Importance of using suitable “ordering” in step down strategies in an insurance portfolio restructuring , and how lack of suitable “ordering” exposed the lack of viability of a “Dynasty Trust” scheme .

“Ordering” defined as: selecting the appropriate sequence for draw outs, draw downs, liquidations, or reinstatements     

We were introduced to a 70 year old couple who had two irrevocable life insurance trusts, containing $85million of coverage, with a premium of $2.7m, and a net cash value of $4.8m.

The older of the two trusts contained six whole life term /blend policies totaling $35m face amount with a premium of $766k +$99k of loan interest annually, and had $2.4m of net cash value.

The newer trust contained three whole life policies: totaling $52m face amount, with a premium of $1.51m, and $2.4m of net cash value.

These new coverages were pitched to the clients to ostensibly reduce out-of-pocket expenditures while creating a dynasty trust to shelter the proceeds from taxation on their children’s death.

A year later, being unsure of this transaction they hired us to determine whether the scheme could be sustained, based on the agent’s scheme of minimizing the premium levels by providing “tax benefits” to the grantors. 

A key element of the scheme encompassed taking a sequence of loans from the older trust to fund the newer trust, followed in later years by repaying a sequence of loans from the new trust to the older trust.

Since not all policies have the same loan interest rate and contract terms, many times arbitrage opportunities to minimize costs exist.

We honed in on the ordering efficiencies of loan withdrawals from the six policies to minimize the loan costs, including interest, and a “direct recognition" reduction of dividend scales.  “Direct recognition” is defined as: the dividend scale of loaned against policies is lower than those of policies not loaned out, translating into an additional loan cost.

Reviewing the proposed schedule of loans out and repaid, we uncovered troubling red flags. For example, we found cost differentials on taking $4.637m of loans of $43,591 (11%) + “direct recognition costs,”  ranging from $387,220 to $414,580 annually. That would amount over the next 15 years, (the life expectancy), to $650k + direct recognition costs.

Also, because they wouldn’t be repaying the loans with the highest costs first, they would realize wasted loan costs.

Furthermore, they didn’t use suitable ordering strategies for the existing $2m loan, they were incurring greater that necessary loan costs.

When we asked the agent about the inefficiencies admitted not using any ordering strategies.

It was precisely this incremental harming of the older trust that began the process of unwinding the scheme, which ultimately led to the settlement of ending the 52m insurance scheme.

Policy can be restructured to stand on its own without any further premium outlay:

As part of an acquisition ,the acquiring company insisted on ending the $50k annual premium interest free financing on the 60 year old CEO’s $1.74m policy. Additionally the acquiring company insisted that the CEO repay the $442,000 outstanding balance right away.

Doing so, meant that the CEO would now need to take over the $50k premium expenditure directly, lose the benefit of the $422k interest-free loan, and potentially force an income tax bill on liquidation of the policy if the CEO wouldn’t keep the policy in force.

We negotiated with the acquiring company and successfully convinced them to permit the CEO to delay the loan repayment until the CEO retired, as initially planned. The CEO in turn, acquiesced to ending the annual $50,000 interest-free loan premium payment.

Furthermore, because the company no longer advanced the $50,000 interest-free loan to cover the premium, and the CEO wanted to maintain the coverage, didn't want to pay $50,000 out of pocket annually, we restructured the policy, allowing coverage to remain in force without requiring any further premium outlay.  As part of the restructuring, the policy face amount was increased by 44%.

At age 65 the CEO retired, funds from the policy repaid the outstanding $422,000 loan, and the remaining cash surrender value was applied towards a new $2m survivorship policy (at a premium level much lower than the initial premium).

Insurance Portfolio Restructuring can help those who will be maintaining all the existing coverage in force:

A 62 year old had a $25m portfolio:

One component included ten whole life policies providing $5mil face amount, premium of $165k + $33.6 interest + $33.6 “direct recognition” cost = $232k annually.

“Direct recognition” is defined as: the dividend scale of loaned against policies is lower than those of policies not loaned out, translating into an additional loan cost.

First cost saving adjustment we made: repaid $542k loans   INTERNALLY, generating annual savings of $27k interest + $33.6k direct recognition cost savings = $ 60k (90%).

Second cost saving adjustment we made: switched $119k of dividends from “paid up additions “ to “reduce”, generating annual savings of  $46k + $6k interest + $6k “ direct recognition” cost = $ 58k (25%).

Third cost saving adjustment we made: switched $155k loans, from policies charging 8% to policies charging only 5%, generating annual savings of $ 4,679 (12%).

Fourth cost saving adjustment we made: switched the premium mode from quarterly to annually = generating annual savings of $6,800 savings (3.6%).

Grand savings total: $130k (56%).

When factoring in savings of 50% gift tax on $130k out of pocket = $65k = $195k savings EVERY YEAR.

Multiplying the annual savings of $195k X 15 (to life expectancy) = $2,925 m + “time value of money” ALL INTERNALLY, without exchanging any coverage!!!!


Loan extinguishing:

A 52 year old had a 10 year old $250k Whole Life policy, annual $4,336 base premium, with a $38,000 remaining loan balance adding $3,040 interest expense. 

The client wanted to “erase” the $38k remaining loan balance, thereby eliminate the $3,040 interest, and remove the loans corrosive consequences on the policy.

We restructured the policy, extinguished the $38k loans (without incurring any tax),   eliminated the $3,040 interest cost and corrosive consequence on the policy, increased the coverage by 90% to $475k , while maintaining an annual $4,336 premium, on a GUARANTEED BASIS to age 121.


Access to Cash:

A 65 year old who lost a steady source of income and was depleting cash reserves rapidly, considered reducing expenses by selling his luxury co-op, find a cheaper co-op elsewhere and use the remaining funds to generate income. However, to sell the co-op required funds to clean it up and buy time to draw the right price, but couldn’t raise the funds.

After reviewing the predicament, we uncovered that he was a beneficiary of a sizable life insurance policy on his mother life in a trust and suggested that he ask the trustee borrow the policy cash value. He did just that, obtained the trustees approval and working with the parties we secured the maximum loan. 

A year later, the co-op was still not sold and so he required additional money.

We then suggested that he ask the trustee to sell the policy to a life settlement provider to raise funds. He did just that, obtained the trustee’s approval and working with the parties we sold the policy. The sales proceeds paid off the loan balance and rebuilt cash reserves.

Months later, these “bridge loan” techniques did the trick. The co op was sold at an acceptable price, letting him regain his financial footing, and has since found a new home elsewhere.


Access to “walled off“ funds for financing legacy protection:

A 64 year old couple, parents of a gainfully employed handicapped 30 year-old were worried what would happen when the  daughter could no longer work, and resolved to provide for her by purchasing  $1,000,000 of coverage. The annual premium for permanent coverage would have been $25,000, which they could not afford.

After uncovering that the husband was a participant of a profit-sharing plan, we showed the couple how to use the "walled off” profit sharing plan funds to cover the premium, and helped them secure the $1,000,000 policy.

Years later, the premium “offset,” meaning that no more out-of-pocket premiums (or loans) were required to keep the coverage in force for life on a non-guaranteed basis.

Using funds saved in a trust over the years, the trust purchased the policy from the profit sharing plan.

Their daughter now has two children of her own, but unfortunately has since lost her job.

The policy recently had over $382k of cash value, with no loans outstanding.


Restructuring to “lock in” reduced lifetime guaranteed premiums, and gift tax outlay

A couple in their mid 70’s had an $8m portfolio:

One component included a whole life policy and four universal life policies providing $4.3 mil face amount, annual premium of $84k base premium + $23k interest =$107,000. 

Lately, the couple learnt that the annual premium of the $1m universal life policy doubled from $17,987 to $36,525, and would further increase each year. When hired to pursue this we contacted the carrier and uncovered that if the clients wanted to keep the coverage in force through age 95 it would require that the $17,987 premium increase immediately to $110,000, a 600% increase. Yet even at the $110,000 premium level, the policy couldn’t be guaranteed to remain in force to age 95.

Upon researching the sustainability of the four other policies we uncovered that only $100,000 (2%) of the $4,189m coverage was guaranteed to remain in force for life at the present premium levels, and that to bring the coverages to age 95 on a non-guaranteed basis ONLY, would require increasing the premium from $83,274 to $190,224, a $106,950 (123%) increase (exclusive of the $22,752 interest due). Yet even the increased $190,224 premium wouldn’t guarantee that the coverages would remain in force for another ten years. 

We restructured the five policies requiring only a $105,000 annual premium which is GUARANTEED through age 121.

As part of the restructuring, the entire $462,585 loan balance was extinguished, thereby eliminating the $22,752 interest due annually, and freeing the policies from the loans’ corrosive consequences.

Grand savings total: $107k (51%).

When factoring in savings of 50% gift tax on $107k out of pocket = $53k = $160k total savings EVERY YEAR.