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So now that LIAM (Life Insurance Awareness Month) is finishing up, let’s review.

Actually, let’s just keep it simple.  Did you review your life insurance program?  Why not?  Do I have to schedule the appointment for you?!  What more impetus do you need?

LIAM  is about understanding life insurance and its applications.  So let’s take a look at an application that maybe you haven’t thought of: insuring your parents.

The first thought that many people have on this is “That’s morbid!”  Death is an inevitable part of life, and understanding that death will eventually come allows us to embrace life even more, to be able to plan ahead with clear thoughts instead of emotional reactions.

Life insurance is designed to create an estate at death, whether it is when you are thirty and have young children and a mortgage that need to be taken care of, or when you are eighty and have grandchildren.  Assuming that Mom and Dad want to create a legacy to help their grandchildren or to assist grown children financially, life insurance is a smart financial planning tool.  Let’s look at a case study.

Assume that Mom and Dad are 70 and have three kids.  One of the kids is very successful, one is OK, and one is a financial mess because they just are lazy and has never grown up.  Let’s for simplicity say that each of the kids has two kids, so there are six grandchildren.  Mom and Dad are retired and aren’t going to worry about money, but aren’t lavish.  They have “enough, but not too much”.

Successful son knows that ultimately his brother that is a mess is never going to be able to send his kids to college nor own a house because of his inability to be a financial grown up (he has no mental or physical disabilities, just lazy and made a lot of mistakes).  The OK one will not be able to send his kids to school without a tremendous amount of student loans even though he is hard working and intelligent because of his career choice.  The successful one is not concerned about his children’s education or his own financial future, but does not want to be his brother’s keeper for the rest of his life.  So what should he do to make sure that he helps his relatives while not coddling or insulting them?

He buys life insurance on Mom and Dad.  He names the other brothers and their kids as the beneficiaries (and his kids too so that his wife doesn’t complain).  And he makes sure Mom and Dad sit down and explain the planning to his brothers.

When they pass on, each grand child and the other two brothers get one eighth of the insurance proceeds (say $100k each for ease of discussion), expected in a bit over a decade.  This will be enough top cover state school education for each of the grandchildren, guaranteeing at least a basic level college education.  If they want to go to a higher level school or for graduate work it will be the kid’s responsibility to cover the additional costs, but getting the threshold education covered is a huge help and very important to Mom and Dad.

There is also enough money for the OK child to either supplement their children’s education or their retirement savings, basically making sure that they too will be financially OK for the rest of their life.  They won’t be rich, but they will not be completely stressed about money.  The insurance makes their life a bit easier.

And the brother that is a mess?  His kids will have the chance for their education, something he would have never been able to achieve.  There will be an influx of cash to allow him to eventually buy a house if that is the goal, or actually be able to save for retirement.  Yes, he could blow it on stupid things like muscle cars and beer, but with some pre-planning by Mom and Dad that too could be avoided and this child protected from themselves (especially if they have a chemical addiction).

And the successful son, what does he get?  Peace of mind!  He knows his nieces and nephews will get a decent education so that they have a shot at success.  He knows his OK brother will continue to be OK, even a little better than that.  And his mess of a brother will not be his financial responsibility ever again.  Successful brother has basically bought himself independence from the financial and emotional burden of the rest of his family by planning ahead with Mom and Dad.

And Mom and Dad get to spend more money on themselves and their grandchildren while they are still here because of the life insurance planning.  They have a guarantee of a legacy for the future, so can go ahead and spend a bit more and spoil their grandchildren like all good grandparents do because now they can do so with a clear conscience.  All because of the life insurance.

As it is still Life Insurance Awareness Month (LIAM), let’s continue to focus on the discussions of what life insurance is and more importantly what it does.

Life insurance is not a religion, it is a tool.  It is a contract that shifts a large risk to an organization that can bear it for small systematic payments (premiums).  People who say “I don’t believe in life insurance” might just as well say “I don’t believe in mortgages” as they are similar in nature (large asset purchased with small payments) or “I don’t believe in probability”, because the mathematics underlying life insurance is actuarial science.  There is little faith, just math.

Now that we have changed the discussion somewhat away from a belief to knowledge, let’s expand our knowledge further to get a better grasp on what the life insurance tool can do.  Let’s look at the specific subset of life insurance applications known as COLI, which is Corporate Owned Life Insurance.

COLI is actually more regulated than just personally owned life insurances because of some perceived abuses on broadly based leveraged COLI (so called “janitor’s insurance”), being under the auspices of not just the Treasury but also the Department of Labor for documentation and fair use reasons.  Assuming that a company has met all the requirements from these organizations, the internal cash value growth of a COLI policy continues tax deferred and the death benefits when paid are 100% income tax free (per section 101j), just like personally owned policies.

As a corporation can have a life time that is longer than that of a human and the ownership thereof is transferred to others over time (sale, gift, etc), there are often multi-decade capital needs that COLI helps offset, especially in organizations that must repurchase shares from existing shareholders.  The classic example is an ESOP repurchasing ownership from retiring or dying members.  Life Insurance is by far the most effective way to fund this as it allows the repurchase to be done for pennies on the dollar, thus allowing more capital to be deployed elsewhere and accelerate the growth of the organization.

Furthermore, if cash value policies are used they can further leverage the value of the company in that the internal growth of the cash value will exceed cash equivalents while maintaining liquidity.  The fact that the cash grows on a non-taxed basis enhances this value, especially in the current extremely depressed interest rate environment.  Four percent tax free blows away 1-2% taxable over a several decade period, directly contributing to the corporate bottom line and hence value.

 This discussion is ignoring the fact that key individuals to the corporation directly positively impact the organization and as such have intrinsic value that needs to be protected.  There is no question that insuring a key machine makes economic sense, and there should logically be little dispute about applying the same financial concept to the people that make the money for the company.  This concept of “key person coverage” will be explored at another point.

To boil it all down: life insurance, when used properly, is a great corporate asset that will create tremendous value for employees and owners, ultimately creating more jobs and tax revenue in the community.  It is a tool that in the right places makes great sense.

 

Let’s talk about life insurance insurance for a few minutes as it is Life Insurance Awareness Month, or LIAM. Specifically let’s talk about how much life insurance you should have.

Basically you should have enough life insurance to make sure that any obligations you have are taken care of, and that any dreams you have don’t die with you. There are all sorts of calculators available from the major life insurance companies or LIFE (The Life Insurance Foundation for Education), but instead of an esoteric black box gadget I want to give you a few basic back of envelop ways to figure out ballpark how much coverage to purchase.

First, how much debt do you have? You should start with that much coverage (total) so that you do not burden others with your debts. AS for the mortgage, it makes sense to purchase the full amount owed to create a cushion and flexibility but to generally not pay it off for tax reasons.

Add to this number expected end of life needs. The last number I saw was the greater of $15,000 or 4% of your net worth, unless you are in a “complex scenario” meaning you have a business, particular property (like the family cabin in the mountains that everyone wants), or will have to pay estate taxes. We believe that this number is a little conservative because it does not take into consideration more than the most rudimentary medical bills or if there are any special desires such as my huge Irish wake, but it can be a good starting point. Dying is more expensive than most people believe.

If there are any future expenditures (like college costs, Sweet 16 Party, etc), add the current price of these in. Yes, college is going up faster than the general inflation rate, but we will take this into account in a few different ways to make sure that the kids still graduate from Whatsamatta U.

Add to this what is needed to produce the income stream that is needed. First calculate the net income needed (after taxes) on a monthly basis, then subtract from here the after tax income that you can count on (spouses income, pensions, Social Security, etc.). This leaves the monthly income shortage. To cover this we need insurance that will generate an income stream upon death, and a good rule of thumb is $1 Million buys $2,000 a month of income, after taxes, adjusted for inflation, for the rest of your lifetime. So if you need an additional $1,500 per month of income for your wife to supplement her income and the Social Security, the calculation would be:

Income Generation # = $need/month x ($1M/$2,000/month)

= $1,500 x ($1M/$2,000)

= $3/4 M

=$750,000

Then you add up the debts, the final expense costs, future needs, and the amount needed to generate the income. If you have any existing insurance subtract it from the total, and you get the total amount of insurance you should be buying to make sure that your dreams don’t die with you. It is probably more than what you thought. But insurance is designed to replace you as an economic entity,m and you are going to be dead a long time so that income needs to be replaced.

One note, we didn’t put in the safety factor yet. Take the number you got and add 10% and you have a good financial engineering fudge factor to cover stock market declines (like now), bonds having low interest rates (like now), spiralling property tax bills (again, like now) and the sundry other things that can affect the best laid plans.

Remember that this is just a back of the envelop calculation, but it makes a good starting point for your planning if you want to verify what an agent has told you or want to try and figure it out on your own.

So today I take off for the NAIFA Conference (National Association of Insurance and Financial Advisors) in DC.  While there  I will be attendng the Real Life Stories Dinner, where people whose lives were dramatically impacted by insurance tell their story.  There is never a dry eye in the place, and it really drives home the importance of what members of the insurance profession do.

Here are some clips.

Tracy’s Story

Karim’s Story

It is LIAM, Life Insurance Awareness Month.  And life insurance has gotten a bad rap because of misuse, of not using the right type of coverge.

First let’s talk about efficiency.  If you have a twenty year need (say cover a mortgage, or cover a baby’s college costs), then permanent cash value life insurance is the most cost effective and efficient way to get the death benefit.  Really anything over roughly a decade swings the numbers to favoring permanent coverage as the most cost effective way to get the death benefit that is needed (UMCG has all sorts of research and analysis proving it).  If the need for coverage is under five years then term insurance is the only way to effectively get the coverage, essentially leasing the death benefit because of the short time horizon.  Great for things like covering cost of education for a high school student, or loans for businesses et al.

In the mid range (5-10) years there is no bright line solution as to which is better, and often a small permanent policy with term insurance layered on top is the best way to go as it gives some flexibility and some efficiency, both of which are needed usually.

I HATE seeing people use the wrong setup.  Businesses with strong cash flow buying term insurance are beinig cheap, and penny wise but pound foolish.  It will cost them significant amounts of money: we did an analysis for a client and if they were touse the permanent coverage (easily within their cashflow constraints) it would literally translate into tens of millions of dollars more for them, or about one and a half percentage points PER YEAR increase in the ROR of the company valuation.

And having people with short term needs buy permanent insurance is just greedy on the part of the seller.  And unfortunately it is all too common.

On the other hand, we have a need for death benefit.  If a client (individual or company) has a $2M need, they better buy $2M of coverage.  Even if they have a twenty year need, the primary purpose of insurance is to provide the check if anything happens, and that check has to be big enough so that the family or business is OK.  It disgusted me when young agents were being held up as idols for selling someone a quarter million dollars of permanent coverage on a young parent and then paying the death claim.  That $250,000 wasn’t going to last that family of five young kids very long, nor would it pay for college or keep them in their home.  There should have been at least four times that amount of coverage and it should have been term insurance (primarily) to make sure that the ultimate check was big enough.

Having the right type of insurance coverage is second only to having the right amount.  Having enough is the primary concern, and any agent that sells a permanent policy because it pays them more instead of fulfilling the client’s death benefit need in the appropriate way should be taken out behind the wood shed and beaten.

Today is September 1st, which means it is the start of Life Insurance Awareness Month (LIAM).  The entire moth will be dedicated to education about life insurance.

This year’s celebrity spokesperosn is Lamar Odom of the LA Lakers.  Here is his story.

LIAM

Aug 31

Tomorrow starts LIAM, Life Insurance Awareness Month.  Look for a series of posts on this.