Insurance: Could You Have Too Much of a Good Thing?

Key Takeaways:

• Assess the key financial information about an existing policy.
• Determine whether you’re financing the policy in the optimal way.
• Options can include keeping things as is, exiting your policy or restructuring it.

Insurance is a key component of a solid wealth plan. But it’s possible that you are sitting on life insurance you no longer need. With some digging and the right analysis, you could possibly free up significant sums of money.

Our need for various amounts of insurance protection can, and often does, fluctuate over time. Sometimes, life changes such as a divorce or children getting older and independent can mean that you no longer need as much life insurance as you initially bought. Changes in tax laws—such as those that raise the estate tax exemption—could also leave you with more insurance than is needed to pay that tax.

That’s why it makes sense to revisit your insurance situation from time to time and “stress test” your coverage so you can determine whether you’re set up as you should be—or whether you could be using money that’s currently tied up in insurance in better, more productive ways.

Here’s a look at the process for sizing up your insurance coverage.

Revisiting your wealth planning

It’s important to revisit your overall wealth plan from time to time. That’s a move that is very commonly made by the Super Rich (those with a net worth of $500 million or more) to regularly reevaluate their wealth planning—indeed, it’s a hallmark of the way the Super Rich make certain they are taking advantage of the smartest solutions available to them. We think it makes sense to emulate this Super Rich behavior in your own life.

The Super Rich’s evaluations almost always involve a review of their life insurance portfolios—the various policies they require to get the necessary amount of coverage. Often, they conclude there’s a need to adjust. Likewise, when those less wealthy take the same approach, it is not uncommon for them to need to tweak their insurance.

Where there is the possibility of having more death benefit than necessary, there are ways to significantly benefit by making sure what you need and what you have are in sync.

For many affluent individuals, reassessing their life insurance needs and what they have is even more important. Occasionally, families are “oversold” life insurance. Consider the scenario where the life insurance agent projects the size of a person’s estate. This is not a bad approach, presuming the growth rate is conservative and reasonable. Unfortunately, there are many times when that is not what happens. This leads to people getting more life insurance than they are going to need. Without a full reevaluation, it is very likely they would not know.

Evaluating your life insurance

There are three steps to evaluating your current life insurance situation.

Step #1: Assess your policy.

When you bought your insurance, you were likely given estimates about its future cash value and death benefit at various times. So, your first step is to see if your policy is performing as you were told it would. That means getting what’s known as an inforce illustration—a report that spells out key financial information about your policy. You may discover that your policy has built up value and benefits at a faster (or slower) rate than expected, or that it’s performing as designed.

Note: Interpreting inforce illustrations can be difficult—clarity is often not insurance companies’ strong suit. Indeed, even trained CPAs can end up scratching their heads over the data and how it’s presented in these reports. That means you’ll want to work with a financial professional who can help you navigate the information, draw conclusions, and evaluate next steps.

Step #2: Evaluate the strategy used to purchase life insurance.

Many times, people pay life insurance premiums out of pocket. Other times, they might use a wealth planning strategy. One example is premium-financed life insurance, which uses borrowed money to buy a life insurance policy. The point: Not only does the life insurance policy itself need to be evaluated, but so do the underlying assumptions behind the approach to financing it.

Step #3: Determine what you need and want.

The most difficult part of the process is determining how much death benefit is “just right.” A good starting point is to review why you purchased the life insurance in the first place and how you came up with the size of the death benefit back then. Ask yourself: Are those reasons still viable, or have circumstances changed?

Additionally, you’ll want to assess whether any new laws or broader developments outside your own life that could change the picture have occurred.

Finally, you need to assess how much death benefit you require going forward based on your evaluation thus far. That means getting clear on your goals (do you want to leave money to heirs, for example?) and your expectations for the future (such as whether you think the current estate tax exemption amount will remain in place ten years from now).

Advice: A professional advisor who understands life insurance well can help you determine your goals as well as spell out the various options you have with your current policy. As just one potential example, a policy that is no longer needed for estate tax payments could potentially be used to pay for a buy-sell agreement with a business partner.

Action steps to consider

Assuming you find that your current insurance isn’t firing on all cylinders or that it simply no longer reflects your current situation (and the situation you’re likely to find yourself in down the road), there are action steps to consider taking.

1. Compare alternatives. You have three big-picture choices:

• Keep your life insurance policy as is. This might mean you keep paying the premiums. For some, this makes sense. Say, for example, you determine you no longer need your policy for estate tax reasons, but you also decide the money could go to your children. In that case, staying the course could be the best route.
• Exit your life insurance policy. If your assessment reveals you do not need the money inside the life insurance policy, you can surrender the policy and take the cash inside. Another possibility: a life settlement, where you sell the policy to a third party for cash. This approach can potentially give you more money than you could get by surrendering your policy.
• Restructure or trade your life insurance policy. You may be able to modify your life insurance policy. This could entail reducing the death benefit if you decide you’ll need less money, thereby having the policy fully paid up. Or you might convert your current life insurance policy into another life insurance policy with different characteristics that are more appropriate for your needs and goals.

Once you see the various possibilities side by side, you can make a more informed decision.

1. Take action. If you have chosen to keep your life insurance policy as is, there is nothing more to do. Otherwise, you will probably need to instruct your life insurance agent or another professional to implement your decision—whether it is to exit your life insurance policy, restructure it or trade your life insurance policy for another one.

The value of stress testing

If you know you no longer need as much insurance as you currently have—or if you just have an inkling that you might be over insured, or you’re simply unsure—it pays to “stress test” your situation. Stress testing is a proven way to make sure that you are not being misled because of the lack of expertise of the professionals you are dealing with (or because they are intentionally misleading you to make more money). It can also help you spot mistakes you’ve made, or a professional has made with your insurance in the past.

Example: People often end up buying more insurance than they need due to faulty assumptions about some aspect of the future. Say your business ends up growing at a slower rate than you expected when you bought your policy. In that case, you could find yourself with insurance you simply don’t need.

To stress test your life insurance, you are going to need to work with an expert in the field. From getting and interpreting the inforce illustrations to finding alternatives to your current policy, relying on a leading authority is a good idea. Moreover, you will likely want your other trusted advisors to be involved in the analysis.