. The $527,000 of premiums paid already represents a “sunk cost” … an irrevocable expense that will not be recovered. The tax-free return of $565,000 will probably be a break even figure, ignoring the past premiums (gulp), given Bill’s projected life expectancy of ten years, but represents the best alternative of the eight options considered. This will help repay the loan the business owes Bill and his wife.
There are no “simple” solutions to this challenging dilemma of Bill’s. However, it is impossible to make an informed decision without information! Now Bill has options to shelter himself and his family from the ‘perfect storm’.
Written by R. J. Kelly – July 2012