Managing mortality risk with life insurance diversification

Transcription

1 Managing mortality risk with life insurance diversification

2 Diversification is an important strategy for mitigating investment loss by selectively combining noncorrelated assets in an investment portfolio. Financial professionals use diversification as a core strategy to help clients accumulate wealth and prepare for retirement. Knowledgeable professionals work hard to make sure their clients assets are well diversified over a variety of asset classes. Diversification strategies can also be applied to life insurance policies. Life insurance and diversification Just as diversification can help us become wealthier by managing investment risk, it may also help us manage our mortality risk. Although we don t like to think about it, death is a big risk to our financial well-being. Death ends our ability to earn and save. It can also trigger an outflow of assets to pay off debts and liabilities. Life insurance death benefits can help replace lost future earnings and provide funds to pay costs and expenses triggered at death. Many people use a one policy approach to manage the financial consequences of death. They purchase a single life insurance policy to meet their death benefit needs. This is a simplistic way to manage mortality risk that limits their options and may not maximize the value of their premiums. By using just one policy, they are putting all their life insurance eggs in one basket. Diversifying life insurance coverage across two or more policies can potentially help us get more value for the premium dollars we spend. It s common for some death benefit needs to be temporary while others may continue until death. Temporary needs can be covered by term insurance; long-term needs can be covered by cash value life insurance. Diversifying coverage through a combination of term and cash value policies can help us shift our focus from the cost of our coverage to the long-term value we can receive from it. 2

3 Can multiple policies really provide more value than one policy? Potentially they can. To understand how, it may be useful to share some observations: Life insurance needs aren t static; they change over time As our families change, our need for life insurance death benefits may change along with them. Having the right amount of coverage is a moving target. As children are born, the need for death benefit coverage increases. As they graduate from college and start living on their own, the amount of life insurance coverage we need decreases. As we take on debt (e.g. a home mortgage) our needs increase; as we pay down debt, needs decrease. The need for life insurance seldom ends at retirement Retirement is often a big transition in life. When we retire our financial priorities and risks change. Although it changes over time, our need for life insurance protection seldom retires when we do. We ll still need money to pay our funeral and final expenses. Our debts will still have to be paid. Our spouses and partners will need financial protection after we retire just as they did while we were working. Our financial stability may have to last over two lives, not just one. As we age, our risk of illness and uninsured medical expenses increases. Because we won t be working, we won t be able to earn our way out of financial problems. Consequently, we ll likely be more financially vulnerable. Life insurance may help us and our spouses/partners deal with the new risks we ll face during retirement. Term insurance is usually designed to end before life expectancy Term insurance is designed to provide temporary death benefit coverage. Many insurers structure their term policies to end before average life expectancy.* Even if we re healthy, it can be difficult to purchase term policies that guarantee coverage after age 85. If a term insurance policy lapses before death, the death benefit protection will be lost and the premiums paid into it will have been wasted. Inflation decreases death benefit purchasing power The value of our life insurance is best measured at the time we die. That s likely to be a number of years after we purchased our coverage. Inflation is the slow, steady rise in prices over time. It is a silent force that steadily erodes the purchasing power of our life insurance death benefits. For example, if inflation averages 4% annually, after 18 years a $500,000 death benefit will only have the purchasing power of $250,000. Policies can be structured to benefit the insureds When properly funded and managed, some types of life insurance have the potential to pay out benefits to policy owners while they are still alive, even if they are also insured under the policy. Life insurance doesn t have to be just for our families; it may also benefit us. * According to the Social Security Administration s 2014 Life Expectancy Calculators, an average 65 year old man can expect to live to 84 and an average 65 year old woman can expect to live to 86. 3

4 A process for managing mortality risk Managing mortality risk requires us to look to the future. We need to manage our policies so they produce the right amount of death benefit at the right time. We need a process to efficiently manage our mortality risk from year-to-year as we age. Here is a four step process for managing mortality risk: Map Our Life Step 1 Step 2 Insurance Time Line Determining how much life insurance to have can be difficult because death benefit needs change over time. The starting point for life insurance needs begins today with an estimate of our current needs. An interactive life insurance calculator can help quantify how much life insurance we need today. The Voya Life Companies (Voya) life insurance needs calculator can help us estimate our death benefit needs. It can be found in the Life Insurance section of Voya.com. Voya s calculator asks us to estimate how much coverage we ll need by looking at eight different areas. The calculator totals Step 3 the entries, subtracts current coverage and liquid funds to determine if we have a coverage gap. The eight areas of potential need include: Outstanding mortgage balance Education (college) funds Final and medical expenses Replacement income for survivors Other debts Estate transfer costs Charitable contributions Emergency funds Step 4 The Time Line has the most impact when the numbers are converted into a graph or other visual display. A visual summary shows the ebb and flow of death benefit needs over the balance of our lifetime. As the years go by, death benefit needs may decrease. If the mortgage is paid off or if children graduate from college and join the work force, death benefit needs may decrease. A workable Time Line is a picture of where we expect to be going. It should track our coverage needs in five year intervals. Summarize Current Coverage, Health and Options It s important to understand where we are today. To do so, we need to summarize our current health, our current life insurance policies, and the options available for additional coverage. By comparing what we have today with our Time Line, it s possible to see if our coverage has gaps or inefficiencies. The state of our current health is an important factor in deciding what coverage options are realistically available. Adverse changes in health in the future could make it impossible to acquire new life insurance protection. Decide on a Policy Mix Based on our Time Line (Step 1) and our current position (Step 2), we can help design a life insurance strategy to meet our objectives. An experienced financial professional can help us with recommendations for new coverage and/or adjustments to existing policies. The recommendation may suggest a combination of term insurance and cash value life insurance. The term insurance can be used to cover the temporary needs (those expected to end after a specific number of years or end at retirement). The cash value policy(ies) can provide coverage designed to last well into retirement. Policies can be stacked on top of each other to meet death benefit objectives that change over time. Manage and Review Regularly Our lives and families can change quickly. As a result, it s important to review/revise our Time Line regularly. As situations change, our life insurance policies may need to be adjusted to meet our objectives. Because of the potential for change, it is important that the Policy Mix established in Step 3 is flexible and can be adjusted as changes take place. Every two or three years, we should review our situation and our policies in three ways: 1. Revisit current and long-term death benefit needs 2. Evaluate policy performance 3. Assess the impact of inflation on death benefits 4

5 Important time line considerations Our Time Line can be a valuable tool to help us manage our mortality risk. A big part of its value comes from the fact that it focuses on the future. Just as investing for retirement is about having enough assets and income to fund our future retirement lifestyle, managing mortality is about having the right amount of death benefit coverage in place at death. The Time Line helps us see how our needs could change over time and how the purchasing power of our coverage could change as well: Time Focus. A discussion about our Time Line should focus on three different ages: Age Today, Projected Retirement Age and Age of Life Expectancy (generally 85 for men, 88 for women). The question to be addressed is: What are our death benefit needs at each of those ages? Impact of inflation. This is important. Most of us think about the future in terms of today s dollars. We make many financial decisions based on what our dollars can buy today. We often carry this mindset with us when we are making decisions about the future. Failing to factor in the impact of inflation on future spending power could lead to problems. Because inflation steadily decreases the purchasing power of our money over time, we need to consciously consider it in our retirement income and death benefit planning decisions. An annual retirement income of $100,000 may seem adequate today. However, if inflation averages 3% annually over the next 20 years, its purchasing power will be reduced to $57,029 in 2015 dollars. Similarly, a $500,000 death benefit today may seem adequate. However, after 20 years of 3% annual inflation, it will only buy what $285,143 would buy today a 43% reduction in purchasing power. Because of its impact over time, we can t afford to ignore inflation s impact. 5

6 Case study The hypothetical case of John Williams John Williams is 40 and married with three children ages 4, 8 and 12. John uses Voya s life insurance needs calculator and determines he needs $750,000 of death benefit coverage today (see below). But down the road he thinks his needs will change. He s confident each of his children will have college degrees and be financially independent by the time they are 25. When he retires at age 60, he believes his mortgage and other debts will be paid off. He also thinks his Final Expense and Emergency Fund needs will be reduced to $50,000. In total, he expects to need only $250,000 of death benefit coverage when he retires. Age 40 Age 60 Mortgage and other debts $250,000 College funding $200,000 Final expense and emergency $100,000 Income replacement $200,000 Total $750,000 John s Time Line and policy strategy Final expense and emergency $50,000 Income replacement $200,000 Total $250,000 Of the $750,000 of death benefit he needs today, John considers $500,000 of the coverage to be temporary and $250,000 to be permanent. After consulting with his financial professional, John decides that a combination of a $500,000 of 20 year term policy and a well-funded $250,000 cash value policy will meet his family s needs. The 20 year term policy will expire when he turns 60. He plans to retain the cash value policy for the balance of his life. If he decides he wants to have more coverage during retirement, he may be able to convert all or part of the term policy into cash value coverage before it ends. The ability to convert term insurance into cash value life insurance could increase his flexibility in managing his mortality risk Year Term Insurance $500,000 Temporary Death Benefit Amount (in thousands) $750,000 $250,000 Cash Value Life Insurance $250, Age 2015 Dollars

7 Case study Impact of inflation Like many people, John is thinking of his future death benefit needs in terms of today s dollars. He s forgotten that during the 20 years between today and retiring at 60, inflation will increase the costs of the goods and services his family will need. Even if the average rate of inflation during this period is low, its cumulative effect could be significant. This graph tracks the death benefit coverage John expects to have both in today s dollars and in future dollars adjusted for inflation at a 3% annual rate. John Williams Time Line This graph shows how this policy mix works for John. By comparing the 2015 Dollars line and the Inflation Adjusted line, we can see how inflation reduces the spendable value of John s coverage over the years. Unless he revises his strategy, his coverage won t provide his family the death benefit purchasing power he wants them to have. (Appendix One has a table showing the inflation-adjusted numbers.) 800 Death Benefit Amount (in thousands) Age Inflation adjustment (3%) 2015 Dollars The premiums for cash value life insurance policies can often be set at a number of different amounts. It may be possible for John to manage the policy and select an annual premium amount which results in the policy s death benefit increasing from year to year. If John uses this premium strategy, he may be able to provide his family with policy death benefits which keep up with inflation and maintain their purchasing power. 7

8 A Possible Accumulation and Protection Planning Strategy Voya s Accumulation & Protection Planning (A.P.P.) Combo strategy has been designed to show how we may be able to manage our life insurance needs more efficiently. The A.P.P. Combo concept combines the purchase of two Voya life insurance policies: one term policy and one cash value policy. The use of the term insurance policy may reduce the costs associated with our total life insurance coverage. The cash value life insurance policy, while also providing death benefit protection, has the potential to provide policy cash values for tax-advantaged supplemental retirement income and other living benefits.** ** A portion of the policy s surrender value may be available as a source of supplemental retirement income through policy loans and withdrawals. Policy loans/ partial withdrawals may have tax implications and may cause the policy to lapse. Income tax free policy distributions may be achieved by policy loans or withdrawing to the cost basis (usually premiums paid). This assumes the policy qualifies as life insurance, is not a modified endowment contract and is not lapsed or surrendered with an outstanding loan. Policy loans and withdrawals may reduce the policy s death benefit and available net surrender value. In addition, in the case with an Indexed Universal Life policy, they may reduce or eliminate index credits and may limit your ability to make elections to the Indexed Strategy. Conclusion Life Insurance is an important tool for managing mortality risk. The need for life insurance protection changes over time, but seldom goes away. The four step process for managing mortality risk may make it easier for us to understand and efficiently manage our life insurance needs. By combining term insurance and cash value life insurance in a coordinated strategy, we can help secure the death benefit protection we need in a way that potentially reduces premium costs and maximizes long term benefits. Understanding how inflation impacts our death benefits can help us make better decisions about the policies we select and how we manage them. By combining term and cash value life insurance policies, we may be able to secure the amount of death benefit coverage we want at a cost that may be more affordable than if we purchased one larger cash value policy. Term Insurance Options. Voya offers term life insurance policies that can be purchased in term periods of 10, 15 or 20 years. Once the term premium period ends (either 10, 15 or 20 years) the term insurance coverage will terminate and only the cash value policy will remain in force. Cash Value Life Insurance Options. We can choose among Voya s Universal Life, Indexed Universal Life and Variable Universal Life insurance products for the cash value policy we use in A.P.P. Combo. Our individual needs and the pros and cons of each product type should be considered in determining which cash value product to use in the strategy. Appendix #1 John Williams Death Benefits Adjusted for Inflation at 3% annual rate Years Coverage Inflation Adjusted Amount Today $750,000 5 years $750,000 $666, years $750,000 $558, years $750,000 $481, years $250,000 $142, years $250,000 $122, years $250,000 $106, years $250,000 $91, years $250,000 $78,938 These materials are not intended to and cannot be used to avoid tax penalties and they were prepared to support the promotion or marketing of the matters addressed in this document. Each taxpayer should seek advice from an independent tax advisor. The Voya Life Companies and their agents and representatives do not give tax or legal advice. This information is general in nature and not comprehensive, the applicable laws may change and the strategies suggested may not be suitable for everyone. Clients should seek advice from their tax and legal advisors regarding their individual situation. Life insurance products are issued by ReliaStar Life Insurance Company (Minneapolis, MN), ReliaStar Life Insurance Company of New York (Woodbury, NY) and Security Life of Denver Insurance Company (Denver, CO). Within the State of New York, only ReliaStar Life Insurance Company of New York is admitted and its products issued. All are members of the Voya family of companies. Not FDIC/NCUA Insured Not A Deposit Of A Bank Not Bank Guaranteed May Lose Value Not Insured By Any Federal Government Agency 2015 Voya Services Company. All rights reserved. CN /20/2015 Voya.com