Life Insurance Policy Valuations

Transcription

1 Life Insurance Policy Valuations New Challenges Bring New Opportunities Presented by: Martin Financial Group 315 Commercial Drive, Suite A4 Savannah, GA 31406

2 DISCLAIMER All rights reserved. No part of this work covered by the copyrights herein may be reproduced or copied in any form or by any means graphically, electronically, or mechanically, including photocopying, audio/video recording, or information storage and retrieval of any kind without the express written permission of the Consultants Training Institute (CTI ), the National Association of Certified Valuators and Analysts (NACVA ), the Institute of Business Appraisers (IBA ), and the presenter. The information contained in this presentation is only intended for general purposes. It is designed to provide authoritative and accurate information about the subject covered. It is sold with the understanding that the copyright holder is not engaged in rendering legal, accounting, or other professional service or advice. If legal or other expert advice is required, the services of an appropriate professional person should be sought. The material may not be applicable or suitable for the reader s specific needs or circumstances. Readers/viewers may not use this information as a substitute for consultation with qualified professionals in the subject matter presented here. Although information contained in this publication has been carefully compiled from sources believed to be reliable, the accuracy of the information is not guaranteed. It is neither intended nor should it be construed as either legal, accounting, and/or tax advice, nor as an opinion provided by the Consultants Training Institute (CTI), the National Association of Certified Valuators and Analysts (NACVA), the Institute of Business Appraisers (IBA), the presenter, or the presenter s firm. The authors specifically disclaim any personal liability, loss, or risk incurred as a consequence of the use, either directly or indirectly, of any information or advice given in these materials. The instructor s opinion may not reflect those of the CTI, NACVA, IBA, their policies, other instructors, or materials. Each occurrence and the facts of each occurrence are different. Changes in facts and/or policy terms may result in conclusions different than those stated herein. It is not intended to reflect the opinions or positions of the authors and instructors in relation to any specific case, but, rather, to be illustrative for educational purposes. The user is cautioned that this course is not all inclusive National Association of Certified Valuators and Analysts (NACVA). All rights reserved South State Street, Suite 400, SLC, UT, The Consultants' Training Institute (CTI) is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted through its web site: learningmarket.org National Association of Certified Valuators and Analysts (NACVA) 2

3 Valuing Life Insurance 3

4 Historically Client or Advisor would contact the insurance carrier Ask for policy value A week later they would receive it Form 712 Cash Value Premiums Paid ITR (Interpolated Terminal Reserve) PERC Client or Advisor picked the appropriate value and moved down the road 4

5 What s Changed? Increase in Types of Policies Increase in Regulation of owners Businesses Trust Disclosure and Tracking Old IRS Regulations are not as relevant State Law differences Insurance Companies reporting practices 5

6 Why Do We Care? Confusion and complexity create a need for confidence in the right answer. 6

7 Industry The marketplace is huge American families have more than $19.3 trillion worth of life insurance protection through individual policies and group certificates. 146 million individual life insurance policies were in force at the end of Of the new individual policies issued in that year, 64 percent were permanent life insurance policies. Sixty-two percent of all people in the United States were covered by some type of life insurance in 2013, according to LIMRA s 2014 Insurance Barometer Study. Life insurance net premiums written for 2013 was $126.1 billion. 7

8 Valuation 2 Types Income Tax purposes Transfer Tax purposes Gift Generation Skipping Tax Estate 8

9 Life Insurance Evolution 60s-70s 80s 90s 00s Today 9

10 Term Insurance Annually Renewable This is a pure death benefit without cash value. The policy is renewable annually without proof of insurability. The premium increases each year with age based on underwriting classification. These policies normally have a right to convert to permanent life insurance without proof of insurability. Level Term The carrier guarantees a fixed term premium over a period of time in blocks of five years up to 30 years depending on the age of the insured. Since the premium is fixed, it is generally higher than an annual renewable term premium in the early years of the level term. These policies usually have a conversion to permanent life insurance feature without proof of insurability. Even if renewable at the end of the term, the premium for the renewed policy will be significantly higher. Group Term This employer provided insurance is available to a group of employees without proof of insurability. The first $50,000 of employer provided coverage is income tax free to the employee. Any excess coverage is generally taxed to the employee using the Table I rates in the regulations. 10

11 Permanent Life Insurance Policy Types Whole Life Current Assumption Universal Life (Traditional) Indexed Universal Life Variable Universal Life Guaranteed Universal Life Policies Payment Options Single Premium/Limited Pay Policies Pay for life 11

12 Whole Life Insurance Whole Life The premium is fixed for the life of the insured and the death benefit is guaranteed if the premiums are paid (either by the owner, policy dividends or cash value loans). A minimum cash value growth is also guaranteed. The cash value growth is low in the initial policy years in order for the carrier to recover its front-end expenses in case the policy owner surrenders the policy or lets it lapse. Thus the carrier assumes the mortality, investment return (for the guaranteed cash value), expense and lapse risks of the policy. As a result, in setting the premium, the carrier makes very conservative estimates in determining the risks. If the policy performance exceeds the conservative estimates, the cash values may exceed the guarantee and mutual carriers may pay dividends and the stock carriers may credit for larger policies, additional interest to the policy account values. Dividends and interest sensitive payments are not guaranteed. Death benefit is normally fixed at the date of policy purchase. However, the death benefit may increase without proof of insurability through purchase of paid up additions with policy dividends or the exercise of a guaranteed purchase option rider added to the contract. 12

13 Current Assumption UL Current Assumption Universal Life (Traditional) It is a general account subject to carrier creditors. These are called flexible premium policies. The owner may pay any amount of premium, may change the amount paid or even skip premium payments for some years. The owner normally sets a target premium payment designed to keep the policy in force during the insured's lifetime but it can be changed. The death benefit is adjustable within limits. The annual premium payment is placed into the policy cash value account with the annual expenses, premium taxes and mortality charges being deducted. The carrier will credit current interest to the cash value annually: universal life policies generally do not pay dividends since the cash value reflects all charges, expenses, premium payments and interest credits. The carrier will guarantee the death benefits only as long as the cash value is able to pay the mortality and other charges and policy expenses. The cash value is not guaranteed but the carrier normally guarantees a minimum interest credit to the cash value. There are several types of death benefit options for universal life policies. (i) Option A-level death benefit regardless of size of cash value or premium payment. However, the death benefit can be increased in order to meet the definition of life insurance contract under IRC Section (ii) Option B-the death benefit is the initial death benefit plus the cash value. Since the pure death benefit remains fixed, the mortality charge will increase as the insured ages. (iii) Option C-the death benefit is the initial death benefit plus the aggregate amount of premiums paid on the policy. 13

14 Indexed Universal Life Indexed Universal Life These are the same as traditional universal life policies except that all or part of the cash value may be invested in indexed equity funds (DOW, S&P, NASDAQ) subject to a floor on losses, a ceiling on gains and participation rate equal to a percent of growth rate. Indexed policies are between traditional and variable policies since they have some investment exposure. There is no minimum guaranteed interest credit. 14

15 Variable Universal Life Policy Types Variable Universal Life These are traditional universal life policies but the owner is able to invest the cash value in investment funds made available by the carrier including bonds, equities, money markets, etc. These are securities for SEC purposes. Any cash value invested in investment funds offered by the carrier are separate accounts from the general account of the carrier and therefore are protected from the carrier's creditors. Because of the insurance policy wrapper, any sales and reinvestments of the separate accounts are free from income tax at the time of the sale or reinvestment. To the extent invested in these separate accounts, there is no minimum guaranteed interest credit to the cash value by the carrier. Variable universal life has the potential advantage of a greater return on the investment but it is also potentially the most volatile of the cash value investments. All investment risk is shifted to the owner. Whole life variable policies are also available but they are not as popular as the more flexible variable universal life policies. A variable whole life has fixed premiums, guaranteed not to lapse (if premiums paid), but cash value and face amount may vary. 15

16 Guaranteed UL Guaranteed Universal Life These are universal life policies where the carrier guarantees the death benefit if the agreed annual premiums are timely paid. If the premium payments are not timely paid, the secondary guarantee of the death benefit is lost. There is no flexibility of premium payments. These policies are for owners who are more interested in the death benefit than the cash value build up. The premium is lower than for traditional universal life policies but there is little or no cash value available at surrender. There is no carrier guarantee of a minimum interest credit to the cash value. Some policies avoid loss of guarantee by catch-up premium payments or a positive shadow account. Loans or withdraws are either prohibited or limited because of small cash value. If the annual premium is timely paid, the carrier assumes all of the risks of mortality charges, expenses, and investment return. 16

17 General Rules for Gift Tax 2 Rules Willing Buyer/Willing Seller Actual Sale or Comparable Contract Rule What if these don t exist or aren t readily ascertainable? 17

18 Gift Tax What if? When actual sale or comparable contract is not available A. Value of a brand new policy Initial cost or premiums paid B. Value of a limited pay policy or single premium New single premium cost for similar coverage (Reg. Section ) Cash value or Interpolated terminal reserve (ITR) if higher than replacement premium C. Value of a policy in-force with future premiums Interpolated terminal reserve D. Value of existing Term policy Annual Renewable Term unused premium (no ITR) Level Term unused premium and ITR 18

19 ITR Interpolated Terminal Reserve 19

20 ITR Interpolated Terminal Reserve What is it? A. An amount designated by the insurer to fulfill its obligations under the contract B. It is determined by making pro rata adjustment upward between the previous terminal reserve and the next terminal reserve C. Designed for Whole Life insurance policies D. Several different reserves for Universal Life policies 20

21 The Dilemma 21

22 Actual Value Example (712) 22

23 Estate & Gift Tax 23

24 Estate & Gift Tax 24

25 Estate & Gift Tax 25

26 Income Tax Guidance 26

27 Example 1 Example 1 Female, age 64 $6.2 million policy death benefit Guaranteed Universal Life Policy Policy has been in-force for 6 Years $840,000 paid in premium ($140k a year) Just bought a new $7 million death benefit policy for annual premium $170k Insurance company said it was valued at $2,000,000 27

28 Example 2 Example 2 Male, age 48 $5 million policy death benefit 20 Year Term policy Policy has been in-force for 4 Years $32,000 paid in premium ($8k a year) Insurance company said it was valued at $56,000 28

29 Other Rulings 29

30 Revenue Ruling

31 Willing Buyer / Willing Seller 31

32 Potential Market Value 32

33 Secondary Market OLD WAY LAPSE FAIRLY OLD WAY SURRENDER RELATIVELY NEW WAY LIFE SETTLEMENT 33

34 Capital Markets The Closing and Funding Process 6 The Client Decision Generating and Negotiating Offers 5 4 THE LIFE SETTLEMENT ADVOCACY PROGRAM 1 2 Discovering Life Settlement Opportunities Evaluating Potential Opportunities 3 Initiating the Life Settlement Transaction 34

35 Policy Appraisal Report 35

36 Settlement 1 36

37 Settlement 2 37

38 Settlement 3 38

39 Settlement Disclosures 39

40 Full Circle Life Insurance Example 1 Needed to confirm insurance company s valuation of $2,000,000 Alternate methodology willing buyer/willing seller Examined the Secondary Market for Life Settlement Found Additional premiums required for guarantees Interest rate increases impacting carrying cost Life expectancy reports indicated almost 20 year joint life expectancy (outside target range) No potential buyer offered the total premiums paid ($840,000) Determined there was no market for this policy Which provided an alternate valuation Tax preparer utilized the alternate valuation in gift tax filing instead of Form

41 Knowledge Determine the situation in which the policy may be transferred Determine the type of policy, when issued and current status (including loans against the policy) Make sure the lawyer is involved to keep Privilege Ask for Informal 712 Valuation(s) Analyze other valuation methods 41

42 Missing Link Client NACVA Tax Preparer Insurance Company 42

43 MFG & M3 Advisors Martin Financial Group Family run financial services firm headquartered in Savannah, GA Independent and provide unbiased advice coupled with best-inclass solutions M3 Advisors Independent consults specializing in privately held businesses Focus on your most important asset first your business Unique combination of business, financial, and tax expertise along with a multigenerational vision 43

44 Questions Questions? Disclosure under IRS Circular 230: This communication is not intended to and does not comply with the U.S. Treasury Department s technical requirements for a formal legal opinion. Consequently, it cannot be used by a taxpayer to avoid any penalty that might be imposed on a taxpayer. Nothing in this communication may be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement to any person. Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Please consult your own independent advisor as to any tax, accounting or legal statements made herein. Fee-Based Planning offered through M3 Advisors, LLC a State Registered Investment Advisor. Third Party Money Management offered through ValMark Advisers, Inc. a SEC Registered Investment Advisor. Securities Offered Through ValMark Securities, Inc. Member FINRA, SIPC, 130 Springside Drive, Suite 300 Akron, Ohio * Martin Financial Group, LLC and M3 Advisors, LLC is a separate entity from ValMark Securities, Inc. and ValMark Advisers, Inc. 44