Over the past three months, clients have likely benefited from a reversal of some of the earlier losses in their portfolio. The current equities rally has some analysts believing that the market has begun its recovery, while others judge the rally as unsustainable, with a genuine recovery still further off in the future.
Regardless of which camp is right, insurance-licensed advisors and their clients have strategies available to take advantage of the recovery, almost irrespective of which equity sectors recover more or less than others.
Universal life (UL) insurance holdings can provide one starting point. A UL policy has three main components: mortality, expenses and the accumulation account holding investments — equity-linked, interest-linked or both — on a tax-exempt basis. With overfunding, the portion of the deposit not spent on the first two components remains in the accumulation account to prepay premiums, take advantage of tax-exempt buildup or increase the dollars available for estate planning.
Positioning an accumulation account in a UL policy for recovery could mean switching investments, where the account currently consists of guaranteed rate assets while ensuring that the switch does not jeopardize funds available for premiums.
“I would look to add exposure by using the indexes [index funds] or a well-managed balanced fund,” suggests Diane Nash, a 13-year veteran of financial planning, and a wealth management consultant and financial management advisor with Wellington West Capital in London, Ontario.
For clients whose accounts already hold equity-linked investments, positioning for recovery might suggest reviewing the asset allocation strategy, reflecting the current belief that some clients overestimated their risk tolerance before the meltdown. “Everything about this market has made everybody revisit their core beliefs and views on equities,” she says.
This means testing the client’s thinking — and potentially revised level of risk tolerance — by asking whether he or she would want the same asset allocation now if starting to put the plan in place.
“We have to revisit the clients’ needs as well as their risk tolerance,” Nash says. “If they still want to leave $2 million to a beneficiary, and that’s more important than something else, then they will have to fund that policy.”
A policy set up several years ago with a projected internal rate of return of 8%, seen at the time as sufficient to cover premiums after 10 years, might need extra funding even to stay fully paid up, she points out.
Where the accumulation account has equity-linked investments that have become eroded during the meltdown, advisor and client may have to examine whether the client can take on more risk and whether it is cost-effective to fund the difference from other sources (such as liquidating other investments). If so, the advisor needs to survey the client’s portfolio of traditional investments for liquidation opportunities.
Getting into position also means looking to see whether a client’s business situation has changed during the meltdown, to ascertain whether the client can afford increased funding or even to continue the premiums. A client whose business has suffered may not be able to maintain a 10-year pay arrangement or continue overfunding a policy, Nash points out.
Guaranteed minimum withdrawal plans are another insurance option to explore in advance of a recovery, since the client gets the minimum amount plus the benefit of any market recovery taking place after funding the plan, Nash suggests.
“You’re still going to get 5% of what it’s worth in the future as an income, and you’re still going to participate on the way up,” she points out. “And if that [the recovery] doesn’t happen, you’re still fine.”
Participating whole life insurance policies may mean another decision. Where the client is taking the dividends out as cash, anticipating a recovery might mean leaving the dividends in the policy, which is likely a more productive move in terms of net returns.
For participating whole life insurance policyholders who have made only the annual premiums, the time may have come to increase the payments. Making advance payments by depositing extra funds into an equity-linked vehicle could provide a reserve for future premium payments, she explains.
Term insurance may provide a best-of-both-worlds recovery strategy, according to some advisors. A client whose investment portfolio has severely eroded during the market meltdown may have become concerned about its impact on estate planning strategies and plans to leave large bequests to beneficiaries.
This client can consider buying a large amount of term insurance, preferably a product convertible to exempt life insurance. When the recovery does crystallize, the advisor and client can evaluate whether to convert from the term product to the exempt product. In the short term, this strategy allows the client to cover potential losses to the estate in the event of his or her death. Longer term, it provides the option to increase the proportion of investments held through insurance.
Al Emid, a Toronto-based financial journalist, covers insurance, investing and banking.
(06/30/09)