Family Insurance Needs - UIECE.com: Insurance Continuing

Transcription

Family Insurance Needs
Table of Contents
Chapter One
Life Insurance
How much life insurance do I need?
Immediate Expenses
Future Expenses
Calculating
Major Functions
Term Insurance
Annual Renewable
Convertible
Decreasing
Level
Deposit Level Term
Cash Value Insurance
Straight Life
Preferred Risk
Interest-Sensitive Whole Life
Universal Life
Modified Endowment Contract
Adjustable Life
Variable Life
Survivorship Life
Single Premium Life
Endowment Insurance
Blended Policies
Family Protection Blended Policies
Credit Life
Travel Insurance
Choosing a Company
Review Questions
Chapter Two
Health Insurance
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Introduction
Presented Bills
Medicare
Medicare Part A
Medicare Part B
Medicare Part C
Medicare Part D
State Universal Health Care Programs
Legislation
Affordable Health Care for America Act
The Health Care and Education
Reconciliation Act of 2010
Prevention and Public Health Fund
Community Care Transitions Program
Community First Choice Options
Independent Payment Advisory Board
Effective in 2012
Effective as of 2013
Effective as of 2014
Effective 2015
Effective 2018
Benefits for Children
Benefits for Young Adults
Benefits for Early Retirees
Benefits for Senior Americans
Benefits for Minorities
Benefits for Disabled Americans
Benefits for Veterans and Military
Personnel
Benefits for Small Businesses
Providing Sufficient Medical Personnel
Where Are We Headed
Dental Policies
Incidental health Care Protection
Health Coverage for Overseas
Travelers
Blanket Health Insurance
Group Credit Health Insurance
Pet Insurance
Review Questions
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Chapter Three
A Child's Insurance Needs
Life Insurance
There are advantages
Health Insurance
Review Questions
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Chapter Four
Planning for Retirement
Pre-Planning
Where will the money come from?
How much is enough?
Annuities; what are they?
Annuity Development
Reinsurance network
Two-tiered annuities
Investment Options
Immediate Annuities
Payout period
Refund Annuity
Straight Life Annuity
Joint-and-Survivor Annuity
Immediate Variable Annuities
Using Variable Annuities for Retirement
11-point Checklist
Deferred Annuities
Equity-Index Fixed Annuity
Accumulation Annuity
Which annuity is Best?
What is annuitization?
Seven-Pay Life Insurance
Exclusion ratio
Why would a policyholder annuitized?
Bail-out Provision
What are some advantages of annuities?
FDIC / BIF / SAIF
Pass-through Insurance
1035 Tax-free Exchange
Guaranteed Death Benefit
Are there any disadvantages?
Pension Plans
ERISA
Defined Benefit Plan
Defined Contribution Plan
ESOPs
Long-Term Care Insurance
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Why buy a LTC policy?
Defining Policy Benefits
Long-Term Care Contracts
Integrated Policies
Hospice
Age-rated Policies
Types of Care Facilities
Qualifying For a Policy
No Policy Covers Everything
Activities of Daily Living
Tax-Qualified Long-Term Care Contracts
Understanding the Difference in
Benefit Triggers
Federal Criteria
Assessing the Need
Realistically Speaking
Asset Inventory
Liabilities
Estate Planning Tools
Asset Transfer
Government Sponsored Programs
Reverse Mortgages
Paid Family Member
Accelerated Life Insurance Benefits
The Largest Payer of LTC: Medicaid
Asset transfers for Medicaid Eligibility
Any Income Available
Review Questions
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Chapter Five
Disability Insurance
Who needs disability coverage?
Why not practical to 100% of income
How much coverage is needed?
Social Security
SSDI & SSI
Workman's Compensation
Degrees of Disability
How soon should benefits begin?
How long should benefits last?
Managing the DI Benefits
Where is DI coverage available?
Employer Provide Disability Coverage
Association or Group Disability
Multiple employers Trusts
Individual Disability Coverage
ARDI
Uniform Policy Provisions
Approaches to Selling
Description of Optional Provisions
Waiver-of-premium Provision
Nonoccupational Provision
Transplant Provision
Rehabilitation Provision
Non disabling Injury Provision
Preexisting Conditions Provision
Free Look Provision
Common Riders
Return of Premium Rider
COLA Rider
Social Security Rider
Purchase Option Rider
Residual Disability Income
Family Income Rider
Accidental Death & Dismemberment
Occupational Classifications
Special Circumstances
Is Underwriting Necessary?
Adverse Selection
The Agent's Role in Underwriting
The Underwriting Process
Moral & Morale Hazards
The Underwriting Decision
Social Insurance
SSDI & SSI
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Qualifying for SSDI
Qualifying for SSI
Following Application for SS Benefits
Definition of SGA
RFC
Life and the Application
Supplement Security Income
Who is eligible for SSI
Commonly asked Questions
Review Questions
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Chapter Six
Paying for College
Introduction
Tips for savings for college
Expenses incurred for college
Estimating College Expenses
How much does a family need to save?
What is the best way to invest?
Bank Accounts
Certificates of Deposit
College Savings Bank
Bonds
Life Insurance
Annuities
Mutual Funds
UGMAs or UTMAs
2503(c) Minor's Trust
Prepaid Tuition Plans
Financial Aid
Ways to Keep Expenses Down
AP Courses & Exams
The Family Plan
Alumni Discount
Attending Community College
Notes
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Chapter Seven
Wills, Probate & Trusts
Wills
Intestate
Codicils
Homemade Wills
Joint Wills
Living Wills
Rule of Revocation
Testamentary Trust
Probate
Living Trusts
Homemade Trusts
Funded Trusts
Standby Living Trust
Revocable Living Trusts
Bypass Trust
General Power of Appointment Trust
QTIP
Irrevocable Life Insurance Trust
Charitable Remainder Trust
Charitable Lead Trust
Avoiding Probate
Revocable Living Trust Disadvantage
Power of Attorney
Guardians, Conservators & Committees
Irrevocable Living Trust
Types of Irrevocable Living Trusts
GRIT
Uniform Gifts to Minors
Testamentary Trusts
Q-TIP / Q-DOT
Combination Trusts
Trust Record Keeping
Trustees
Planning for Death
Joint Accounts
Choosing an Attorney
Special Provisions
Spendthrift Clause
Ademption
Real Property & Personal Property
Simple Fee Estates / Life Estate
Remainderman / vested & contingent
Special Agreements
Domiciles & Property Ownership
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Concurrent Ownership
JTWRS
Gifting & Other Property Disbursement
Third Party Transfers
A Sham Gift
Preferential
Dower / Statutory Share
Per Stirpes / Per Capita / Specific Bequests
Secondary & Tertiary Beneficiaries
Following Legal Procedures
Self-Proving Wills
Property Transfers
Selecting Trustees & Other Representatives
Executor / Executrix
Administrator / Administratrix
Settling the Estate after Death
Common Property Agreement
Empty or Non-Funded Trusts
Preparation for postmortem managmt.
The Gross Estate
Funeral Planning
Review Questions
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Chapter Eight
Divorce
Retirement Accounts
QDROs
Defined Contribution Plans
Defined Benefit Plans
Property
Life Insurance
Health & Medical Insurance
Social Security
Wills
Review Questions
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Chapter Nine
Agent Ethics
Ethics
What are ethics?
Our Past Becomes Our Present
Who Determines Ethics?
Virtues
Ethics Decisions
Promoting Ethical Behavior
Egoism versus Egotism
What is the Scope of Ethics?
What does it take to be a moral person?
What do I want my legacy to be?
EXAMPLE #1
EXAMPLE #2
What are our responsibilities?
Selling Ethically
Education
Getting Education in a Timely Manner
Laying Out Policy Benefits & Limitations
Full Disclosure
Policy Replacement
Why would an agent replace their own?
When the Agent Allows Misconceptions
When Premium Appears too High
Obtaining Proper Signatures
Keeping in touch after the Sale
Selling the “Fast Buck” Items
Commingling Funds
Following Regulations
Competency
Simultaneous representation
Admitted Assets
Consolidated Assets
Investment Grade Issues
Mandatory Securities Valuation Reserve
Capital Ratio
Net Premium Income
Surplus Reinsurance
Review Questions
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8213 – 352nd Street East
Eatonville, WA 98328
Fax: (253) 846-7536
www.uiece.com
Email: [email protected]
Page 5
Welcome
Welcome!
Welcome to the Family Insurance Needs course. This course provides
continuing education credits; it does not provide pre-licensing credits.
The Family Insurance Needs course is designed to provide accurate
insurance-related information. It is not intended as selling material or to
provide any type of professional or legal advice. Since this material is
gathered from multiple sources, there may be differences of opinion
expressed or implied. The course material is subject to change as laws or
customs may change.
This course may not to be copied or used in any manner without express
written authorization from United Insurance Educators, Inc. All courses
offered are the sole property of United Insurance Educators, Inc. with all
rights are reserved.
Agents are required to complete their own work; this includes reading the
text and personally taking the test. It is not permissible or legal to copy
another’s work or to have any individual complete the work on behalf of the
certifying agent. Certificates of completion may be denied or credit hours
rescinded if all state and regulatory requirements are not followed.
Family Insurance Needs is designed to benefit the field agent by
broadening his or her knowledge. Since change is laws are always possible,
this course may be periodically revised. No book or manual is ever
completely "up to date" due to changes in federal or state regulations. In
most cases, little is lost or left out since the general principles of insurance
remain fairly stable. Those facts or figures that may change should be noted
in industry brochures.
We also find it nearly impossible to catch every statement that may seem
ambiguous or awkward to the reader; the same may be said for punctuation
and spelling. Our computers are in charge of spelling, but errors may still
sneak through. Our punctuation people are dedicated to their craft, but with
constant and numerous revisions, it is a most difficult job. Perhaps it could
be said that the authors and proofreaders, like the agents who read this, have
Welcome
Page 6
Welcome
not yet reached perfection. Author and educator, Robert Mehr, has stated:
"criticism is the disapproval not of those having faults, but for having faults
different from those of the critic.” We couldn’t have said it better.
We appreciate you business and thank you for ordering from United
Insurance Educators, Inc. We know you have many choices in the education
field. We compile new courses each year, but much of the information is
repetitive since there is only so much that may be said on any given topic.
As long as the course number is different from others that you have
completed this will not pose a licensing renewal problem.
8213 352nd Street East
Telephone: (253) 846-1155
FAX: 253-846-7536
www.uiece.com
Welcome
Page 7
Chapter 1 - Life Insurance
Life Insurance
Insurance covers one's life, health, liabilities, possessions and property giving the
assurance of a better financial future. In the book, Consumer's Guide to Insurance
Buying by Vladimir P. Chernik, it says Americans buy most of the personal
insurance written in the world. While this may be rapidly changing as other
countries meet and surpass the United States in affluence, it is clear that we value
what is often termed “peace of mind.” Insurance is not something that can be seen,
touched, and flaunted so why do we buy so much of it? While the reasons are
varied we clearly believe in having this protection. Since we do buy so much
insurance, the goal would seem to buy the best products for the goal we wish to
attain. Furthermore, the avoidance of unnecessary insurance is important since
wasted dollars are lost dollars.
How much life insurance do I need for my family?
Adequate financial planning generally includes some form of life insurance. For
the young person just beginning a career and family, life insurance creates their
estate. As assets are accumulated this may change, but initially it is the life
insurance policy that allows financial stability to be provided for another.
The next question is, of course, how much life insurance does the family need?
There are many ways to determine the right amount to purchase although not all
agree on how this should be determined. One procedure suggested by Judith Briles
in her book Money Phases is using 60 to 75 percent of the actual yearly income
based on the age of the spouse. If there are two working individuals, both incomes
will need to be considered. Even if one of the two partners stays home it is
important to consider the services provided by that individual. His or her death
would mean someone else must care for the children and maintain the home.
Today most families survive on two rather than one income. Few parents are
fortunate enough to be able to remain home to rear their children. One parent
households must especially be aware of the needs of the children since their
support could not be transferred to a second individual.
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The goal is to leave the living spouse with enough money to replace the deceased
spouse's lost earnings. For example, let's say the husband makes $40,000 a year
and he is 35 years old. Take the earnings for the year and multiply it by between
6.0 and 8.0. Using these figures, the family would need between $240,000 and
$320,000, which would be the recommended amount of coverage.
The following chart lists goals that may help in determining the actual amount of
insurance needed.
Current Age:
Percentage of
gross earnings
$23,500
$30,000
$40,000
$65,000
Insured/Spouse
Ages:
25
Insured/Spouse
Ages:
35
Insured/Spouse
Ages:
45
Insured/Spouse
Ages:
55
75%
60%
75%
60%
75%
60%
75%
60%
6.5%
7.5%
7.5%
7.5%
4.5%
5.0%
5.0%
5.5%
8.0%
8.0%
8.0%
7.5%
5.5%
6.0%
6.0%
6.0%
8.5%
8.5%
8.0%
7.5%
6.5%
6.5%
6.0%
6.0%
7.5%
7.0%
7.0%
6.5%
5.5%
5.5%
5.5%
5.0%
The New Money Dynamics by Venita Van Caspel suggests taking the family's
present monthly salary multiplied by 70 to 75 percent (using the higher percentage
if there are three or more children). Assuming the monthly income is $4,000 per
month, multiplied by 70 percent it comes to $2,800 per month that must be covered
by insurance. Whether or not the family could make it on the reduced income
must be considered of course. If there would not be any decrease in family
spending following the death of the major wage earner more coverage may be
needed.
Whether or not the major wage earner lives may not affect some future needs,
such as college, mortgages, retirement needs, and so forth. It is not necessarily
prudent to cover all these future costs by life insurance, but such expenditures must
still be considered. It may be determined that college, for example, could be
handled by the children through grants and scholarships. It is not always necessary
for the parents to fund education, especially if the remaining parent is low income
(providing the child with additional funding avenues).
Once the final figure is arrived at it does not necessarily mean the amount of life
insurance that will be purchased. While life insurance is intended to fund the
futures of those left behind the premium cost must be affordable today. It may be
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necessary to begin with a lower amount or look at using some term insurance in
combination with cash value insurance.
In New Money Strategies for the '90s by Terry Savage, it suggests the prospective
client take:
• The annual budget,
• Figure out how it will increase as the family grows,
• Take the percentage of income that is expected to be contributed and,
• Multiply it by at least five.
This provides the client with an idea of the amount of life insurance coverage that
may be needed.
In the book From Cradle to College by Neale S. Godfrey, he suggests using an
estimation future of expenses by following four steps:
1. Immediate expenses: When a death occurs (especially a sudden death)
there are immediate expenses that must be handled. To do a complete job, it
is necessary to consider the consequences of both spouses dying within a
short time of each other, such as might occur following an automobile
accident. Immediate expenses are those that occur at or immediately
following death and generally speaking, because of the death. Immediate
expenses could include funeral costs, probate costs, estate taxes, uninsured
medical costs, and so forth.
(a) Funeral costs can range from the elaborate to a simple casket funeral.
Funerals always cost more than we expect them to. Nationally, a simple
funeral can range from $6,000 to $10,000. The more elaborate the
ceremony, the more one can expect to pay. Unfortunately, when an
individual dies unexpectedly immediate family members tend to
confuse guilt over personal interactions with grieving. As a result, more
than necessary is often spent on funerals because it is very difficult to
make wise choices at this time. Those who pre-plan their funerals have
made the lives of those they love much easier.
(b) Probate is the legal process that validates the will after a person dies
making sure the debts are paid and the deceased's wishes are carried out.
Most wills go through probate, especially if the deceased has property in
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their name, has given property to their children or other relatives and
friends, or set up trusts. The probate procedure will probably include
attorney fees, filing fees, court fees, and fees to the executor. Although
each state may have varying procedures for probate, they will generally
be similar procedurally. Even so, a move from one state to another
means the will must be reevaluated because some of the differences can
greatly affect how a will is probated (especially where assets are
concerned).
(c) Federal estate taxes come into effect on an estate when it is valued in
excess of the federally stated amount. The exact amount has changed
from time to time so we will not state it here. State taxes vary; some
states have death taxes and some do not. States may allow a person to
pass their entire estate to their legal spouse tax-free. A person will want
to consult with a CPA or tax specialist to see what applies in their state.
When an individual moves to a different state, again they must
reevaluate the procedures that will be involved.
(d) Medical costs are often involved in a sudden death, but even a lingering
illness resulting in death is likely to have medical care costs involved.
If a person dies with medical costs that were not covered by their health
insurance or some other type of policy, it can be financially devastating
to the family left behind. There is no way to know what medical costs
may total up to, but we can do some planning. Obviously, the practical
thing is to have a good health care plan in place, but with fewer
employers offering health care and costs of private individual medical
insurance skyrocketing in most areas, this is not always the situation
that exists. There may be no easy answers to this dilemma, but some
type of planning is essential.
2. Figure the future expenses families can expect to incur. Future expenses
represent a much more substantial category since they can involve virtually
anything your client desires. Typically they include money for family living
expenses, emergencies, childcare, education - all the day-to-day and longterm expenses that a person may plan to cover with a paycheck and their
investments. Some items cross over into multiple categories. A mortgage,
for example, is both a current and future expense. Some individuals elect to
have separate mortgage insurance so that the home would be automatically
paid off, but mortgage insurance is actually life insurance; it simply has a
different name attached to it. Therefore, it could be covered under a policy
specifically for that purpose or it could be covered under one broad life
insurance policy.
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(a) Determining monthly expenses is often taken from the family budget
if there is one. If no budget is currently in place (and in writing) the
agent has a tougher job. It is necessary to include many things:
insurance, groceries, clothing, dry-cleaning, gasoline, and even the
weekly family outing to the movies. Each family will have their
own priorities regarding what they consider to be necessary
spending. At this point, merely listing everything is the goal, not
necessarily trying to insure the entire list. Determining life insurance
amounts can only be accomplished after such lists are made.
(b) We mentioned earlier that mortgage insurance could be included in
one broad policy or covered under an individual policy specifically
aimed at paying off the mortgage. If the family is renting, they will
be using that monthly figure with inflation of rental prices factored
in. If the mortgage is on a fixed rate it is easier to calculate, but if
the mortgage is a variable contract, those rising mortgage premiums
must be considered. If the homeowner chose an interest only
mortgage, he or she must be aware that they must eventually begin
paying principal. In many cases, this will equate into a doubling of
the mortgage payment. Of course, selling the home and buying
something more moderate could cut down these expenses. If local
markets are currently performing poorly, however, it may not be so
easy to accomplish.
(c) Childcare expenses may be part of monthly expenses. If one spouse
stays at home with the children currently, that person would likely
have to go to work to cover the family expenses should the working
spouse die. Even if both parents were working, the remaining parent
would still have to cover childcare since this tends to be an ongoing
situation until the children reach an older age. Quality childcare is
expensive. If a grandparent can be relied on it may not be a
consideration, but who could guarantee their constant availability?
As the children grow, full-time childcare can move to part-time
childcare and then to no childcare. Reevaluation of a family's
insurance needs must continually happen. At some point the family
may readjust the amount of life insurance required, decreasing the
benefits as circumstances change.
(d) Funding college expenses must consider each child separately since
each child may have different requirements. College expenses can
vary widely. Local and community colleges may be less expensive
than out-of-state colleges, for example. Private colleges are often
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more expensive than public colleges are. Recently the cost of
education has been increasing steadily so what is true today may not
be sufficient ten years from now. Attempting to cover the cost of
college will be expensive and insurance companies may not issue a
policy that makes an individual worth more dead than alive.
Sometimes insurance companies will require the proposed insured to
prove that the family needs the added coverage.
(e) Along with general living costs, a family may want to cover cars
loans, bank loans, and credit card debt as future expenses. Since
covering absolutely everything may not be possible, however, the
family may have to categorize and provide cash only for the most
important items. Usually the goal of life insurance is not to pay for
everything and not even to cover general expenses forever. Rather
the goal is to get the family financially situated and allow the
remaining worker time to establish him or herself in a career that
provides sufficient income to pay living costs and provide a secure
retirement. This may mean going back to school to obtain a wellpaying career.
(f) Every family should have an emergency fund. If one has not
previously been established or if it was depleted due to the insured’s
death, another must be set aside. Most professionals recommend
setting aside three months of after tax income for emergency
expenses. For those clients who cannot even establish and maintain
a Christmas club account, it may be difficult to ever establish an
emergency fund even following payout from a life insurance policy,
but the suggestion must be made.
3. Calculate all assets that currently exist that could go towards covering
expenses. When calculating assets, include pension plans, current life
insurance, and Social Security survivors' benefits.
(a) If a person is covered by a pension plan at work, he or she may want
to check with their pension administrators to see if there would be a
lump sum survivor's benefit payable upon the spouse's death. If
there is, include this among the assets listed.
(b) Currently owned life insurance, including employer purchased group
life, should be included in an individual’s assets.
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(c) Social Security survivors' benefits can be a major source of income
when the primary breadwinner dies. The monthly payment received
depends on the percentage of a certain number that the Social
Security Administration (SSA) calculates for the person, based on
current savings records. The surviving spouse would only receive
these benefits if he or she were less than 60 years of age or taking
care of children under the age of 16. Once all children reach age 16,
benefits stop. If the surviving spouse is caring for a child that was
disabled prior to age 22, he or she will receive benefits for as long as
the child remains disabled. SSA will pay benefits to surviving
children until age 18 regardless of whether or not their mother or
father receives benefits. To accurately calculate Social Security
benefits, individuals may call a national toll-free number or visit
their local Social Security office to fill out the appropriate forms.
Social Security administrators will compute these benefits for you.
4. Subtract all assets from all expenses. The difference will be the amount that
the individual may want to cover with life insurance proceeds. Again, the
goal is not to insure everything, but rather to allow the remaining spouse to
gain a financial foothold and proceed on his or her own.
All expenses minus assets = insurance needs.
For most families, Social Security Survivors’ Benefits are a major source of
income when the breadwinner dies. When calculating insurance needs this income
source should be included. If this is not done excessive insurance may be
purchased and this means higher than necessary premiums. The survivors are paid
monthly. The amount is based on the deceased's earnings record calculated by the
Social Security Administration. Individuals would be wise to periodically check
on the figures that the SSA has recorded. It is possible for earnings to be
incorrectly applied. If such errors are not found and corrected within a specific
time period, those earning credits may be lost. The credits under SSA are called the
primary insurance amount. The actual amount the survivors receive depends on
several factors. They are:
1. The amount of past earnings,
2. The age when the person dies,
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3. The ages of the surviving family members, and
4. The amount of income the remaining spouse earns.
A surviving spouse with no minor children does not qualify for Social Security.
The spouse could begin receiving Social Security at age 60, age 50 if the spouse is
disabled. A surviving spouse caring for young children who does not have
substantial earnings might qualify for Social Security.
If the surviving spouse earns less than a specified amount, which changes
periodically, Social Security pays the full benefit. If the spouse earns more than
the specified allowed amount, the benefit amount is reduced by $1 for every $2 of
earnings above the specified amount. When figuring a life insurance amount,
remember that income from investments, pension benefits, or insurance proceeds
are not included as income for the Social Security survivor’s benefit. A divorced
spouse who was married for at least ten years prior to legal separation is also
eligible for survivor’s benefits. Benefit qualification would end when the divorced
spouse remarries. Although Social Security pays benefits for the term of the
child's disability, if the child marries benefits cease.
Social Security pays benefits to the surviving children. This is the case whether
or not his or her mother or father receives benefits. Children can receive Social
Security until age 18. If the child is still in high school, they receive benefits until
their 19th birthday.
Social Security has a maximum family benefit.
Social Security has a maximum family benefit. Therefore if three or more in the
family are eligible for Social Security each person may not necessarily receive the
full amount otherwise allowed sine the family is allotted a total maximum benefit.
There are numerous ways to calculate insurance needs. An agent can only advise
based on his or her method of calculation. It cannot be emphasized enough to
make sure the family is not underinsured. Life insurance plays an important role
following a person’s death; life insurance formulas insure that correct amounts
exist. The purpose of life insurance is to temporarily replace income, to take care
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of large obligations, and settle debts. It is not a measure of a person's love for their
family.
The most important part of planning for a family's insurance needs is personal
analysis. This is the first step. Many professionals feel the potential policyholder
must take an active role in analyzing their needs, which is why questions are asked
during the first meeting between the agent and client. When the client plays an
active role he or she is less likely to have buyer’s remorse following the sale, but
more importantly, they will understand the purpose of the contract they bought.
Unfortunately this is seldom done. Most people have no idea how much insurance
they need, relying instead on their agent.
The need for insurance coverage may be less, the same, or more as time goes by.
Polices must be periodically reviewed and adjusted as needs change or new
situations develop. This would especially be true if additional children join the
family through birth, adoption or marriage. Remember, the purpose of life
insurance is to cover the family if the insured wage earner dies prematurely, and to
provide immediate cash for estate taxes. If the policyholders purchase a home and
the remaining spouse cannot afford to make the payments alone, insurance must
cover this possibility along with whatever other obligations exist. The goal is to
develop and implement the best insurance plan for the client's needs.
Following personal analysis if the client decides that life insurance is needed
other steps will follow. A complete analysis often allows the client to make a
comfortable decision quicker and without the uncertainty that often follows
purchase of non-tangible items.
Once the need for insurance is established and accepted by the client and the
amount of potential benefits analyzed, the next step must address realistic
insurance benefits and premiums. It could be possible to insure every future need,
but that often is not practical. While the buyer knows their family's needs and
personality he or she may not know how to determine the best type of insurance to
fit their needs. The agent is likely to ask specific questions, which might include:
• Do you want just enough life proceeds to maintain your current standard of
living?
• Do you want to cover specific debts rather than maintain a specific standard
of living?
• Do you want your family to receive enough cash to pay for current lifestyles
for a specific time period, such as five years?
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• Is your family provided death benefits from an employer or pension plan
that could offset the insurance you personally pay for?
Questions and the resulting answers are used to guide the family during their
decision-making process. Questions help focus on the actual intent of the
insurance and avoid under- or over-insuring. When deciding how much coverage
to purchase be aware of duplication since that can result in paying needless
premium. Most families have many financial needs; it is important not to waste
their income on benefits that may not be necessary.
The first step is personal analysis.
The second is deciding how much insurance is necessary.
Not everyone believes life insurance is the only answer to future financial
security. If the individual does not wish to rely entirely on life insurance then
realistic views and goals must be established and practiced. Usually an ulterior
method means a wealth-building program. While most financial planners are
completely in favor of wealth-building programs, few people can immediately put
together enough assets to adequately protect a family, pay off a mortgage, or
eradicate existing debt. If the individual were to prematurely die and had not
diligently saved, the family would certainly suffer the consequences. Therefore,
even when saving is the goal, life insurance is still typically the starting point.
While most experts would not call life insurance an investment, it is a necessary
financial protection. While the goal is to provide financial security, some policies
do accrue a cash value. In some cases, life insurance might even be used along
side financial investments and may occasionally be used like an investment.
However, this is not the typical goal of life insurance. When life insurance
contracts become confused with investments, their proper use may be overlooked.
There are three types of insurance: legal, mandatory and voluntary. Each type has
specific contracts involved. Life insurance is voluntary since people choose to buy
or not buy. Other types of voluntary insurance include automobile coverage,
homeowner’s coverage, and multiple types of health insurance coverage. In each
voluntary case the policyowner made the decision to buy the policy and pay the
premiums.
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Before an individual purchases life insurance, he or she should be aware of the
programs already operating on their behalf. Some possibilities include Social
Security, Workmen's Compensation, state unemployment insurance, disability
insurance, Medicare (for those over age 65 and over), and various state and federal
welfare programs. Some types of insurance are mandatory, such as Social Security
and Medicare payments. Others, like life insurance contracts are voluntary.
Obviously some of insurance we have, such as Worker’s Compensation benefits,
will not help a family when the major wage earner dies. Agents often work with
three principles of insurance, which are:
1. The age of the buyer and his or her responsibilities that determines the
need for insurance. Individual consideration must be exercised. If the
person is single, does not own a home, has little debt, and works at a job
regularly he or she probably does not require much life insurance; perhaps
only enough to pay for a burial. If the individual is married with children,
making house and car payments, and has additional debt he or she more
likely to need and buy life insurance.
2. Inflation affects the security provided by insurance. Economic stability
directly affects the security you purchase. It is not wise to build future
economic stability on fixed returns, such as life insurance. Erosion of the
dollar over the years will cause a financial loss of buying power, which is
why we constantly advise revisiting the amounts and types of insurance
currently in place.
3. Despite the name, there is really no all-risk insurance. Loopholes exist,
even in the best plans. However, it is possible to purchase coverage that
does provide security, even if every single item is not covered. Insurance is
based on compromise (“I can’t afford to cover everything, but I can cover
most of it”). The agent and consumer decide which items must be covered,
which items he or she would like to cover, and which items could be
eliminated if coverage were not available or not affordable.
According to The Consumer's Guide to Insurance Buying, "the major rule in
insurance buying is to seek protection first; all other considerations are secondary.
It is better to buy a policy for a lesser amount but with fewer exclusions than the
other way around." It is important to comparison shop, even when it concerns
insurance. It may be possible to reduce premiums without affecting coverage.
Sometimes paying premiums annually will reduce the total amount paid. Term
insurance is usually less expensive than cash value policies, but it is important to
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pay attention to how term rates increase with age. Older-age applicants may find
better values in cash values but it is important to look at all avenues.
There are many books advising consumers to research their own insurance prior
to seeking out an agent. With the number of insurance policies that can now be
purchased online, the agent is in danger of job loss in some insurance areas.
However, it is difficult to ask the questions that need asking without having a
career agent available. It is unlikely that any online website will be able to
skillfully determine the amounts of insurance needed, for example, although there
will be basic formulas available. Whether or not the client is able to successfully
compute this may be questionable. Online agents are generally available to answer
the questions, but to completely understanding any policy purchased online the
insured must read the entire policy. It will give them valuable information and
actually all policies should be completely read, but let’s be realistic: few
consumers do so. All policies will tell the reader what is covered, for how much
and, most importantly, what is excluded (not covered). Insurance agents make
themselves available to answer consumer questions but a community located agent
does much more than that. He or she is there when a death occurs to help with
paperwork, provide support, and make suggestions regarding any coverage that
might be in place. Internet companies are probably going to continue and the
services they provide are often excellent, especially when it comes to price
comparisons, but agents also provide a needed service; there is room for both in the
marketplace.
Major Functions
Life insurance provides two major functions: family income if a spouse dies and
estate liquidity. The policy owner may have a sizable estate, own a house, have a
stock portfolio and even own a lucrative business. If he or she were to die the
family could be left with little actual cash to cover the day-to-day expenses
however. Life insurance provides instant cash. Without life insurance, the family
may have to sell assets to cover expenses. For example, let's introduce you to the
Barnes. They are a family of three: Charles, Jazelle and Jade. Charles owns a
towing business, a home on a couple acres of land and a collection of antiques.
When he suddenly dies in an auto accident the estate is left with little cash. Jazelle
does not want to mortgage their home and doing so would take 30 to 45 days, if it
were even possible considering the probable need to probate the estate first. There
may be continuing income from the towing business if she has a driver available to
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continue the jobs. Charles loved his antiques and they are valuable, but finding an
immediate buyer may not produce the best price. Additionally, it may be very
difficult for Jazelle to sell something Charles loved so much. If Charles has a life
insurance policy his family will have immediate cash without selling or
mortgaging their home. This will also provide time for Jazelle to familiarize
herself with his business and possibly continue it to support her family.
Life insurance provides two major functions:
1) Provide the family with income should a spouse die, and
2) Provide liquidity for the estate costs.
Once the insurance needs of the family have been completed, the agent may move
on to the next step: choosing the best plan for the family's situation. There are
three major kinds of life insurance with numerous variations of each type:
1. Term,
2. Cash value, and
3. Endowment.
Life insurance is a contract and it is unilateral (the contract terms may not be
changed). The contract stipulates that for a financial payment (the premium), a
specified party (the insurer) will pay another party (the insured) or his beneficiary,
a defined amount of money upon the occurrence of death or some other specified
event such as disability. Once both the insurer and the insured enter into the
contract, the insurer cannot back out as long as the premiums are paid in a timely
manner. While most agents have personal preferences, nearly every type of life
insurance works well in some specific situation. The experienced agent makes the
best use of each type of life product rather than attempting to use only one type for
every case.
Life insurance companies rate prospective policyholders with what is called
mortality tables. This is the base for calculating cost per thousand dollars of a life
insurance policy. Each year people grow older, so the chances of dying become
larger. The first table used by insurance companies was the American Experience
Table, which was based on statistics gathered between 1843 and 1858. During that
time, out of 1,000 men age 35, statistically 8.95 of them died during that year. The
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second table the insurance companies were required to use was the Commissioners'
1941 Standard Ordinary Table based on death statistics between 1930 and 1940.
During this period of time the death rate for men at age 35 was 4.59 per thousand
or almost half the rate listed in the previous mortality table. In 1966, the insurance
companies were required to use the Commissioners' 1958 Standard Ordinary Table
based on death statistics between 1950 and 1954. Obviously this would be an
outdated table, but this was the last required table to be used. On this table, the
rate per thousand dropped to 2.51. Every year Americans tend to live longer
because of many reasons, one of them being the advance of medical technology.
Choosing an insurance company that uses the most current mortality tables will
insure your clients are receiving the cheapest premium rates. Insurance companies
are not required to go back to old policyholders when new mortality tables come
into use even though it would reduce their premiums. They will continue year
after year to charge at the old mortality table rates.
Term Insurance
Term life insurance does not build cash reserves; unless it is combined with
another vehicle such as an annuity, there is never any cash available, except upon
death. Term insurance provides protection for a specified time period (the term
stated in the contract). If the term is not renewed (often at higher prices because
the insured is now a year older), the coverage ends. Term insurance is widely used
by young individuals who need substantial coverage but cannot afford or do not
want cash value products. Those favoring term insurance often feel strongly that
cash value products are a waste of premium dollars. Not everyone agrees with this
however. In some situations term is the best product but that is not always true.
There are reasons why cash value products, even though the cost may be initially
higher, makes more sense for the situation. Term insurance may be ideal for many
families because the insurance needs of the family decrease as the children grow
and become less dependent upon the parents or as assets are accumulated that
offset the need for life insurance. Although term insurance does not necessarily
have to decrease, some types do.
Under term insurance contracts:
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1. The insured must die before the term expires (the period of time under which
the policy is effective). Term insurance may be purchased for as short as a
one-year term or for a twenty-year term or longer.
2. At the expiration of the term, the insurance ends. A new term may be
started, however, depending upon the insurers terms of the policy. A person
may not have to prove they are still insurable with some types of plans.
Some term policies will provider coverage for life; they can be renewed for
as long as the insured lives.
3. The cash outlay (premium) is relatively low, especially at younger ages. As
the insured gets older, term insurance premiums increase.
Even within the various types of insurance there can be subcategories. Term
insurance has basically four categories, although there can be variations of each.
The four types are:
1. Annual renewable term insurance, which is renewable each year regardless
of the insured’s health. The premium will be higher each year.
 David is in-between jobs and cannot afford the premiums of a whole
life policy. David can take out an annual renewable term until he can
afford to purchase a whole life policy if that is what he decides he wants
at that time, which accumulates cash value. Another option for David is
choosing to build up his own cash values through annuities, stocks or
bonds. Many agents advocate term insurance combined with a wealthbuilding plan. This approach is often referred to as “buy term and invest
the difference.” Once David had accumulated sufficient assets, he could
then drop the term policy if he felt there was no longer any need for it.
2. Convertible term insurance allows the insured to exchange the policy
without evidence of insurability. The exchange often means converting to a
whole life policy or an endowment-type policy.
 Henry may choose to purchase a convertible term policy, which offers
lower premiums, until he can afford the whole life policy he really
wanted. Convertible term guarantees the ability to change to another
type of policy within the same company even though a health problem
may develop that would otherwise make him uninsurable. When Henry
is shopping for insurance, he will want to make sure he chooses an A+
(A.M. BEST Rating) company with programs that he likes. If he chooses
a company that is rated lower there is the danger that they may go out of
business or otherwise experience something that makes conversion less
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desirable. If Henry chooses a company that has limited policy change
choices, then the convertible term policy did him little good in the long
run unless the program he wanted is still available. It is advisable that
the insurance be rated highly by several different rating companies, not
just by A.M. Best Company. This hopefully would give a higher chance
that the company would be around for the long haul.
3. Decreasing term is often called mortgage insurance because it is used to
cover the decreasing mortgage on a fixed-rate loan. The death benefit
decreases over a specified period of time although the premium usually
remains level.
 Jaime just bought a house. He could purchase a term policy that
would decrease benefits along with the decreasing amount of the
mortgage loan; this is called Decreasing Term Insurance. The
premium usually remains level even though the death benefit that would
pay off the mortgage is decreasing as Jaime pays the mortgage down.
4. Level term insurance generally has both a level death benefit and level
premium cost for the entire term of the policy.
 Michaels' parents bought a house and they wanted to purchase
insurance to cover the mortgage. They are both 50 years old. Level term
insurance will cost more initially than a decreasing term policy, but they
will come out ahead if they keep the policy for 15 to 20 years. This is
because the premium stays the same, even with the increasing age. A
decreasing term policy would increase the premium with age. Whole life
would have been more expensive due to the cash value that would have
been acquired over time. Remember, term insurance acquires no cash
value.
Deposit Level Term
Deposit Level Term is a level term policy in periods of 10, 15 or 20 years. The
policyholder makes a premium deposit to the company as evidence of their intent
to retain the policy for the specified number of years. Deposit Level Term was
designed to reward the person who did not cancel their policy after a couple of
years, which costs the insurance company in commissions to the agent, placing the
policy in force initially, paying for the health examinations, etcetera. According to
The New Money Dynamics, of every three new policies written today one is lapsed
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within two or three years. Two things can happen if the policyholder does not
lapse the policy: the policy owner either completes the number of years or dies
within the period. If the policyholder lives to complete the period, the insurance
company will normally return the policyholder's premium deposit doubled or more
and tax-free.
In the event of the policyholder's death some companies may return the premium
deposit to the beneficiary, while others will pay the maturity value as an
additional death benefit. The maturity value is the amount it would have grown to
if the policyholder had lived to the end of the contract period.
At the end of the term, the policy owner will have various options. If the
policyholder still needs protection for their dependents, he or she may want to
renew for the same contract terms or the policy owner may want a different benefit
amount or time period. All premiums for all life insurance policies are based on a
mortality table; as an individual grows older his or her rate of insurance per
thousand will increase because the insurer’s risk increases.
Modified Premium Whole Life contracts are policies that have the same basic
provisions. Instead of automatically converting to some form of term however,
they convert to whole life coverage if the policyholder makes no other choice.
Modified Premium Whole Life does not affect the essential elements the
policyholder may want for their coverage. Tax laws are such that this designation
may save the company considerable amounts in taxes. A tax expert should be
consulted anytime a policy is purchased with tax concepts in mind.
Insurance agents, financial planners and other specified financial designations
may not agree on the types of insurance a consumer should purchase, but generally
all types fit somewhere. The disagreement among agents can be confusing to the
buying public since they lack the same information agents and planners have.
Unfortunately, this sometimes results in consumers not trusting any agent or
planner.
When consumers know what they want, even if the agent feels they are
misinformed, documentation is essential. This would especially be true if the
agent feels the buyer is making a large financial mistake. Even though the buyer
may realize it was his choice, his heirs will probably not know this following his
death. Documentation is always important, but especially in this type of situation.
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If Great Aunt Hazel felt she had a whole life policy that was inadequate for
retirement, an agent could give Hazel an understanding of why she is right or
wrong, depending on the information provided. People often believe what they are
told without doing the research to get accurate knowledge. If the prospective client
is dead-set against cash value insurance, for example, we may want to do what
they wish rather than push what we believe to be true, but with full documentation
in our files.
Cash Value Insurance
Whole life insurance may be known by several names including permanent
insurance, straight life insurance or ordinary life insurance). It is the most
commonly sold life insurance. Most people have at least heard of whole life
insurance but their knowledge is typically limited to the fact that it accumulates a
cash value.
Educating the prospective clients is a time consuming job, but the advantages are
great. Taking the time improves the agent's creditability and sales success - time
well spent. Knowledge allows the client to choose an insurance program that best
suite their insurance needs; when the client understands the program they
purchased they are more likely to keep the coverage. Consumers may have read
that agents sell whole life insurance for the high commissions. It is true that
commissions are higher for cash value products than for term insurance but the
career agent will place the type of product that best fits the client’s needs. A client
that clearly prefers term insurance should, of course, be presented with the product
they want. As previously stated, documentation is essential.
Whole life or permanent insurance has several characteristics including:
1. The premium remains level throughout the policy's lifetime.
2. The contract builds up cash reserves in the early years, which allows the
company to maintain level premiums even though the insured becomes older
and a higher risk. Increased age would normally trigger higher premiums.
These reserves also bring about a cash value that may be borrowed by the
policyholder or may be taken as surrender proceeds if the policy is canceled.
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3. A whole life contract, by definition, can be kept at the same premium level
for the lifetime of the insured.
Both straight life and limited payment life are variations of whole life policies.
Under a limited payment life policy, premiums are payable over a shorter period of
time (a limited period of time). Because premiums are paid over a shorter period
of time they are higher. In effect, one might say the cost is the same but the policy
owner is just paying off the contract sooner. It can provide a lifetime of coverage
and, again, with premiums payable for the specified period of time: 20 years, 30
years or paid up at age 65 (which would be a variable number of years depending
on one's current age). At the end of this time period, the policyholder’s premiums
are "paid up" with no additional premiums due. This type of policy does a
disservice to young families since it seldom delivers the quantity of protection
needed at a price that is affordable. Young families are looking for life insurance
protection, not cash values. Paying higher premium rates early in life when fewer
dollars are available would not make sense.
A straight life policy offers the cheapest type of permanent life protection. The
policy cannot be canceled for health reasons and it has a cash value. The greatest
advantage of straight life policies is its ability to convert to other types of insurance
within the same company. The policy owner can borrow on the policy or receive a
surrender value if the policy owner decides to withdraw from the program. A
disadvantage of straight life insurance is its cost. For the same premium amount, a
term policy can be acquired with greater death benefits. Premiums and policies
will vary from company to company so price shopping is always a good idea.
Another disadvantage of straight life policies is the time required to pay up the
premiums. If the policyholder fails to acquire it early enough, premiums may
continue to be due after the policyholder retires. This type of policy is
conservative and is for conservative people.
There are also modified whole life policies and preferred risk whole life policies.
A modified whole life policy typically begins at a lower cost for a specified time
period; then the premiums are higher for the remainder of the premium period.
Modified plans usually have lower initial cash values than would a corresponding
face amount in a typical straight life policy.
Preferred risk policies, as the name implies, usually requires applicants to be in
better than average health at the time of application. Preferred risk policies are
often sold to professionals or others in low risk occupations. Also, these policies
are sometimes sold in higher face amounts. The premiums may be slightly less
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than standard policies. Preferred rates (which are obviously lower) are given to
policyholders having lower risk factors. Before a preferred rate is quoted, agents
must determine that the prospective policyholder meets the criteria. This is done
through basic health questions. Of course, even after doing the best "screening"
available to the agent the insurance company may still approve the client with
"standard rates", which are higher.
Interest-Sensitive Whole Life
Interest-sensitive whole life (ISWL) products were introduced in the late 1970s in
response to the fears and concerns of the universal life products. The universal life
products allow a measure of freedom for the policyholder, and this freedom
sometimes means a stop in premium flow. The need for a product to beat these
disadvantages was born in the interest-sensitive whole life product.
The interest-sensitive whole life (ISWL) policies were the start of the no-frontload options. The costs were divided up by applying a rear surrender charge that
vanished over a 20-year period. The client was rewarded for staying with the
insurance company with a contract that extracted no expense charges other than the
mortality fees. Those who surrendered the policy early were charged these fees.
Premiums were fixed, but a version of the policy would vanish based on current
assumptions. The commissions on these types of policies compared to older types
of whole life products. The ISWL policies seemed to offer the advantages of both
whole life and universal life.
As this type of policy became popular competing companies came up with
variations of this whole life product. Universal life plans moved to a similar no
front loads to compete. Some competing companies mounted a defensive position
of cautioning agents not to overstate interest values. It still happened of course and
many states took legislative action as a result, requiring the presentation forms
turned in with applications.
Since there are so many conflicting views on policies, here are some basic points
to help:
1. One of the advantages of universal life is that it is more flexible than either
whole life or interest-sensitive whole life.
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2. On the other hand, whole life and interest-sensitive whole life products
provide better guarantees than universal life.
3. Whole life, universal life or ISWL will not perform forever on current
interest rate assumptions. As an agent, know what interest has been used to
determine dividends. If it is the same as the universal life or ISWL, it is
subject to change.
Universal Life Insurance
Universal life products are cheaper than whole life, but more expensive than term
life. Universal life insurance is a hybrid of whole life insurance policies with a
tax-deferred investment program included. It offers adjustable features that allow
policyholders to change the face amount or the premium level to suit the family's
changing needs. Families have the ability to put in more money some years to
build up cash values, and less in other years to cover only the cost of insurance.
When explaining the differences between whole life and universal life, it is
important to stress that the rates of a universal life are adjustable, fluctuating with
current rates. Insurers may offer higher rates initially, and lower rates thereafter.
Mortality rates and expense charges may rise within a contract period, which will
increase premium. The policyholder has to decide each year how much to invest in
the policy. For busy people, this is one more thing they have to keep track of. IRS
imposes maximum funding levels on universal life products. The consumer cannot
increase their investment portion without increasing their life portion also.
Universal life products work well for people who like a hands-on approach in their
investments, and can be used as part of an investment program.
Many consumers are aware of the term "universal life" but have only a vague idea
of what it actually is. A universal life insurance policy, first introduced in the
1970s, is a life insurance policy in which the investment, expense and mortality
elements are separate from the insurance component and specifically defined. The
policy owner selects a specified death benefit, which typically remains level. The
death benefit may, however, be one that increases over time, coinciding with the
increased cash value of the policy (death benefit Option II), or, alternatively, the
death benefit can remain level regardless of the underlying value changes (death
benefit Option I). A load is deducted by the insurance company from the premium
paid by the policyholder for defined insurer expenses. These can fluctuate within a
contract period. The premium remaining is credited towards the contract owner's
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policy cash values. Then mortality charges are deducted. Interest earned on the
remaining cash is credited at whatever percentage current rates happen to be.
Since specific policy details do vary from company to company, variations will
occur. Increased expenses or "loads" and/or increased mortality rates will also
result in lower cash values. Just like annuities, there is usually a minimum
contractual guarantee on the interest rate earned; typically around four or 4.5
percent. Mortality costs also generally have a guaranteed maximum premium
charge for the pure cost of the death benefit. Most insurance companies do not
charge that maximum rate however. Typically, the rate charged is lower.
Universal Life separates the insurance portion
from the cash value portion of the policy.
Many consumers assume there is a "standard" universal life insurance policy that
is somewhat uniform from company to company. Actually there is no such thing
as a "standard" universal life policy. The level of premiums paid, the amount of
death benefits, and the lengths of time over which premiums are paid are all
variable. While the first policy year may have a stated minimum premium due,
following that first year, the contract owner usually varies factors including:
1. The premium paid,
2. The payment date, and
3. The frequency of payments.
These features are what make this type of policy favored by consumers. These
features are sometimes called "Stop-and-Go" features or options. The ability to
discontinue payments and then resume them at a later date does not require
reinstatement of the policy. As long as there are enough cash values within the
policy to pay the required expenses and mortality rates, the policy will remain in
force. The policy will terminate if the cash values are not adequate, although there
is usually a grace period allowed of up to 60 days.
Example:
Charles can design the policy to have constant level premiums, like
a whole life policy, and guarantee the death benefit forever. Or he
could design the policy so he'll only pay minimum premiums, like
term insurance. With the second option, the premiums would
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increase each year to keep the death benefits fully in force. Charles
could design the policy so he pays large premiums, which would
allow the policy to accumulate tax-free cash. After seven to ten years
it would be unlikely he would ever need to pay premiums again.
Whichever Charles decides to do, he could still change his mind in
midstream. He could initially pay lower premiums in the beginning,
but later increase the premium payments if he wished. If Charles
continued to pay the higher premiums they could eventually vanish
entirely once the policy was fully paid for. He could even alter the
amount of death benefits, and then alter the premiums paid in. With
the same premium dollars, Charles could choose smaller death
benefits and that would give him a larger cash buildup, or smaller
cash buildup and higher death benefits. All these choices are up to
the policy owner, which is why the universal policy has become a
favorite of the consumer.
Charles could also withdraw the surplus cash and lower the death
benefit with no interest expense. The cash withdrawal would
permanently lower the death benefits, even if Charles repaid the cash.
Charles could, however, take the withdrawal as an interest-bearing
loan. When he repaid the money, the death benefit would then be
increased by the amount he repaid.
Universal life contracts have great flexibility; policyowners may, for example,
withdraw cash from their policies. This is in contrast to other types of cash value
insurance. Most of the traditional cash value insurance policies require a
policyholder to take a loan out or surrender the entire policy in order to withdraw
cash. Some whole life policies also allow cash withdrawals like the universal life
policies do, but the withdrawal in whole life policies provide the policy's cash
value through receipt of dividends.
Universal Life gives flexibility to the insured.
As these examples show, the most appreciated advantage of a universal life policy
is the flexibility it provides. Of course, with these advantages come disadvantages.
A disadvantage is the discipline required to make regular payments to the policy to
insure that there is enough premium paid in to keep the insurance active. A
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policyholder may ask for an in-force ledger to do a "check-up" on the policy to
make sure it is growing adequately; if the policyholder has withdrawn cash this
would especially be a wise decision. When the policy is first taken out, the
insurance company will recommend a "target" premium. This target premium is
the amount the policyholder needs to pay under the insurer's current assumptions to
keep the policy in-force to the age of 100. The policyholder has the option to pay
less or more, thus the threat of not paying enough to keep up with the policy's
costs. Essentially, a person could pay a large premium amount one month and skip
the next couple of months. In any month that the policyholder does not pay
enough premium to cover the cost of the coverage, the extra sum needed will be
deducted from the policy's cash values. If this happens too often the policy may
use up all the cash reserves causing the policy to lapse.
A warning regarding universal life: the policyholder may decide to invest extra
money in the policy to benefit from the tax-deferred compounding feature.
Because this was done so often Congress placed limits on this tax benefit; too
much invested cash can turn the policy into a modified endowment contract
(MEC). This would restrict the ability to take tax-free loans out of the policy in
later years. A modified endowment contract taxes the policyholder on loans they
take against the policy up to the amount that the policy has earned. This would
also be the case if the policyholder received any money when pledging the policy
as collateral. The policyholder would further owe ten percent penalty on loans or
withdrawals made before age 59 ½, unless the policyholder is totally disabled. A
good insurance agent will advise the policyholder on methods to safely invest
without running into tax complications.
Universal life products can also be used as mortgage insurance, which is often
protection for the lender as much as it is for the homeowner. Mortgage insurance
protects the lender against default by the borrower. What people normally use for
this purpose is decreasing term insurance, but an agent may consider and
recommend universal life products instead. Here's why: the decreasing term
product typically has a level premium for the term of the loan. The amount of life
insurance decreases annually along with the decreasing mortgage amount. Thus
the policyholder is paying the same amount of premium they paid for $100,000 of
coverage, but at the end of the loan period have only $3,000 in coverage.
An alternative to this is a decreasing universal life plan that is designed to pay off
a mortgage and at the same time gives the policyholder a monthly income
beginning at age 65. This type of product also offers the advantage of setting up
the premium to vanish within a set number of years, such as ten years. A family
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may also be able to add a monthly disability waiver to the plan. Some insurance
companies may only offer a waiver of mortality charges under a universal life plan,
but most companies will allow for the premium waiver provision. Under the
decreasing universal life plan used as a mortgage redemption policy, there is
always cash value for the policyholder, a death benefit for the beneficiary and
generous commissions for the agent. In addition, if the family chose the added
disability waiver, there is that added protection.
If a policyholder is looking for good investment yields, universal life may not
give them what other investments would. The policyholder may not realize the
expense of the policy when first looking. There are added insurer fees and
commissions that can deduct from the investment's overall return.
Adjustable Life Contracts
Adjustable life offers three possibilities for policyholders and agents:
•
It can be a traditional whole life policy with flexibility,
•
It can be a level paying term contract with flexibility and/or
•
It can be a contract that begins as term and evolves into a whole life (or a
whole life that turns into a term life policy).
The plans available on most adjustable life contracts range from a five-year term
to a five-year paid-up whole life policy. The five-year term is a very lean plan and
is absolutely guaranteed for a minimum of five years. When the dividend option
chosen is 'policy improvement,' the protection period is usually extended for
additional years because the dividend is plowed back into the policy. The fiveyear paid-up whole life plan is at the opposite end of the spectrum. It is a very rich
plan and is guaranteed to be a paid-up whole life policy in five years. Dividends
purchase the paid-up life insurance. The plan chosen by the policyowner can be
adapted to any particular individual or business need. Changes may also be
accomplished at any time by adjusting the amount of premium directed into the
contract.
Stated Michael D. Minear: "Adjustable life is similar to universal life in several
respects. Both earn current yields (either in the form of current interest rates or
current yield dividends), both also have flexible premiums and flexible death
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benefits, both have partial cash withdrawal capabilities and both can meet the
personal or business marketplace needs."
Variable Life Insurance
A variable life insurance policy is, in relation to other types of insurance, a
relatively new product. The sale of a variable life insurance product usually must
be accompanied by or preceded by a prospectus approved by the Securities and
Exchange Commission (SEC).
A variable life insurance policy resembles the traditional whole life policy, but it
has two major differences:
1. Both the death benefit payable upon death, and
2. The surrender value payable during life is not guaranteed.
They can either increase or decrease depending upon the investment performance
of the assets upon which the policy relies. The death benefit generally cannot
decrease below the initial face amount, assuming all the premiums have been paid.
With this type of policy, the consumer trades the cash surrender value guarantee
for the potential of investment growth. Variable life insurance uses a portion of the
premium to buy pure protection, like whole and universal life contracts. The
difference is that the insurer invests the remainder of the premium on the
policyholder’s behalf.
Variable Life insurance gives the policyholder
a large measure of control over the buildup of cash value.
The policyowner may direct the premium (after certain deductions are made) to a
specific subaccount held by the insurer. What those subaccounts are will vary.
They could include a money market account, a growth stock account, a bond
account, or some other type of investment vehicle. Some companies may allow
changes among the accounts more than once per year while other companies may
have limitations on the number of times that funds may be moved among the
various investments. Usually, the death benefit is adjusted once per year while the
cash value is adjusted on a daily basis. Premiums tend to be fixed so that they
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remain the same. The product gets its name, variable life, because both the
surrender value and the death benefit can vary.
If Daniel took out a Variable Life insurance policy, he could have the choice of a
number of mutual funds in which to invest the cash inside the policy. Or, if Daniel
plans on staying with variable life for a few years, he will probably want to invest
in growth stock mutual funds that are likely to out-perform fixed interest rates.
Otherwise it is not worth paying the extra charges and fees associated with variable
life policies.
Before the policy owner may divert any of the contract’s funds into a subaccount, charges must first be paid. These charges would include administrative
and sales expenses, any state premium taxes, and of course, mortality costs. This
is one of the biggest problems with variable life policies. The policyholder may
think their investments are doing well but the cash value may not be growing quite
as much. To reiterate, this may be due to the insurance company taking out their
fees and mortality charges before the investment return is credited to the policy's
cash value. This, of course, would lower the policy's total investment return.
For those policyholders who desire to take an active role in their finances, a
variable life policy is an attractive mode of life insurance. The policyholder may
direct where their premium dollars are placed but it can also be a gamble. The
insurer may not offer the options necessary to really be a worthwhile investment.
Variable life insurance policies enjoy the same income tax treatment as other
types of insurance policies. Earnings from the investments are currently income
tax deferred, which is always a benefit to the consumer. There is no tax on the
internal build-up of cash values. If the policy is surrendered (cashed-in) and if the
cash proceeds are more than the policyowner’s cost basis, then the proceeds may
experience some taxability. Death benefits, regardless of growth, pass income tax
free in most cases.
Most variable life insurance policies allow the policyowner to borrow a
designated percentage of the cash value without surrendering the policy.
Normally, the insurance company charges interest on the loan, but often the rate is
lower than the rate that would be charged from a bank or lending institution.
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Like other insurance policies, one may see riders and/or waivers added to the
basic policy. These might include such things as accidental death riders or waiver
of premium if disability occurs.
The consumer can choose two different types of Variable Life:
1. Variable Whole Life, and
2. Variable Universal Life.
Variable whole life has fixed annual premiums, but instead of getting a fixed
interest return, the growth of the cash value in the policy depends on investment
choices they make.
Variable universal life still has the flexibility of choosing the premiums and
death benefits, with the variable being the amount at which the cash value will
grow. It depends on the policyowner’s investment choices, not on a fixed rate
promised by the insurance company. As the name would imply, variable universal
life is a combination of universal life and variable life. This combined flexibility
makes the product unique.
Since 1981, interest-sensitive products have seen a decline in popularity because
the rate of return is diminishing. To highlight some important advantages of
variable universal life: the expenses and loads are lower. This means that a
variable universal life policy may be more cost-effective than a regular universal
life product. The variable universal life is considered a security, thus the Securities
Act of 1940 limits its expense- loading.
Variable Universal Life offers lower expenses and loads.
Survivorship Life Insurance
Survivorship life insurance is also called Joint-and-Survivor-Life insurance.
Survivorship life insurance is used to insure two or more people under the same
policy. There are some variations offered for this type of policy including some
universal life products.
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The death benefit is not paid under a survivorship policy until the last of the two
or more insured individuals die. At that time, the full death benefit goes to the
named beneficiaries. Since there are so many variations in a survivorship policy,
the agent involved must pay special attention to the provisions listed.
Most of the survivorship life policies use whole life products, although other
types are also available. They provide for an increase in cash values upon the first
death of one of the insured individuals. If the policy were a participating policy,
which pays dividends, the dividends would then also increase. Depending upon
the terms of the contract or policy, the premiums may continue until the survivor's
subsequent death. It is possible that, through a special option, the policy is paid up
at the first death so that no further premiums would be required.
As with other types of policies, there must be an insurable interest on the
individuals insured in the survivorship life policy. This type of policy is typically
used between spouses, parents and children, or business owners. This type of
policy is effective in easing federal estate taxes on those who would be subject to
such taxes and have elected to take maximum advantage of the marital deduction,
which would have tax due upon the survivor's death.
It should be noted that there is no requirement that all those insured must also be
policyowners. Any party that could own any other type of insurance policy may
own the policy.
Single Premium Life
Unlike traditional life insurance policies, the Single Premium Whole Life policy
has only one premium payment (thus, the name). The initial premium is paid up
front with no further premiums required. Single premium policies are ideal for
older people having a lump sum of money to invest and seeking tax-deferred
growth of principle plus insurance benefits for their beneficiaries.
Single Premium Life offers many of the traditional tax advantages offered by
whole life policies:
1. The money contributed to the policy builds up tax-free through policy cash
values.
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2. The policyowner can borrow those cash values tax-free.
3. Upon the death of the insured, the policy’s face value (not the cash surrender
value) would go to the named beneficiaries’ income tax free. The proceeds
would bypass probate procedures if there are named beneficiaries. It is
likely that the existence of the policy must still be reported during the
probate proceedings, but this will not delay disbursement of policy funds.
The immediate cash value of the policy is, of course, one of the main reasons for
selecting a Single Premium Whole Life Policy (SPWL). The cash value may be
accessed through policy loans or by surrendering the policy. Since the insurance
company imposes penalties for early surrender, loans make the most sense in the
early years of the policy. Although the insurer will charge interest on any loans
taken out, in many cases the insurer will also credit the policy with an equal
interest earning. As a result, as long as the policyholder’s percentage rates are
identical, they will cross each other out entirely, which gives a zero net loan cost.
Single premium policies allow the policyowner access to the cash buildup, but the
policyowner is best served if he or she is over age 59 ½. This is because any
money withdrawn by a younger policyowner, even as a policy loan, would be
subject to a ten percent federal tax penalty, plus the ordinary income taxes if the
policy has enough cash to qualify as a modified endowment contract.
The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) established a
new classification of life insurance called the modified endowment contract
(MEC). As stated earlier, any insurance policy that exceeds, on a cumulative
basis, a maximum contribution within the first seven years will be classified as a
modified endowment contract. Single premium policies are a form of modified
endowment contract and fall under the definition of this. The policyowner invests
far more money than is needed to buy life insurance. The extra money will grow
tax-deferred. Before June 21, 1988, the consumer could borrow money out of the
policy without paying any taxes. All policies sold after June 21, 1988, are taxed
when funds are borrowed because the funds are considered income. This
classification means single premium policies now receive last-in-first-out (LIFO)
treatment rather than first-in-first-out (FIFO). The credited interest, which is the
last increase in the account, is now considered the first amount taken out. This
means that any kind of withdrawal made on the account will be taxed up to the
investment performance. On top of the ordinary income tax on investment
performance withdrawn, a ten percent penalty is assessed on distributions made
before age 59 ½.
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Let's say Charles inherited $50,000. He wants to invest it. Charles also needs to
take out a life insurance policy on him. Should he choose an annuity product and a
life insurance product? Single Premium Life (SPL) or SPVL (Single Premium
Variable Life) could be described as a combination of an annuity with life
insurance. The cost of the insurance is paid out of the investment performance.
An advantage is that term insurance premiums are paid with investment dollars
that have never been taxed.
There are three basic types of single premium life products. The difference
between them is the risk. They are:
1. Single Premium Whole Life (SPWL)
2. Single Premium Universal Life (SPUL)
3. Single Premium Variable Life (SPVL)
Of the three products listed, SPWL is the most conservative. The SPWL
guarantees the policy will stay active and mature at the policyholder's age of 95 or
100 as long as the premium is paid and no loans or withdrawals are taken. The
downside to the SPWL is that premium payment and the face amount are
inflexible. SPUL and SPVL offer the advantage of flexible premium payments and
face amounts. When deciding which product to use, one must consider the
policyholder's risk tolerance level. When the policyholder's risk tolerance level
shows a need for a fixed account, one might want to consider the SPUL.
Single Premium Whole Life premiums
& face amounts are not flexible.
Single Premium Universal Life
& Single Premium Variable Life products are flexible.
The MEC disadvantage will apply to whole life and universal life policies as well
as single premium life policies. With this in mind, it is very important for the
policyowner to understand how much cash value is accumulating after charges for
mortality and other expenses are deducted by the insurer.
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Endowment Insurance
Endowment insurance is not widely used anymore. The primary characteristic
of endowment insurance is payment of the face amount at the sooner of either the
time of endowment, which is the maturity of the contract, or at the insured's death,
if prior to the endowment date.
Endowment policies pay the insured when the policy "matures,"
or if the insured dies, the beneficiary collects in full.
Endowment life insurance policies are typically considered a type of "forced
savings." In fact, the protection aspect of the policy is relatively low. Various
types of endowment policies are often found in pension plans since the aim of
pension plans is to provide cash during life. Since the cash values in endowment
plans build up tax free, they are well utilized by individuals in high income tax
brackets.
Endowment policies enable the policyholder to accumulate funds in the insurance
account by a given age. When the policy matures, the policyholder is paid. If the
policyholder dies before the policy matures, the beneficiaries collect in full. A
different way to look at this is that an endowment policy is a savings plan with a
decreasing term component included. The amount of the coverage is calculated so
that the amount of the term coverage combined with the accumulated savings
always equals the face amount of the policy.
Endowment premiums are the highest of any type of policy and therefore are not
generally considered suitable for a young family needing adequate life insurance
for the family’s protection. There are variations of the endowment plan, including
the straight endowment and the retirement-income endowment plans. Straight
endowment plans usually feature a fixed payment period of 10 to 30 years to meet
special goals such as college funding. Retirement-income endowment plans can be
given in a lump sum at a specified age of retirement or the policy can make
monthly payments for life with a minimum number of years of payments
guaranteed.
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Blended Policies
Blended policies are the latest creation of the insurance industry. The policy
owner can lower the initial commission costs and increase the cash value available
to earn interest. If these types of policies are not set up correctly they can cause
problems later in the policyowner’s life. They may not have enough cash value to
keep paying premiums on the blended policy. The policyowner would be left the
choice of paying the premiums or letting the policy lapse out. On the surface,
blended policies may seem similar to endowment policies but that would not
necessarily be true. Endowment plans pay out at a specified age dictated by the
policy. Blended policies collect cash, which in later years pay the premiums of the
insurance policy.
Insurance professionals use blending to lower the cost of cash value insurance in
states where rebating of commissions is not allowed, which is the case in most
states.
Blended policies mix a combination of higher cost cash value insurance with
smaller amounts of term insurance. Blended policies are offered by some major
insurance companies (paying lower sales commissions), which offer a larger
amount of cash value available to earn interest. The all-around cost of the policy is
lower because the term portion of the package carries lower premiums. In fact,
some of the cash value in the policy is used to pay the term portion of the package.
Over the years, the dividends on the whole life portion of the blended policies are
used to buy something called paid-up additions. Essentially, paid-up additions
are little whole life policies on which all the premiums are prepaid in one lump
sum. The paid-up additions gradually increase the death benefits of the whole life
portion, just as the term portion becomes too expensive to keep. The death
benefits have also increased so that the term insurance portion can be eliminated.
A disadvantage for the agent is a lower commission, resulting from using the
paid-up additions to increase the death benefit since more money goes to building
cash values. A disadvantage for the consumer is the slower buildup of death
benefits compared to a policy that is completely whole life and starts out with
larger, fixed death benefits.
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Most blended policies use about 25 percent term insurance although some of the
more aggressive policies may use up to 50 percent term insurance. If a higher
percentage of term is used, it may be wise to pay in extra premium dollars for the
first few years to build cash values.
Family Protection Blended Policies
Family Protection policies were developed to meet the needs of the major wage
earner in families with minor children. This type of plan was designed to
accommodate, to some extent, the changing needs for protection that a family has
as it moves through the cycles of family life. Blending the two types of insurance
helps the family keep up with the premium of the insurance because premiums are
lower than whole-life policies alone.
The Family-Income policy combines a decreasing-term component with a
straight-life policy; this runs for 10, 15, or 20 years from the date of purchase. If
the insured outlives the period protected by the term insurance, the life part of the
policy remains, probably with a reduced premium. The Family Plan policy also
combines straight-life and term insurance on the breadwinner of the family. This
policy typically includes a certain amount of whole-life on the insured. Term
coverage of a specified amount may also be placed on the mother (typically to age
65) and a similar amount placed on each dependent child, including those born
after the insurance policy was issued. The cost is not much more than the parents
would pay for similar protection individually.
Credit Life Insurance
This type of policy is usually taken out when the policyholder takes on a
substantial loan, such as car or boat loans. Lenders often recommend this type of
insurance to cover the loan in case the borrower dies. In most states, lenders
cannot require this insurance as a condition of the loan.
Credit life insurance is almost always over-priced when compared to other types
of insurance. A policyholder could purchase a term policy for much less to cover
the same loan amount. If a person already has an adequate life insurance policy,
added policies may not even be needed. If the lender is requiring such coverage it
may be wise to shop around for other lenders.
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Travel Insurance
This product is normally sold in airports to protect the traveler from accidental
deaths related to the flight. The insurance policies are sometimes sold from
vending machines. This type of policy is very inexpensive since the risk of paying
claims is also very low. Considering the number of flights each day and the
number of travelers involved, there is very few flight related deaths. Travel
insurance is often offered by credit card companies.
Choosing a Company
After careful consideration of all options for life insurance, consumers must select
an insurer from which to purchase their policy. Obviously the agent will
recommend the company he or she favors, and usually the client will accept
whatever company is recommended. It is important to select one that is highly
rated and offers the best features at the best rates, designed to help the family build
a living estate. Typically this means choosing a company offering policies that are
renewable and convertible at the policyholder’s option to a variety of other policy
choices, without evidence of insurability, to a ripe old age.
There are several consumer organizations that will provide an analysis of life
insurance policies to help the policyholder find the best coverage at the lowest
cost. Perhaps the best-known company is the National Insurance Consumer
Organization (NICO) but there are others as well. Web based companies now
offer to price shop for consumers and we may see this trend blossom as consumers
begin to feel educated enough to make their own decisions.
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Review Questions
1) The purpose of life insurance is to:
a) temporarily replace income
b) to take care of large obligations
c) pay debts
d) all of the above
2) All-risk insurance does not exist.
(T)
(F)
3) Death benefits, regardless of growth, pass income tax free all the time.
(T)
(F)
4) Blended policies mix a combination of higher cost cash value insurance with:
a) smaller amounts of term insurance.
b) higher amount of term insurance.
c) smaller amounts of variable universal life.
d) higher amounts of variable universal life.
5) Single premium policies are a form of:
a) modified endowment contract.
b) individual retirement account.
c) credit life insurance.
d) paid-up additions.
Please continue to the next chapter.
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Chapter 2 - Health insurance
Health Insurance
President Barak Obama will go down in history as the President who finally
succeeded in passing American universal health care legislation in 2010. It was
not an easy accomplishment since the Republican Party primarily opposed its
passage. The landmark bill gives health care coverage to an estimated 30 million
people who did not, as of the bill’s passage, have health insurance benefits.
The measure requires most Americans (this coverage is only available to legal
citizens and legal aliens) to have health insurance coverage as well as adding
approximately 16 million poor people to our Medicaid system. Private coverage
will also be subsidized for low and middle income people.
Presidents as far back as Franklin D. Roosevelt wanted national health care for
America’s citizens. President Harry Truman wanted a universal health care
system that would require every citizen to pay into a national health care fund. In
fact, every Democratic president and even some Republican presidents have
wanted some type of affordable health care system for the American people. We
should not be surprised by this. Every day our news gives examples of people
who cannot afford personal health care. Other countries have addressed this issue
many years ago so we seemed to be far behind when it came to providing good
health care for all our people. Presidents have been trying to bring all Americans
equal health care benefits since Roosevelt in 1935; it has taken America
approximately 75 years to accomplish it.
There are probably many reasons why President Obama was successful when
others, such as Bill Clinton, failed. Perhaps one of the most notable reasons has to
do with employers. Many companies were becoming alarmed at the increasing
cost to provide their workers with health care. Because of the soaring health care
costs, businesses were willing to work with the Obama administration if it would
relieve them of this burden while still providing health care for their employees.
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When President Clinton was pushing for universal health care, the insurance
companies strongly opposed it, which played a major role in the health care
failure. In 2009 insurers said they understood the need for change but they did not
want to be put out of business in favor of a government-ran program. Insurers
said they would only support a plan that includes them.
The Democratic Party probably expected the usual intense opposition to
universal health care. They appeared well prepared for the fears that always seem
to emerge: America would have to give up the familiar in favor of the unknown.
Many of the scare tactics heard were just plain ridiculous while others had merit.
We saw a dramatic example of how intense views were when Representative Joe
Wilson of SC yelled “you lie!” when President Obama said illegal immigrants
would not be eligible for the health care benefits under his plan. It is such fears
that have repeatedly defeated past attempts at health care for everyone. Those
who have studied our health care system and those of other countries shake their
heads at the number of uninformed people who persuade and even lead the
equally uninformed. There are some valid reasons for opposing health care
reform but opposition should be based on facts rather than fears. Certainly
political representatives should be informed. The health care bill that was passed
does not cover illegal aliens, as Representative Wilson had an obligation to know.
If our elected officials do not appear to understand the health care reform, how
can we expect the man on the street to understand it? That is precisely why the
Obama administration will be attempting to educate the average citizen so that
such unfounded fears do not continue to be an issue.
Some in the health care field believe that such falsehoods help new legislation to
be implemented because it diverts attention to something that can be proven false
while avoiding issues (especially financial issues) that should be focused on. It is
a massive program with unproven financial consequences. If America’s attention
can be diverted to something as inconsequential as whether or not illegal aliens
will receive program benefits, then the bigger issues can be hidden until the
program is completely integrated. By the time Americans realize that the true cost
of the program will mean continually higher taxes the program will already be
implemented. That is why some in the medical field feel so much attention is
allowed (even encouraged) on what is essentially a minor financial detail of the
program. Although illegal aliens will not be included, anyone who shows up in
the hospital emergency ward will likely receive medical care. Does it really
impact us any differently whether federal hospital subsidies (our taxes) or a
universal health care program (funded by our taxes and premiums) pays the costs
of the care? This should be an immigration issue rather than a universal health
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care issue. As long as Americans focus on an inconsequential issue the truly big
issues will not be recognized.
Presented Bills
Several bills were presented. The Baucus Bill was put forth in the fall of 2009; it
closely represented what President Obama wanted, but did not include a new
government insurance plan that would compete with private insurers. The
Congressional Budget Office announced that the Baucus Bill would reduce federal
deficit by slowing the rate of health care spending, even though the price tag was
significant. Except for one Republican, only Democrats supported this Bill.
The House Bill finally gained support after promising not to pay for abortions
with federal money and tightening abortion restrictions. There was also concern
regarding the public option plan, which would have to negotiate rates just as
private insurers do, rather than offering a rate set just above what Medicare pays.
Although liberal Democrats did not like all aspects of the House Bill they
supported it because of the coverage that would be extended to around 36 million
people who did not have health insurance. Much of the funding would come from
new fees and taxes and cuts in Medicare. Despite the cost, it was expected to cut
the deficit over the next ten year period because it would reduce health care
spending.
In November 2009 Senator Reid introduced a bill in the Senate that included the
public option that was part of the health committee’s bill but with an “opt out”
state provision so states could have their own universal health care program if
they wished. Reid’s proposal was similar to the House bill but there were also
differences, such as the increase in the Medicare payroll tax on high-income
people and a new excise tax on high-cost Cadillac plans offered by employers to
their most valued employees. Reid’s bill allowed greater access to abortion and
imposed lesser penalties on people who did not join the health care program.
According to the analysis released by the Congressional Budget Office, Reid’s
bill came in under the $900 billion goal wanted by President Obama. However, it
did not necessarily insure all Americans. By 2019 potentially 24 million people
still would not have health insurance. One-third of those would be illegal
immigrants however, so of the 24 million just 16 million would be American
citizens.
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Senator Reid began looking for changes that could pull together the 60 votes
they needed to avoid a Republican filibuster. Some significant changes resulted
from their efforts to obtain the votes they needed. For example, the proposal that
people between the ages of 55 and 64 be permitted to buy into Medicare was
dropped.
Although it seemed that the bill was set to be approved, following several
changes that were made to bring in votes, the death of Ted Kennedy made passage
uncertain. His replacement with a Republican had the potential of changing the
vote margin.
President Obama’s State of the Union address to Congress on January 27, 2010
asked Republicans to develop their own ideas so that universal health care would
not once again be lost to the millions of uninsured citizens. The President did not
lay out his own preferences for the bill’s final form; he hoped Congress could
develop a plan that worked for the majority. Two weeks later President Obama
announced a bipartisan summit at the White House where Americans could
witness whether or not their representatives were part of the solution or part of the
problem.
It was not necessarily that Republicans were against health insurance for the
masses; rather they opposed a government ran health care system. Republicans
preferred health coverage based on the market, not on government requirements.
Although Republicans did not offer a unified health care bill, they outlined a set of
ideas intended to make health insurance more affordable and available with
emphasis on tax incentives and state innovations, with no new federal mandates
and just a small expansion of the federal safety net. Republicans would not
require employers to offer their workers insurance coverage and opposed the
Democrats’ call for a large Medicaid expansion. The US had already experienced
financial difficulty from the current Medicaid system and it was felt expanding the
program would also mean expanding the current burden it represented. State
budgets were already in trouble and part of the problem was their huge Medicaid
costs.
Both Democrats and Republicans had valid concerns. The Congressional Budget
Office did not analyze the Republican proposals but everyone knew their
approach would not insure everyone, as was the intention of the Democratic Party.
Republicans felt it was financially better to make what they called incremental
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progress – a slower approach to universal health care. In effect, the Republicans
were satisfied with the current course of our health care in America.
In February 2010, prior to his health summit meeting with Republicans,
President Obama released a detailed set of proposals. The bill was intended to
meet his goals of expanding coverage to the uninsured and keep down health
premiums. An important aspect of his proposal was the elimination of health care
insurance underwriting. In other words, insurance companies would no longer be
able to deny coverage to anyone, regardless of existing health conditions, past or
present. In an effort to alleviate Republican concerns for their state’s financial
well-being Obama offered more money to the states to pay for Medicaid over a
four-year period. He also included something for the elderly by ending the “donut
hole” in Medicare’s prescription drug program.
Although the President’s proposal was much like the Senate version passed in
December 2009 there were some important differences. For example, he
eliminated Nebraska’s special deal that would have the federal government paying
for that state’s Medicaid expansion costs (it was referred to by Republicans as the
“cornhusker kickback”) that had been granted in order to get Nebraska’s health
care vote. Instead, the White House would help all states absorb the cost of the
Medicaid expansion between 2014 and 2017 – not just help one state and ignore
the rest. The White House version also adopted the Senate’s proposed excise tax
on high-cost employer-sponsored insurance plans but with some adjustments.
These adjustments were based on agreements with organized labor leaders, while
also attempting to avoid the look of special union treatment.
The White House Summit was held on February 25, 2010. It lasted seven hours
and was televised throughout the debate on health care reform. This meant that
voters could witness for themselves who was for and against specific health care
details. The result was politicians who were very aware that their ideas and their
actions could be viewed by their voters. That did not mean that Democrats and
Republicans agreed on much, even with voters watching. Although there were
multiple disagreements, a central disagreement was on the expansion of coverage
to the uninsured. Republicans were not against insuring all citizens and legal
aliens; they were against the cost of insuring them. Democrats, on the other hand,
felt all Americans deserved coverage regardless of the cost. Republicans pointed
to the financial problems America already faces in continuing Medicare and
Medicaid. We have known for years that there is not enough money to continue
funding the programs, at least in their present forms. To add coverage of more
than 30 million additional people, Republicans argued, made no sense when we
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were already facing huge shortfalls for current programs. How could the
government expect taxpayers to accept the additional burden of insuring 30
million more people who could not afford to insure themselves? It is not
surprising that much of the funding would have to come from additional taxes in
one form or another. Whether the tax is imposed on the individual or on the
business, it comes out of our pocket eventually. Businesses that must pay higher
taxes will hire less people and pay lower wages to make up for the additional
taxation.
Although the health care bill was primarily backed by Democrats, not
Republicans, it should not be thought that Democrats were not also concerned
with the potential cost of the program. Many Democrats expressed financial
concerns. A large influence in reducing financial concern was the Congressional
Budget Office’s assessment that the bill would reduce the deficit by $138 billion
during the first 10 years. Although their assessment was not necessarily always
accepted as fact, it certainly influenced the views of many.
After the House passed the Senate’s bill, it passed and sent to the Senate what
was called the “sidecar” of fixes, which removed some elements that were a
problem to its passage, such as the special deal that had been made with Nebraska.
Other provisions were also adjusted, including the excise tax the Senate had put
on high-cost coverage.
Just about everyone expects other changes to come over the next few years as
some items work and others don’t. Much of the change is likely to focus on cost
of services and how those services can be paid for.
In an April 2010 article titled “Health Reforms to be Clear” by Susan Heavey, it
was acknowledged that much of the future work will be the education of our
citizens; people often fear what they do not understand. With opposing views
often confusing actual facts consumer education is vital.
Americans who were lucky enough to have employer-sponsored health care
coverage often forgot that excessive use drove up costs. An individual who does
not write the checks does not always realize how expensive the service is. The
basic purpose of health insurance is to provide protection against catastrophic
health care costs, not necessarily the small costs that occur day to day.
Traditionally this included hospital care and physician care, including the costs of
surgery and long term recoveries. As workers demanded, and often received,
health coverage for every bruised toe and stomach ache costs skyrocketed. Health
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benefits were often part of union negotiations when contracts were renewed.
Non-union companies often wanted to offer their employees health care benefits
but found affordable plans difficult to obtain. Many companies offered health
benefits but did not fund them; employees were left to bear the entire cost for
themselves and their families. Although group plans have many advantages
(coverage for all, even those with pre-existing health conditions, for example),
cost can still be high. For those in service-based jobs insurance rates offered on
their group plans were often beyond the financial ability of the low paid workers.
Therefore, even though group coverage was available, many employees and their
families still went uninsured.
Many employers covered the premium cost for their employees, but not their
families. It has long been felt that employees with health care benefits miss less
work because health conditions are treated quickly, preventing loss of work time
later on. Therefore, the focus was often on insuring workers, not their families.
Benefits could be purchased for the worker’s family but for many low-paying
positions, cost was prohibitive. Unfortunately, as a result those least likely to
have coverage were children. It was not unusual for a spouse to take a job based
entirely on health care benefits that were being offered.
As America’s health care costs rose quicker than almost any other commodity in
the United States, employers increasingly found themselves unable to afford the
group premiums, which rose to reflect the increased costs of providing health care.
If workers were disproportionately older, group rates tended to reflect this.
Without a younger pool of employees to keep premiums down, rates were high.
Although there are anti-discrimination laws, it is likely that employers considered
the age of those they were considering for positions within the company since
average worker age is reflected to some degree in a company’s health care plan
premiums.
In recent years we have seen many companies discontinue company-sponsored
health care plans. The companies might substitute a less costly benefit, but not
necessarily. Just as recent financial downturns have been difficult on individual
families so too have they been difficult on companies, as witnessed by the many
company layoffs. There has been some fear that forcing companies to sponsor
group health care for their workers will lead to additional company layoffs; others
disagree. Only time will tell.
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Health insurance has never paid for everything; the goal was always to cover
“most” costs. It is always important to understand any policy exclusions. Health
insurance cannot protect the insured from the crisis itself, but it can protect the
insured from the medical debts caused by the crisis.
If a long-term illness or injury is the cause of the medical costs it is important to
realize that lost income can be just as devastating as high medical bills. No matter
how good the health insurance is it will not make up for lost work time resulting
from sickness or injury and the resulting lost wages. Only disability insurance
products can replace lost wages.
Coverage under the new health care legislation will not immediately help
everyone. There will continue to be a period of time before all citizens are
insured; many of us will continue to carry private coverage for some time. There
will probably be continuous changes in the health care plan, but the basic formula
is likely to remain the same. For now, there will be many questions as we
consider new options and address old fears.
Soon after signing the bill the administration launched a special coverage
program for uninsured Americans called the Pre-Existing Condition Insurance
Plan. It was designed for those with existing medical conditions and no insurance
for the previous six month period. Although premiums for the guaranteed
coverage were not cheap it provided coverage to many who could not otherwise
have qualified for health insurance. Congress allocated $5 billion, although it will
fund the program for less than three years.
The Pre-Existing Condition Insurance Plan began accepting applications in 2010.
The actual cost of the insurance premiums varied by state since cost was partially
based on the cost of health care in the area. Monthly premium rates of $400 to
$600 per person (and significantly higher in some areas) make this coverage
difficult for many to maintain but for those with existing health care issues who
have not had access to coverage before will likely be glad to have the coverage
available. There are deductibles of $1,500.
Even though the premiums were high for many households, the Pre-Existing
Condition Insurance Plan was expected to draw around 700,000 people
nationwide. This was a temporary fix until 2014 when core provisions of the new
health care law took effect. By 2014 insurance companies must accept all
individuals, regardless of current or past health. To qualify for the temporary
program individuals were required to have a pre-existing medical condition and
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have been uninsured for six months or longer. Most expected self-employed
people (and their families) and those working for companies without group health
care benefits would be most likely to apply.
Health care programs under President Obama’s bills are only available to
citizens of the United States and legal residents. Illegal aliens may not access
these health care benefits. It is expected to take an additional $5 billion to $10
billion to fully meet the demand. Most states already operated their own programs
for those who were otherwise uninsurable but about 20 states still participated in
the Pre-Existing Condition Insurance Plan, which meant Washington DC would
run the program for those 20 states. Although we cannot say why some states
chose to participate and others chose not to, it was likely that the participating
states were doing so because of their state budgets, which were already stressed.
The states with existing health care plans for high risk individuals do generally
charge higher rates than the premiums charged under the federal program. If it is
deemed possible to switch from a state plan to the federal plan, it is likely the
beneficiary would have to go without coverage for at least six months in order to
qualify for the federal high risk program. That is a risk that should not be taken
lightly since medical bills in that six month period could be substantial.
Critics felt the Pre-Existing Condition Insurance Plan was too expensive and was
likely to run out of funds. If that happens it is unclear what the federal
government plans to do. It would be difficult to simply discontinue the plan prior
to 2014 when the new health care plan steps in. Critics say it will force Congress
to allocate yet additional funds to the program and that will be money our citizens
may not want to spend.
Medicare
America already has experience with universal health care in the form of
Medicare. The Medicare program is universal health care for those aged 65 and
older. There may also be individuals that are disabled on Medicare even though
they are not yet 65 years old. As we know, Medicare has had numerous problems,
including (though not necessarily limited to) fraud, duplication of services, lack of
economic controls, and tremendous cost issues. The new health care program
hopes to prevent the same problems experienced in the past with Medicare.
Critics are doubtful that President Obama’s administration will be successful since
the government is known for under-estimating costs.
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Medicare is not free to participating beneficiaries, but the cost is low when
compared to other health care coverage. Those who elect to take Part B coverage
for doctors and outpatient care have a premium deducted from their Social
Security benefits each month. If the beneficiary elects to also carry a private
insurance policy to fill the gaps left by Medicare, that premium will be additional.
Most people do elect to also purchase health insurance in addition to Medicare.
Originally there were two parts to Medicare: Part A for hospital benefits and Part
B for doctor and outpatient benefits. We now have four parts to Medicare:
besides Parts A and B, there is also Part C, usually referred to as Medicare
Advantage, and Part D for prescription drugs.
Initially Medicare was simply called Medicare; now it is called the Original
Medicare. Those with the Original Medicare go to the doctors and medical
facilities of their choice. Beneficiaries do not need a primary doctor or referrals to
specialists. The Original Medicare is run by the Federal government and provides
Part A and, if purchased, Part B coverage. Participants may purchase Part D from
private insurers for their prescription coverage needs.
Some individuals who are at least 65 years old and eligible for Medicare benefits
will select Medicare Advantage Plans (formerly called Medicare Part C) for their
medical care. Medicare Advantage Plans are run by private insurance companies
that have received approval and are under contract with Medicare. Beneficiaries
who select Medicare Advantage Plans will still have Part A and Part B of
Medicare but the Advantage Plans can charge different amounts for certain
services. While they may not necessarily be less expensive than the Original
Medicare plan, there may be coverage for additional services, such as eye care and
prescription glasses. Costs and coverage will vary based on the Medicare
Advantage Plan selected. Generally prescription coverage is purchased through
the Advantage Plan rather than purchasing a separate Part D Plan. A separate
insurance policy (Medigap plan) is not necessary and would not work with
Medicare Advantage Plans.
Medicare Part A
Part A is typically earned through working and paying Medicare taxes, but if an
individual did not earn enough work credits to qualify for Part A benefits, they
may be purchased. Generally beneficiaries who choose to buy Part A must also
purchase Part B. When an individual signs up for Medicare benefits he or she will
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receive a Medicare card. This is a white membership card with a blue and red
stripe across the top. It will say the beneficiary’s name, their Medicare claim
number and the benefits they are entitled to (hospital and medical coverage).
The Medicare Part A initial enrollment period (and Part B if it is selected)
begins three months prior to the month in which the beneficiary turns 65 years old
and continues for three months after the person’s birth month (totaling 7 months).
There is also a general enrollment period between January 1 and March 31 each
year. Coverage for those who enroll during this time will begin on July 1 of that
year. It is likely the beneficiary will pay a lifetime higher premium if he or she
enrolls in Medicare past the initial enrollment period.
Medicare Part A will pay for the first three pints of blood, home health services
if they are medically necessary and meets all the criteria and hospice care for the
terminally ill. All services received under Medicare must meet Medicare’s
criterion in order to be covered. There are limitations to coverage, even when all
criteria are met. For example, home health services may only be provided on a
part-time basis; never will the beneficiary receive full time home health services.
Medicare Part A also covers hospitalizations in a semi-private room. Care in the
nursing home is provided on a limited basis; only skilled nursing care is covered
in a semi-private room. Neither intermediate nor custodial care is covered by
Medicare. Custodial care, also called personal or maintenance care, is not paid for
by Medicare. Custodial care is the type of nursing home care people are most
likely to receive for an extended period of time.
All types of care covered by Medicare may be subject to copayments,
coinsurance and deductibles. Copayment and deductible amounts under Medicare
are likely to increase periodically.
Medicare Part B
Part B of Medicare covers medically necessary doctor’s fees, outpatient care,
home health services, some types of preventive care, and other medical services
that are not part of hospitalization. Cosmetic care or other procedures that are not
medically necessary will not be covered by Medicare.
There is a Part B premium that is due each month; this is deducted from the
individual’s Social Security check. The premium amount may not be the same for
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all beneficiaries. If the person’s modified adjusted gross income, as reported on
their IRS tax return from two years ago, is above a specified amount the
individual will pay a higher Part B premium. An individual’s modified adjusted
gross income is their taxable income plus their tax exempt interest income.
Individuals who fail to sign up for Part B when they turn 65 years old may pay a
higher premium when they do sign up. It is typically referred to as a late
enrollment penalty and will apply for the person’s lifetime.
Medicare generally will not cover health care outside of the United States. The
“U.S.” includes all 50 states, the District of Columbia, Puerto Rico, the Virgin
Islands, Guam, the Northern Mariana Islands, and American Samoa. There may
be some exceptions, but typically a Medicare beneficiary that is traveling may
want to consider purchasing travel insurance.
Medicare Part C
Medicare Part C is usually called Medicare Advantage (MA). They are another
health care choice available those aged 65 or more and on Medicare. MA plans
are offered by private companies approved by Medicare. Those who join a
Medicare Advantage Plan will receive all their Part A and Part B services. In all
plan types the beneficiary is covered for emergency and urgent care even if they
are not near their Medicare Advantage facilities. MA Plans must cover all of the
services that Original Medicare covers except hospice care. Original Medicare
covers hospice care even if the beneficiary is in a Medicare Advantage Plan.
Medicare Advantage plans are not considered supplemental plans; they are the
primary provider whereas supplemental plans are secondary to the Original
Medicare option.
MA Plans may offer extra coverage, such as vision or wellness services. Most
include the Part D prescription drug coverage. There is likely to be a premium for
the Medicare Advantage plan, although there are some that rely solely on the
payments they receive from Medicare on behalf of the beneficiary. Medicare pays
a fixed amount for the care in the Medicare Advantage Plan each month. These
companies must follow rules set by Medicare, but they can charge different outof-pocket costs and have different rules for how services are received, such as
requiring a referral to specialists.
Usually, individuals may only join a Medicare Advantage Plan at specified times
of the year, such as between January 1 and February 1. There are requirements
for joining a Medicare Advantage Plan:
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• Both Medicare Parts A and B must have been purchased.
• The applicant must live in the service area of the plan.
• The applicant may not have End-Stage Renal Disease (ESRD) although
there may be some exceptions to this.
Medicare Part D
Medicare Part D is for prescription drug costs. Part D of Medicare is offered to
any person who has Medicare. Insurance companies and other private companies
that have been approved by Medicare run the Part D plans. Prescription drug
plans are sometimes called PDPs (Prescription Drug Plans). They add drug
coverage to Original Medicare plans; usually Advantage Plans include
prescription drug coverage as part of their comprehensive coverage.
State Universal Health Care Programs
A few states have taken steps towards universal health care for their state’s
citizens. Some, such as Massachusetts, found offering state-wide care is not
without its problems. There were numerous resident complaints regarding
difficulty getting in to see doctors; doctors felt overworked as their patient loads
jumped dramatically.
Legislation
There were several proposed health care reforms during the Obama
administration, including a variety of specific types of reform. The Obama
administration suggested a package of reforms, as did several Congressional
legislative proposals. On February 22, 2010, Obama released his plan for reform
that outlined the key elements on which he wanted to focus, such as cost
containment and fiscal sustainability. Congress proposed H.R. 3962 and H.R.
3590. The first was a House Bill and the second a Senate Bill.
On November 7, 2009, the House passed their version of health insurance
reform, called the Affordable Health Care for America Act, 220-215. On
December 24, 2009, the Senate passed their version, called the Patient Protection
and Affordable Care Act, 60-39. On March 21, 2010, the House also passed the
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Patient Protection and Affordable Care Act, 219-212. The passage of this act
essentially abandoned the previously passed Affordable Care Act through the
Health Care and Education Reconciliation Act of 2010, which the House also
passed on March 21. On March 23, 2010 President Obama signed the Patient
Protection and Affordable Care Act into law. The Health Care and
Education Reconciliation Act of 2010 was passed by the Senate on March 25 by
a vote of 56-43. It was signed into law on March 30, 2010.
Although it is always possible (perhaps even likely) that some changes may
occur, the bill:
1. Expands Medicaid eligibility up the income ladder, allowing a greater
number of people to obtain benefits, if they meet eligibility requirements;
2. Establishes health insurance exchanges and subsidizes for those making up
to 400% of the poverty line;
3. Offers tax credits to certain small businesses (less than 25 workers) that
provide employees with health insurance.
4. Imposes a penalty on employers who do not offer health insurance to their
workers;
5. Imposes a penalty on individuals who chose not to buy health insurance;
6. Offers a new voluntary long-term care insurance program;
7. Pays for new spending through various ways, including the elimination of
Medicare Advantage, and other cuts to both Medicare and Medicaid
programs. Of course, there is likely to be an increase in various taxes as
well.
8. Imposes a $2,500 limit on contributions to flexible spending accounts that
allow for payment of health costs with pre-tax funds. This will lead to an
increase in taxable income, which critics argue amounts to a tax increase.
2010-2011
There are key elements to the March 2010 legislation. Within one year of its
enactment, namely years 2010 to 2011:
1. Insurance companies are barred from dropping people from coverage if
they get sick, ending the practice of rescission. Insurers are prohibited from
looking for an error on an insurance application, which can then be used to
rescind the policy when a claim occurs. There can be no discrimination
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against children with pre-existing conditions since the new law specifically
bans the practice by insurers.
2. Lifetime coverage limits are eliminated and annual limits are also restricted.
We are accustomed to seeing million dollar limits on our major medical
policies, but under the Affordable Care Act there will be no limits.
3. Young adults are able to stay on their parents’ health care plans until they
become 26 years old. Many health plans currently drop children from
coverage once they turn 19 or later if they finish college.
4. Uninsured adults with pre-existing conditions will be able to obtain health
coverage through a new program that will expire once new insurance
exchanges begin in the year 2014.
5. A temporary reinsurance program has been created to help companies
maintain health coverage for early retirees between the ages of 55 and 64.
This will also expire in the year 2014.
6. Medicare drug beneficiaries who fall into what has been called “the
doughnut hole” will receive a $250 rebate to cover the gap they have
previously experienced. The bill eventually closes that gap, which
currently begins after $2,700 has been spent on drugs. Coverage starts
again after $6,154 has been spent. An estimated four million people who
hit the gap in Medicare prescription drug coverage in 2010 will receive the
$250 rebate.
7. A tax credit becomes available for some small businesses to help provide
coverage for their workers.
8. A 10% tax on indoor tanning services that use ultraviolet lamps goes into
effect on July 1.
The law creates an easy to use website for consumers so they can compare health
insurance coverage options and chose the plan they feel is best for them. The law
also provides consumers with a way to appeal to their insurance company and to
an outside board if the insurer denies coverage on a claim.
All plans must cover certain preventative services, such as mammograms and
colonoscopies, without charging a deductible, co-pay or coinsurance. A new $15
billion Prevention and Public Health Fund will invest in proven prevention and
public health programs that will hopefully keep Americans healthy. This includes
anti-smoking and anti-obesity programs.
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There will be an emphasis on preventing fraud and abuse of the system. In 2009
more than $2.5 billion was returned to the Medicare Trust Fund and it is hoped
that increased efforts will return even more funds in the future. The new law
invests new resources and requires additional screening procedures for health care
providers to reduce fraud and waste in Medicare, Medicaid and other programs.
The law allows states to keep or implement measures requiring insurance
companies to justify their premium increases. As of 2010, grants were awarded to
encourage companies to keep premiums reasonable.
During 2011 the following becomes effective:
1. Medicare provides 10% bonus payments to primary care physicians and
surgeons;
2. Medicare beneficiaries will be able to get a free annual wellness visit and
personalized prevention plan service. New health plans will be required to
cover preventive services with little or no cost to patients.
3. A new program under the Medicaid plan for the poor goes into effect in
October 2011 that allows states to offer home and community based care
for the disabled that might otherwise require institutional care.
4. Payments to insurers offering Medicare Advantage services are frozen at
2010 levels. These payments are to be gradually reduced to bring them
more in line with traditional Medicare.
5. Employers are required to disclose the value of health benefits on
employees’ W-2 forms.
6. An annual fee is imposed on pharmaceutical companies according to
market share. The fee does not apply to companies with sales of $5 million
or less.
Seniors who fall in the coverage gap will receive a 50 percent discount when
buying Medicare Part D covered brand-name prescription drugs. Over the next
ten years, seniors will receive additional savings on brand-name and generic
prescription drugs until the coverage gap is completely closed in 2020. There will
be free preventive care, such as annual wellness exams, for those on Medicare.
There will also be an emphasis on improving care for seniors after they leave the
hospital. The Community Care Transitions Program will help high risk
Medicare beneficiaries following their departure from the hospital with the goal of
fewer readmissions.
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The new Community First Choice Option allows states to offer home and
community based care to disabled people through Medicaid with the hope of
delaying or preventing the necessity of care in nursing homes. While this saves
the costs of care in nursing homes, it will also give frail and ill individuals what
they most want – the ability to remain at home. People generally do better in
some type of home environment (not necessarily their own home) and often go
downhill once admitted to a nursing home. The law includes new funding to
support the construction of and expand services at community health centers,
allowing them to serve approximately 20 million new patients across the country.
In 2011 the Independent Payment Advisory Board was to develop and submit
proposals to Congress and the President with the goal of protecting and improving
benefits for seniors and extending the life of the Medicare Trust Fund. In
particular, the goal was to target waste, reduce costs, improve health outcomes for
patients, and expand access to high quality care. Of course, such promises have
been made in the past by politicians so we can only wait to see if the program is
successful.
By 2010 Medicare was paying Medicare Advantage insurance companies over
$1,000 more per person on average than for those on Original Medicare. The
Medicare Advantage plan was intended to save the system money but as with so
many government plans, it did not work as intended. This is paid in part by
increased premiums paid by all Medicare beneficiaries. The new law levels the
playing field by gradually eliminating Medicare Advantage overpayments to
insurers.
Effective in 2012:
1. Physician payment reforms are implemented in Medicare to enhance
primary care services and encourage doctors to form “Accountable Care
Organizations” with the intent of improving quality and efficiency of care.
2. An incentive program is established in Medicare for acute care hospitals to
improve quality outcomes.
3. The Centers for Medicare and Medicaid Services, which oversees the
government programs, begin tracking hospital readmission rates and puts in
place financial incentives to reduce preventable readmissions.
4. Companies will be required to issue 1099 forms to any vendor of service or
rental property to which the business has paid more than $600. Form 1099
is also sent to the IRS. Under existing law, business issued the Form 1099
only to those who provided services or property to the business. The
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healthcare law included the same form to be issued to corporations as well
as to individuals and corporations providing property to the company. Only
business related payments are reportable, personal payments are not.
There are a number of exceptions. Payments for merchandise, telephone, freight,
storage, and rent payments to real estate agents are not included. The goal of the
health care bill is to collect lost revenue from companies that currently under
report on their tax returns. They hope these measures will raise $17 billion over
ten years.
The law establishes a Value-Based Purchasing program, called VBP, in
traditional Medicare, which offers financial incentives to hospitals to improve the
quality of care they provide. Hospital performance must be publicly reported
beginning with measures on treating heart attacks, heart failure, pneumonia,
surgical care, healthcare associated infections, and patients’ perception of their
care.
Much of our health care industry still relies on paper records so the new law will
institute changes to standardize billing and require health plans to begin adopting
and implementing rules for secure electronic exchange of health information. It is
hoped that this will reduce duplication of services. Additionally, it should reduce
paperwork in general, cut costs associated with that paperwork, reduce medical
errors, and improve the quality of care.
Effective as of 2013:
1. A national pilot program is established for Medicare on payment bundling
to encourage doctors, hospitals and other care providers to better coordinate
patient care, thus reducing duplication and waste.
2. The threshold for claiming medical expenses on itemized tax returns is
raised to 10% from the previous 7.5% of income. The threshold remains at
7.5% for the elderly through the year 2016.
3. The Medicare payroll tax is raised to 2.35% from 1.45% for individuals
earning more than $200,000 and married couples with incomes over
$250,000. The tax is imposed on some investment income for that income
group.
4. A 2.9% excise tax in imposed on the sale of medical devices. Anything
generally purchased at the retail level by the public is excluded from the
tax.
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State Medicaid programs will receive new funding to expand the number of
Americans receiving preventive care with little or no cost to those receiving it.
An important change in January 2013 is the establishment of a national pilot
program to encourage hospitals, doctors, and other providers to work together to
improve the coordination and quality of patient care. Hospitals, doctors, and other
providers will be paid a flat rate for an episode of care, rather than the current
fragmented system where each service or test is billed separately to Medicare.
Instead of a surgical procedure generating multiple claims from multiple
providers, the entire team is compensated with a “bundled” payment; this provides
incentives to deliver health care services more efficiently while maintaining (and
perhaps even improving) the quality of care received.
There will be additional funding for children’s health insurance programs as of
October 2013. States will receive two more years of funding to continue coverage
for children not eligible for Medicaid.
Effective as of 2014:
1. State health insurance exchanges for small businesses and individuals open.
2. Individuals with income up to 133% of the federal poverty level (FPL)
qualify for Medicaid coverage.
3. Healthcare tax credits become available to help people with incomes up to
400 percent of poverty purchase coverage on the exchange.
4. Premium cap for maximum “out-of-pocket” pay will be established for
people with incomes up to 400 percent of FPL.
5. Most people required to obtain health insurance coverage or pay a tax if
they refuse to do so.
6. Health plans no longer can exclude people from coverage due to preexisting health conditions.
7. Employers with 50 or more workers who do not offer coverage face a fine
of $2,000 for each employee if any worker receives subsidized insurance on
the exchange. The first 30 employees aren’t counted for the fine.
8. Health insurance companies begin paying a fee based on their market share.
As of 2014 there may be no discrimination due to pre-existing medical conditions
or gender. Higher rates may not be charged based on gender, health status, or
other factors.
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Perhaps one of the biggest benefits to citizens is the elimination of annual limits
on insurance coverage. Under the new law there may not be any maximum dollar
limitations. Many current policies have million dollar lifetime limits, which might
seem like sufficient coverage, but in today’s high cost long-term care scenarios
that amount can quickly be spent.
No longer will insurers be allowed to drop or limit coverage because an
individual chooses to participate in a clinical trial. This applies to all clinical trials
that treat cancer or other life-threatening diseases.
There will be tax credits making it easier for the middle class to afford insurance.
To qualify there will be parameters; at this point it is set at incomes above 100
percent and below 400 percent of poverty that are not eligible for or offered other
affordable coverage. There may also be reduced cost sharing, meaning the
individuals will pay lower copayments, coinsurance and deductibles.
The law requires health insurance exchanges to open in each state to enable all
Americans easy access to more affordable private insurance. Plans offered in the
exchange provide at least a basic level of benefits and services. The exchanges
will increase competition and give consumers a wider choice of health plans. It is
expected to bring down premium costs as well.
Americans who earn less than 133 percent of poverty will be eligible to enroll in
Medicaid. States will receive 100 percent federal funding for the first three years
to support this expanded program, reducing down to 90 percent federal funding in
subsequent years.
An important goal of the new law is promoting personal responsibility. Most
people who can afford to pay for health insurance will be required to buy basic
health insurance or pay a fee to help offset the costs of caring for uninsured
Americans. If affordable coverage is not available, then there will be an
exemption made.
Effective 2015:
Medicare creates a physician payment program aimed at rewarding quality of
care rather than volume of services. The new provision ties physician payments to
the quality of care provided. Doctors will see their payments modified to reflect
the quality of care they provide.
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Effective 2018:
An excise tax on high cost employer-provided plans is imposed. The first
$27,500 of a family plan and $10,200 for individual coverage is exempt from the
tax. Higher levels are set for plans covering retirees and people in high risk
professions.
There may be some legal challenges to President Obama’s health care plan,
which could bring about some measure of change. Some of the states objected to
mandatory insurance. For example, the Virginia General Assembly passed the
Virginia Health Care Freedom Act before Congress completed its bill. On March
23, 2010 the Attorney General of Florida, along with the states of South Carolina,
Nebraska, Texas, Utah, Louisiana, Alabama, Michigan, Colorado, Pennsylvania,
Washington, Idaho, and South Dakota filed a joint lawsuit in a Florida district
court challenging the new law. However several constitutional law professors feel
the lawsuits and state laws are unlikely to succeed.
People seldom like change; we tend to hang on to familiar ideas and resist new
ideas. Perhaps that is why it has been so difficult for universal health care to
materialize and so easy for some industries to scare us into hanging onto the
familiar. Those who fought the creation of Medicare predicted the financial
downfall of our economy if we enacted the Medicare legislation. There have
certainly been some major financial mistakes and we can’t say for certain that the
new legislation won’t experience similar problems. Still, we did not collapse with
Medicare’s creation; perhaps we bent a little here and there but the lives of many
were much better for having the program.
Although the previous pages provided information, let us look at how The
Affordable Care Act specifically benefits select groups. Many of the benefits
equally apply to everyone, such as ending pricing discrimination.
Benefits for Children:
• Eliminates pre-existing coverage exclusions as of 2010. We often do not
think of children having existing conditions; it seems like something older
people would experience. However, children are often born with existing
conditions. This prohibits excluding such children on health policies.
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• Extends the Children’s Health Insurance Program (CHIP) through
September 30, 2015. It further provides states with additional funding to
ensure children have access to the program.
• Pediatric Benefit Package that includes oral and vision coverage for all
children. This is required not only in the basic pediatric services under all
new health plans, but also oral and vision requirements, as of 2014.
• Expansion of the pediatric health care workforce, including pediatricians,
pediatric nurse practitioners and specialists in pediatrics and pediatric oral
health. Many health care professionals are concerned about having the
number of health care specialists needed (for all ages) once health benefits
are provided for everyone. It might especially be an issue in some rural
areas. As of 2010 parents enrolling in new plans must be allowed to select
their child’s pediatrician from among any participating provider. There will
be education incentives to attract additional health care workers.
• As of 2014, coverage for children aging out of foster care. It makes the
current state option of extending Medicaid coverage up to age 26 to foster
children mandatory. Children leaving the foster care system due to age face
many obstacles; finding affordable health care should not be one of them.
• Develops priorities and promotes children’s quality measurement and
reporting to improve the care our children receive. A child’s care must be
equal without bias towards the type of health coverage (or lack of it) in
place. Prior to universal health care, a study found that children receive
recommended care less than half the time. 1
• Childhood obesity will receive $25 million in funding through the
Childhood Obesity Demonstration Project. This program was established
through the Children’s Health Insurance Program (CHIP) legislation. The
Secretary of Health and Human Services will award grants to develop a
comprehensive and systematic model for reducing childhood obesity. It
will require guidance to the states and health care providers on preventive
and obesity-related services available to Medicaid enrollees and requires
each state to design a public awareness campaign on available services.
• As of 2010 it requires new plans to cover prevention and wellness benefits.
These benefits are exempt from deductibles and other cost-sharing
requirements. It further invests in prevention and public health to
encourage innovations in health care that might prevent illness and disease
before they require more costly treatments. An important step in preventing
1
The White House Health Care Reform 2010
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disease relates to obesity, which causes or contributes to diabetes and heart
disease. In 2010 the government reported that 32 percent of our children
were overweight or obese.
• Expands coverage to improve access to care by providing health insurance
choices through state-based health insurance Exchanges to families without
job-based coverage. It provides tax credits to those who cannot afford
coverage. We have known for a long time that poor health contributes to
poor performance in other areas. If we can improve our children’s health
they will be able to perform better in school and as adults.
• As of 2010 the Act eliminates all lifetime limits on the amount insurers
cover if beneficiaries get sick or injured and bans insurance companies from
dropping people when they get sick. The Act also restricts the use of
annual limits in all new plans and existing employer plans, until 2014 when
all annual limits for plans are prohibited. Two-thirds of middle class
families with access to employer-based coverage said their children were
not insured because they could not afford the cost of their employersponsored premiums for health care. Of course it is necessary to make the
coverage affordable. It won’t matter if lifetime limits are banned if families
cannot afford the premiums. The reforms hope to help reduce health care
costs for families to ensure children are insured.
• Extends dependent coverage for young adults up to age 26 as of 2010. In
other words, a child may remain a dependent for health insurance purposes
on their parent’s coverage up to age 26 if the young adult is not eligible for
employer-sponsored coverage of his or her own. In 2014 children up to age
26 can stay on their parent’s employer-sponsored plan even if they have an
offer of coverage through their own employment.
• Provides “Child-Only” coverage that is available whether their parents
change jobs, leave a job, move or get sick. There will be a premium since
this is an insurance policy, not a free benefit service.
We commonly hear citizens complain that their coverage would be better if their
politicians had to utilize the same health care plans the average person uses. The
Act creates state-based health insurance Exchanges to provide families with the
same private insurance choices that the President and members of Congress will
have, including multi-state plans, to foster competition and increase consumer
choice. While this is likely to please the adults in our country, it should also allow
affordable choices to families with children.
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Benefits for Young Adults
• Beginning in 2014, the Act provides premium tax credits for young adults
making less than a specified amount each year to ensure they can afford
quality coverage in the new state-based Health Insurance Exchanges.
Although this will cover millions of young adults, those who still cannot
afford coverage will qualify for a hardship waiver.
• As of 2010, the Act eliminates all lifetime limits on how much insurance
companies must cover when participating members become ill or injured.
Additionally, insurers may not drop members who develop an illness or
become injured.
• As of 2010 there will be better preventive care, with the goal of improved
health. An individual who maintains their health will have fewer expensive
problems later on. While this is certainly good for young adults, it may also
save the program health care dollars in the long run.
• Plans in the new Exchanges and all new plans will have a cap on what
insurance companies can require beneficiaries to pay in out-of-pocket
expenses, which includes copayments and deductibles. The reforms ban
what is called “gender rating” which allows women to be charged higher
rates than men for the same coverage.
Benefits for Early Retirees
Those who retire prior to eligibility for Medicare have found health care
insurance to be very expensive and sometimes unavailable due to existing health
conditions. Many people have gone without coverage because rates were so high.
Since Medicare benefits are not available until age 65, unless disabled and
meeting the disability criterion, ages 55 to 65 were often left uninsured. The
Affordable Care Act gives early retirees greater control over their own health care.
• The Act provides $5 billion in financial assistance to employer health plans
covering early retirees. This is a temporary program that will make it easier
for employers to provide their early retirees with coverage and provide
premium relief of up to $1.200 for every family with insurance through
employers. The goal is an increase in the number of large firms willing to
provide workers with retiree coverage. Between 1988 and 2008 our
government reports that the number of people with retiree coverage
dropped 35 percent with just 31 percent of large firms providing retiree
coverage.
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• The elimination of lifetime limits on insurance benefits is likely to benefit
early retirees since they will not have to worry about meeting their
maximum lifetime benefits.
• From 2011 health insurance companies must justify premium increases. If
this keeps rates lower for early retirees it may allow these individuals to
purchase and keep health insurance.
• It is our early retirees that may especially benefit from the Acts prohibition
on denying coverage or charging more based on a person’s medical history
and current medical conditions. While any person of any age can
experience illness or injury, as we age we are more likely to have existing
health conditions. Older individuals are more likely to have chronic
conditions such as heart disease and diabetes for example.
• The Act provides a temporary subsidy, beginning in 2010, for those with
pre-existing conditions that are currently uninsured and have been
uninsured for the previous six months. This is not free; there is a premium
for the coverage that will vary based on where the person lives and other
criterion. The high-risk pool is a stop-gap measure that will serve as a
bridge to the implementation of the reformed health insurance marketplace.
• One-stop shopping allows the early retirees to make their own health care
choices through the Exchanges, which will allow Americans to compare
pricing, benefits, and other elements of the various programs available.
This program actually allows individuals to select the same coverage used
by our President and Members of Congress. Exchanges will be particularly
useful for those between the agents of 55 to 64 because it gives greater
access to multiple types of insurance coverage. This greater access means a
greater possibility of finding an affordable plan. Since all plans cannot
discriminate on the basis of current or past medical conditions, qualification
is not an issue.
Benefits for Senior Americans
• The Affordable Care Act eventually closes what is referred to as Medicare’s
“donut hole.” The donut hole is the gap in prescription drug coverage
under Medicare Part D. More than 8 million seniors hit the “donut hole” in
2007 according to The White House, a federal publication. As of 2010
beneficiaries who hit the donut hole received a $250 rebate. In 2011 the
Act instituted a 50% discount on brand name drugs in the donut hole and
completely closes the donut hole for all prescription drugs by 2020.
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• In an effort to reduce costs, the Act reduces unwarranted subsidies to
insurance companies. Medicare Advantage plans (Part C) will come more
in line with the costs for the original Medicare program. The Act provides
new incentives for health plans that improve quality and enrollee
satisfaction. Medicare’s guaranteed benefits are not affected and reducing
such unwarranted subsidies will save Medicare more than $150 billion over
ten years.
• For years we have heard dire warnings about the financial stability of
Medicare. The Act strengthens the financial health of Medicare by
devoting additional dollars to fighting waste, fraud and abuse of the system.
The payment system will be reformed in an effort to reduce harmful and
unnecessary hospital admissions and health care acquired infections. These
proposals will extend the financial health of Medicare by approximately
nine years. Not a penny of Medicare taxes or trust funds, according to the
administration, will be used for health reform.
• Like other age groups, senior Americans will receive improved preventive
care, with elimination of deductibles, copayments and other cost-sharing
features for preventive care. There are free annual wellness checkups as of
2011.
• The Act creates affordable long-term care insurance programs for care
outside of the nursing home. These provide a cash benefit to help seniors
and people with disabilities to obtain services and supports that will help
them remain in their homes and communities, avoiding institutionalization.
While people would certainly prefer to remain at home or in their
communities (in assisted living, for example) it is also less expensive to
provide care in settings other than nursing homes.
• The Act invests in innovations that improve the quality of care received by
seniors, such as medical homes and care coordination. The intention is to
improve the delivery of care for those with chronic health conditions.
• Promotes better patient care following a hospital discharge. Payments are
linked between hospitals and other care facilities to promote more effective
transitional care following discharge. The Act encourages investments in
hospital discharge planning.
• The Act will try to improve quality of care for seniors. While most care
currently received is good, there is room for improvement. The Act invests
in developing and reporting quality of care measures across all providers to
help beneficiaries make more informed choices among the providers for the
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care they may need. The Act also creates incentives to reward providers
that meet quality goals or show significant progress in improving patient
outcomes. The goal is to make quality care important to those who provide
health care services.
• The health care reform includes the bipartisan Elder Justice Act, which
helps prevent and eliminate elder abuse, neglect and exploitation.
Specifically the law requires the Secretary of HHS, in consultation with the
Departments of Justice and Labor, to award grants and carry out activities
that provide greater protection to individuals in facilities providing longterm care services. It supports and provides greater incentives for
individuals to train and seek employment at long-term care facilities. It
requires the immediate reporting of suspected crimes to law enforcement
officials.
• There will be a standardized complaint form for use by nursing home
residents or their representatives (including family members) for filing
complaints with a State survey and certification agency and a State longterm care ombudsman program. The Act requires States to establish
complaint resolution processes as well.
• The Act establishes criminal background checks for nursing home
employees. There will be a nationwide program for national and State
background checks for employees that have direct access to patients in
long-term care facilities.
The Act supports states beginning 2011 in requiring health insurance companies
to submit justification for requested premium increases and insurers with
excessive or unjustified premium exchanges may not be able to participate in the
new Exchanges. It will crack down on excessive insurance overhead as of 2011
by applying standards to how much insurance companies may spend on nonmedical costs, such as bureaucracy, executive salaries and marketing. There will
be consumer rebates if non-medial costs are too high.
Benefits for Minorities
The Affordable Care Act has addressed the health of our minority populations. It
elevates the National Center on Minority Health and Health Disparities at the
National Institutes of Health from a Center to a full Institute, reflecting an
enhanced focus on minority health. It codifies into the law the Office of Minority
Health within the Department of Health and Human Services (HHS) and a
network of minority health offices within HHS to monitor health, health care
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trends, and quality of car among minority patients and evaluate the success of
minority health programs and initiates.
The Act includes $6.3 billion in new Medicaid funding for the Territories and
Puerto Rico. The Territories and Puerto Rico may establish Health Care
Exchanges and receive $1 billion for subsidies to individuals and families of
modest means who participate in the exchange.
Benefits for Disabled Americans
The Affordable Care Act is designed to provide greater choices for Americans
with disabilities. It expands the Medicaid program to cover more Americans,
including those with disabilities. There are new options for long-term care
supports and services to make sure disabled Americans can remain in their homes
or in community programs while still receiving the medical care they need:
• Provides a new, voluntary, self-insured insurance program (CLASS Act)
that helps families pay for the costs of long-term supports and services if a
family member develops a disability.
• Creates new options for states to provide home and community based
services in Medicaid, enabling more people with disabilities access to longterm services in the type of setting the beneficiary prefers.
• Extends the Money Follows the Person program and makes improvements
to the Medicaid Home- and Community-Based Services (HCBS) option.
As we know, the Act has eliminated discrimination of many types. Insurance
companies cannot deny coverage based on health or gender. Insurance companies
may not charge differently based on existing health conditions or gender.
As of 2010 the Act provided access to affordable insurance for uninsured
Americans with pre-existing conditions, which would certainly apply to those
with disabilities.
Most disabled Americans probably do not work, but if they do they are not faced
with giving up employment in order to qualify for Medicaid’s health care benefits.
The Act provides access to health insurance through Exchanges for those without
job-sponsored health plans.
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The Act tries to address health disparities. It moves toward eliminating them by
improving data collection on health disparities for those with disabilities and
improving the training of their health providers. Investments are being made in
innovations and care coordination in Medicare and Medicaid to hopefully prevent
disabilities from occurring in the first place, at least in older Americans who are
most likely to experience disabilities.
The Medicaid program is expanded allowing greater numbers of people to
receive health benefits under it. The expansion will increase access to care for
low-income adults, including many people living with HIV/AIDS.
Although we usually think of being disabled as someone who has lost a leg in
war or had some experience that adversely affected them for life, a disability may
be something as common as diabetes or a chronic lung condition. The Act invests
in innovations and care coordination in Medicare and Medicaid to assist one in
every ten Americans who experience a major limitation in activity due to a
chronic condition.
Benefits for Veterans and Military Personnel
The Act does not impact VA health. Veterans eligible for VA health care remain
eligible under the health reform. Nothing in the legislation affects veterans’
access to the care they had prior to the passage of the health care reform measures.
The Department of Veterans Affairs retains full authority over the VA health care
system.
The Act does not affect TRICARE or TRICARE for Life. There is nothing in
the legislation that leads to increases in copayments, changes in eligibility
requirements, or modifications as to how the programs are administered. Those
who are covered by TRICARE would meet the shared responsibility requirement
for individuals to have insurance, thereby exempting such members of the
uniformed services and dependants from being assessed any type of penalty. The
Department of Defense maintains sole authority to operate TRICARE.
Americans who are covered by VA health care, TRICARE, or TRICARE for
Life will meet the individual responsibility requirements. This means that
veterans and service members and their dependents will be exempt from any
required health insurance penalty levied for not buying insurance coverage.
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The Act includes provisions to ensure that veterans are provided additional
choices for high quality and affordable health care. The legislation allows
veterans receiving VA health care to also enroll in an insurance plan if they wish.
The Act does not require anyone to change their health insurance coverage, but it
does ensure increased health insurance options as well as expanded consumer
protections to prevent insurance companies from denying or limiting coverage.
Uninsured veterans will have access to quality, affordable health insurance
choices through health insurance Exchanges, which will bring about competition
and increases in choice. They may also be eligible for premium tax credits and
cost sharing reductions. The legislation will improve the private health care
market, says the federal government, and help American veterans obtain the type
of coverage they want.
Harvard researchers found that nearly 1.5 million veterans lacked health care
coverage in 2009. Many had health conditions that went untreated, primarily due
to the fact that they did not have health insurance. This led to premature deaths.
One goal of the Act was to help these veterans obtain medical care through health
insurance availability at prices they could afford to pay.
Benefits for Small Businesses
Although small businesses, as a group, make up our largest employers providing
health coverage for their workers is often not possible. Over the past ten years
average annual family premiums for workers at small companies increased by 123
percent. In 1999 average group rates was $5,700 per year; in 2009 average group
rates rose to $12,700. It is no surprise that the percentage of small firms offering
coverage fell significantly with these rising premium rates.
The definition of “small business” is important in any statistical or legal
information. In this case the law specifically exempts all firms that have fewer
than 50 employees, which accounts for 96 percent of all companies in the United
States (34 million employees). The Affordable Care Act does not include an
employer mandate. In 2014 the Act requires large employers to pay a shared
responsibility fee only if they don’t provide affordable coverage and taxpayers are
supporting the cost of health insurance for their workers through premium tax
credits for middle to low income families. Those companies with fewer than 50
employees are exempt from any employer responsibility requirements. Less than
0.2 percent of all firms may face employer responsibility requirements. It is
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hoped that companies currently not offering their employees health care benefits
will begin to do so when premium costs become affordable.
Under the Affordable Care Act, an estimated 4 million small companies
nationwide may have qualified for a small business tax credit in 2010. Over ten
years there could be $40 billion in relief for small businesses.
1. Small employers with less than 25 full time equivalent employees and
average annual wages of less than $50,000 that purchase health insurance
for employees are eligible for the tax credit. The maximum credit will be
available to employers with 10 or fewer full-time equivalent employees and
average annual wages of less than $25,000. To be eligible, the employer
must contribute at least 50 percent of the total premium cost.
2. Businesses that receive state health care tax credits may also qualify for the
federal tax credit. Dental and vision care qualify for the credit also.
3. From 2010 through 2013 eligible employers will receive a small business
credit for up to 35 percent of their contribution toward the employee’s
health insurance premium. Tax-exempt small businesses meeting the above
requirements are eligible for tax credits of up to 25 percent of their
contribution.
4. In 2014 and beyond, small employers who buy coverage through the new
Health Insurance Exchanges can receive a tax credit for two years of up to
50 percent of their contributions. Tax-exempt small businesses meeting the
above requirements are eligible for tax credits of up to 35 percent of their
contributions.
Prior to the Act small companies usually paid higher premiums than larger
companies, often 18 percent or more. Some plans also added on costs for
administration overhead, which could come under a variety of names in the
policy. Perhaps the biggest problem faced by small businesses was simply finding
coverage they could afford. Since they usually paid higher rates and up to three
times as much in administrative costs, it was not easy finding an affordable plan to
offer their employees.
As of 2014 companies with up to 100 employees will have access to state-based
Small Business Health Options Program (SHOP) Exchanges. They will expand
the purchasing power of smaller companies. In 2017 the Affordable Care Act
provides states flexibility to allow businesses with more than 100 employees to
purchase coverage in the SHOP Exchanges as well.
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Providing Sufficient Medical Personnel
There has been concern expressed regarding the number of available health care
providers. The Act provides new investments to increase the number of primary
care practitioners, including doctors, nurses, nurse practitioners, and physician
assistants.
Rural areas are traditionally where shortages in medical professionals become
most apparent. Since fees in rural areas are often less than that of larger cities, it
is common for medical specialists to set up practices where they can receive
higher fees. After all, it is expensive to go through medical school; graduates
often have thousands of dollars in loans that must be repaid.
The health care reform invests in the health care workforce to ensure that people
in rural areas have access to doctors, nurses and high quality health care. As of
2011, the Act provides funding for the National Health Service Corps ($1.5
billion over five years) for scholarships and loan repayment for primary care
practitioners, including doctors and nurses, who work in areas with a shortage of
health professionals. There will be additional resources to medical schools to
train physicians to work in rural and underserved areas, and establishes a loan
repayment program for pediatric specialists who agree to practice in medically
underserved areas, such a rural communities.
Nearly one third of rural Americans work for small businesses according to The
White House, a federal publication. More than half of them are uninsured because
the small businesses do not have the funds to provide health care plans and
certainly not enough funds to pay the costs of providing health care for their
workers. As of 2010 there will be tax credits for small businesses to make
employee coverage more affordable. Tax credits of up to 35 percent of employer
premium contributions will be available to firms that choose to offer coverage;
small non-profit organizations can receive credit of up to 25 percent. In 2014
small business tax credits will increase to up to 50 percent of employer premium
contributions and up to 35 percent for small non-profits.
The affordable Care Act ensures that hospitals and other providers in rural and
remote communities will receive the reimbursement they need to provide quality
care to patients, while staying in business. It ensures that rural health care
providers receive appropriate Medicare reimbursements to address longstanding
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inequities that exist among providers from different geographic regions. Helps the
many small and rural communities where patients must travel long distances to
obtain their health care services.
Women have often been discriminated against when it comes to insurance. This
was considered “legal” discrimination because it was based on the amount of risk
faced by the insurance companies. It was known that women tended to use more
medical services than men of the same age. Some of this additional use was
expected. For example, women of child bearing age were likely to have children;
obviously men would not incur this expense. In 2010 a healthy 22 year old
woman would likely be charged 150 percent more for the same coverage given to
a healthy 22 year old man. Going forward from 2010, the Act prohibited
insurance companies from denying any woman coverage or limiting her coverage
due to a pre-existing condition, but that did not address the higher premium rates
she paid. Since the Act now prohibits charging higher rates based on gender
women will no longer face this legal discrimination when they purchase health
insurance.
Where Are We Headed?
In the past it was often a struggle just to obtain health care coverage. Many
Americans worked at jobs purely for the health care that was offered through their
employer. Millions of Americans do not have health coverage at all, so they shy
away from seeking medical care as much as possible. Just because we now have a
signed health care plan in the works doesn’t mean that Americans feel any better
about their situation. Most people say they don’t know enough about the passage
of the health care bill to feel confident about the benefits they will receive. There
are so many articles both for and against the health care bill that it is hard to know
truth from fiction. Many of those who opposed passage of the health care bill
opposed it because they felt it did not do enough, not necessarily because they
were opposed to universal health care in general.
The reforms will not be fully implemented until 2014 and even then will not
provide guaranteed health care to everyone living in the United States, although
many of those that are not covered will be undocumented immigrants. The health
care laws apply only to American citizens and legal residents, says Anne
Dunkelberg, associate director of the Center for Public Policy Priorities in Austin.
However, there will be some Americans who are not covered either, namely those
who choose to pay the penalty for remaining uninsured. One might assume those
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who chose not to become insured and pay the penalty will be the wealthy, but that
is probably not going to be the case. Instead it will be the low to moderate income
Americans who feel they will be better off financially if they pay the penalty
rather than the cost of insurance premiums.
Dental Policies
Although many people would like to have dental coverage, relatively few
actually do. Most dental insurance is part of an employer sponsored medical plan.
Individual policies are difficult to find. When an employer does offer dental
insurance to their workers, they commonly cover examinations, X-rays, fillings,
extraction's, root canals, crowns, and perhaps even orthodontic work (braces).
This type of insurance is expensive to provide so even those employers who have
offered it in the past may begin to discontinue it.
When it is possible to individually buy dental insurance, it may not be worth the
price. Everyone tends to have dental work, so the insurance company can predict
their expenses quite well. Therefore, the premiums reflect their payout. In many
ways, the premium represents more of a prepayment plan than it does an insurance
policy. In fact, the premiums and copayments could add up to more than the
actual dental bills.
Incidental Health Care Protection
There may be some types of insurance that remain along with universal
coverage, although it is likely that they will make some changes. These policies
are not intended to provide major medical benefits, but rather are incidental health
care policies that some may feel have a place in their household.
Dread Disease insurance is primarily marketed as protection for the costs of
treating cancer and other dread diseases. For example, while cancer is a major
cause of death, the chances of a policyholder getting cancer are still small when
compared with all the other types of treatment for other conditions people obtain.
Even if an individual actually gets cancer, the policy may only cover certain parts
of the treatment. Side effects and conditions related to the cancer are often not
covered by dread disease polices.
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Hospital Indemnity insurance may offer a benefit of $50 to $200 per day while
the policyholder is hospitalized. Most people do not need a hospital indemnity
plan and this will probably be even truer once the health care bill is fully
implemented. Hospital indemnity coverage is not intended to be the primary
coverage and would not get the policyholder through a single day in the hospital
since the average room cost is many times greater than the indemnity policy pays.
Some indemnity plans do not take effect until the policyholder has been in the
hospital for several days. The average hospital stay is less than a week.
While premiums for dread disease and hospital indemnity insurance policies may
seem low, the chances of the policyholder collecting benefits are also low.
Health Coverage for Overseas Travelers
At one time few people traveled to foreign countries across the seas. That is no
longer true. Americans travel frequently and their travels include virtually every
country around the globe, for both business and pleasure. This insurance market
is developing due to the high costs of medical care in general, including follow-up
care back home.
Medical travel insurance plans cover expenses typically not covered by standard
health insurance. One of these uncovered expenses is medical evacuation, which
can be exceptionally expensive. A surprising number of travelers purchase
polices that will cover their medical transportation home following an illness or
injury in another country.
Some credit cards include or offer limited medical assistance abroad; few
cardholders realize the number of benefits often attached to their credit cards.
There are generally specific requirements to receive this coverage, but it may be
worth a telephone call to the merchant to find out what is covered and under what
circumstance. Travel insurance policies usually issue a card with a toll-free
number to call if an emergency happens. A policy typically only costs a few
dollars a day and the deductibles range anywhere from $25 up. Some policies
have coinsurance requirements.
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Overseas health coverage should be purchased only from a reputable company
and even investigating the company's level of expertise may be wise. If a
prospective insured needs coverage, they may want to find out if the medicalassistance company has local representatives at the destination or even a good
database of English-speaking physicians and hospitals. Coverage restrictions and
policy benefit limitations will generally apply.
Blanket Health Insurance
Blanket health insurance protects all group members against the insured perils.
Blanket insurance differs from group insurance in that no actual insured is named
and there are no certificates of insurability issued. There are many times when we
are unknowingly covered personally under a blanket insurance policy. For
example, spectators at a sporting event may be covered under the blanket policy of
the sport arena. Volunteer firemen are typically covered under a blanket policy
also. So, in short, a blanket policy is generally one that covers a group of people
participating in a like action or grouping for a common reason. In general, the
group covered (those participating) is constantly changing and the policy covers
the changing "membership" without paperwork. The policy is a "for whom it may
concern" type of coverage.
Group Credit Health Insurance
Most of us have also had some type of experience with group credit health
insurance. It can be purchased to pay a disabled debtor's payments until recovery
or until the debt is fully paid. There can be various benefits involved. In some
plans, benefits are paid if the disability is continuous for a given period of time.
In other plans, benefits are paid only for the time following the waiting period.
There is the tendency on the part of insurers to avoid retroactive plans since it is
thought to possibly encourage malingering.
It is extremely difficult to generalize on the cost of group health insurance since
there are so many factors that may affect pricing. Each plan may be different.
Competition is often keen and each company will determine their own rates. Even
initial rates are sometimes misleading. The net cost after dividends or rate credits
is the important consideration. Initial rates vary with the age distribution,
occupations covered, portion of females in the group (women have roughly twice
as much time loss through sickness as men do), variations in medical care costs in
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different localities, and, in major medical plans, the earning levels of the
individual members. High-income people tend to demand higher priced medical
services and may be charged more than low-income persons for the same service.
There are of course private plans available for disability insurance, as well as
group plans. Private plans purchased by individuals vary based on many factors,
including occupation, health history, policy definitions of disability, benefits
selected, and other items specific to the policy issuance. Some disability contracts
are short-term plans limited to just six months, for instance. Others allow for
long-term benefits, which may go all the way to the age of 65. Of course, you can
expect to pay higher premiums for higher benefits. Also, underwriting will vary
from company to company.
Pet Insurance
As pets have achieved the status of family members in America, their care has
also become important. In the last twenty years society has been introduced to
veterinary pet insurance. As medical science improves, medical care for pets
improves. Veterinary medicine has the ability to treat animals with the same
science applied to their human counterparts. For many American families there
are limited funds available for our pet’s medical care, regardless of how much we
love them.
There are now several medical policies available for the treatment of our pet’s
medical needs. Some policies treat only accidents, such as being hit by an
automobile, while others are more comprehensive. Few policies pay for
preventative care, such as vaccinations and altering (spays and neuters). As with
all insurance contracts the greater the benefits the greater the cost.
The insurance plans will vary by company, but they tend to have similarities.
Usually they have established benefit schedules based on specific procedures and,
depending on the plan chosen, these benefit allowances have maximum limits per
policy term. Veterinarians around the country charge less or more depending on
geography, just as physicians do. Knowing what veterinarians charge in the area
will allow consumers to effectively shop for the best pet medical insurance.
Nearly all these policies will limit the amount of benefits paid.
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Veterinary pet insurance is considered major medical coverage. Plans are chosen
based on the age of the pet with various deductibles available. Premiums are
normally collected semi-annually, annually, or biennial (every two years). For
pets older than 9 years old it will be difficult to find coverage since most plans are
designed for younger ages. Plan deductibles and copayments vary widely so the
shopper will want to make as many comparisons as possible.
For additional premium, cancer riders can be added that double the coverage
available for feline leukemia, neoplasia of the pancreas, thorax or prostate. This
added coverage is referred to as Cancer Endorsement Coverage.
The companies that offer this type of insurance are under state regulation and
licensed by each state where sold.
Veterinary pet insurance often offers a free-look provision so the buyer has the
option of reviewing the issued policy before deciding to keep it. Look at the
policy brochure for the free-look provision. Normally it is 30 days from the date
of issue.
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Review Questions
1. The Act will require most Americans (this coverage is only available to legal
citizens and legal aliens) to have health insurance coverage as well as adding
approximately 16 million:
(a) dollars to our deficit.
(b) poor people to our Medicaid system.
(c) people to our group insurance rolls.
(d) politicians to the same group coverage.
2. It was not necessarily that Republicans were against health insurance for the
masses; rather they opposed:
(a) a government ran health care system.
(b) anything that gave private carriers a part in the plan.
(c) President Obama’s meddling.
(d) removal of pre-existing coverage.
3. Much of the funding for the new health care reform would come from new fees
and taxes and cuts in Medicare. Despite the cost, it was expected to cut the deficit
over the next ten year period because:
(a) fewer people would be on Medicaid medical benefits.
(b) how the deficit is determined would change.
(c) the deficit would no longer apply to health care spending.
(d) it would reduce health care spending.
4. Under the Act, companies will be required to issue 1099 forms to any vendor
of service or rental property to which the business has paid more than:
(a) $400.
(b) $600.
(c) $800.
(d) $1,000.
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5. The Act supports states beginning 2011 in requiring health insurance
companies to submit justification for requested premium increases and insurers
with excessive or unjustified premium exchanges:
(a) would have to subsidize their policyholders.
(b) must contribute part of their earnings to selected charities.
(c) may not be able to participate in the new Exchanges.
(d) would have to resubmit lower premium requirements.
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Chapter 3 – Children’s Insurance Needs
Children’s Insurance Needs
Life Insurance
Parents are bombarded with advertisements promoting life insurance products for
children. The advertisements may be promoting life insurance as a means of
saving funds for college, burial coverage, or as a means of maintaining insurability
into adulthood.
Many professionals feel it is not appropriate to place life insurance on a child for
any reason although many consumers still do so. Life insurance on children is very
inexpensive, which is probably why so many people buy it. Even though they may
be wasted premium dollars many people do seem to mind wasting a minimal
amount.
In the book titled The Parents' Financial Survival Guide by Theodore E. Hughes
and David Klein it states: "Insuring children makes no sense at all, because they
earn no income, because the death rate in children beyond the age of one is very
low, and because money would not compensate you in the highly improbable event
that your child should die before you."
The New Century Family Money Book by Jonathan Pond states: "You don't need
it. Almost anything you put your money in instead of a child's life insurance policy
will end up being a better investment."
The amount a child will collect from a life insurance policy varies from policy to
policy. The insurance advertisement may state that the collected sum of money
(cash value) will be at least equal to all the premiums paid for the child’s life
insurance. This sounds like a safe investment but receiving back the amount of
premiums is still a loss since no interest was earned and it is likely that inflation
has reduced the sum’s spending power. When investments of any kind do not
grow with the inflation rate the investor is actually loosing money.
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In the book Making the Most of Your Money by Jane Bryant Quinn, she states:
"Insurance policies typically don't start accumulating serious money until after the
15th year. That doesn't help a parent whose daughter will matriculate 10 to 12
years from now. Furthermore the gross interest rate that the company advertises
may be much higher than the net rate that is actually credited to your cash values.
An advertised 8.5 percent may net down to only 5 percent, after expenses."
The point of life insurance is to replace lost income due to premature death.
Children do not earn income in most cases so there is no lost income to be insured.
Policies advertising life insurance as a means of saving college funds or burial
costs are not presenting a logical solution. It would be better to put the premium
dollars into a savings account, money market account or an annuity. Virtually
anything would be a better financial vehicle than a life insurance policy.
There are Advantages
Some parents may still want their children to own life insurance despite all the
reasons against doing so. One advantage of a life insurance policy is the guarantee
that some coverage will be available on the life of the child, regardless of health.
Knowing their family’s health history, if parents are worried their children will be
considered uninsurable a life insurance policy that guarantees coverage into
adulthood, with additional benefits available at specific ages, may be worthwhile.
Most parents do not buy life insurance on their children for the money.
Statistically speaking, the chances are very low that a child will die. Some experts
tout that buying life insurance on their child is not wise because no parent would
enjoy spending the money received. While this is true, the parents will still need to
pay for the burial expenses. The peace of mind that the life insurance policy
provides may be worth the minimal cost of such contracts. We would hope that no
parent insures a child with the thought of receiving the death benefit, but there may
be some who feel the coverage is necessary. If so, only minimal amounts should
be purchased (enough for burial, for example).
Health Insurance
Generally speaking, whatever health coverage the parents have selected will also
cover their dependent children. The Affordable Care Act gives, according to the
government, greater control over their own health care coverage. For example, key
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provision that takes affect immediately is the anti-discrimination against children
with preexisting conditions. This is especially important for new born babies that
experience health conditions from birth. It would also include children that are
adopted that have existing conditions. Beginning in 2014 this prohibition applies
to all persons.
Young adults will also see some benefits. Under the new law, young adults will
be allowed to remain on their parents’ plan until they turn 26 years old unless they
are offered insurance coverage through their work. While the provision became
effective September 2010, most insurers began implementing the new practice
soon after passage of the health care reform.
According to Anne Dunkelberg, associate director of the Center for Public Policy
Priorities in Austin, the federal government will offer subsidies that cap premiums
at no more than 9.5 percent of family income. Even so, some will choose not to
purchase health care insurance (opting to pay the penalty instead) because the
penalty is likely to be less than their health care premiums. Although this might be
risky from a financial standpoint, 9.5 percent of income is not seen as “low cost”
either. A family existing on a tight budget already may not be able to spare nearly
one tenth of their income for insurance.
Review Questions
1. Why would parents choose to have life insurance on their children?
__________________________________________________________________
__________________________________________________________________
2. Under the Act young adults will be allowed to remain on their parents’ health
care plan until they turn 26 unless:
(a) the insurance company has not adopted the provisions of the Act.
(b) the family can afford higher premium rates.
(c) they are offered insurance coverage through their work.
(d) Medicaid offers an alternative coverage.
Please continue on to the next chapter.
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Chapter 4 - Planning For Retirement
Planning For Retirement
Retirement planning can involve many subjects. This chapter will cover aspects
of this but since the subject is so vast, there may be subjects that are not covered
that could have been. Annuities are covered since we feel they are an insurance
product that works exceptionally well for retirement planning. Annuity popularity
comes and goes, depending on current stock market performance, but for long-term
investors they are ideal. Long-Term Care insurance is also covered in detail. With
the Deficit Reduction Act of 2005, Partnership long-term care policies are now a
product that is designed for retirement planning since they protect the insured’s
assets from spend-down requirements for Medicaid qualification.
Although financial advisors routinely advise individuals to begin saving for
retirement from their first job, realistically this seldom happens. There are so
many places for funds to go early in a marriage: saving for their first home, saving
for their children’s college and becoming financially stable in general. However,
the earlier an individual plans for their retirement, the more their retirement will be
free from financial anxieties.
Pre-Planning
Deciding how much money will be needed throughout retirement is the first step
in planning for it. This is not an easy task since there are a number of variables to
consider including:
1. Inflation,
2. The planned age of retirement,
3. Life expectancy,
4. The size of the couple's Social Security benefit,
5. If applicable, a company pension or Keogh plan, and
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6. How does the couple plan to spend their retirement? Will the couple want to
spend it traveling, gardening, or wintering in Texas?
Most financial planners recommend individuals aim for a retirement income that
is 70 to 80 percent of their gross earnings before retirement. The amount actually
needed varies among people, but it is always best to have more than needed (less
than needed is never advisable). Some retirees will plan to travel extensively,
while others are content to tend their garden at home; some retirees will want to
golf daily while others are happy with a good book; every person is different and
these differences must be taken into account. What cannot be anticipated, but must
be planned for, are physical care needs. Who can say which person will need
assisted living or nursing home care? Since we cannot be sure who will need it,
every individual should plan to pay for long-term care needs, whether they believe
they will actually use it or not. Failing to do so will create a burden for their
children.
Where Will Retirement Money Come From?
Most couples put their incomes together from three sources:
1. Social Security income;
2. Company pensions or Keogh plans;
3. Personal Savings and/or Investments,
It has become a cliché but it bears repeating: while we do not believe Social
Security will ever become extinct, it is a “supplemental” income intended to
supplement what the individual has done for themselves. The Social Security
Administration will send individuals a free estimate of future earnings if they fill
out and send in a SSA-7004 Request for Earnings and Benefit Estimate Statement
form. To get a copy of this form, call your local Social Security office.
If an individual has a retirement qualified plan, it may be sufficient for retirement,
but it never hurts to save additional through personal savings or individual
retirement accounts. Some employer-sponsored retirement plans are generous, but
increasingly companies are moving to plans that put the responsibility on their
employees. The Social Security Administration estimates that less than half of
retirement needs will come from Social Security and pension plans combined; the
balance must come from the efforts of the retirees during their working years. This
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leaves personal savings and investments to pay for the other half of retirement
needs.
While most couples plan for their retirement utilizing the efforts of two workers,
each individual must look at their own needs since late-life divorce is also
becoming more frequent. Today it is common for both husband and wife to have
personal income and it must also become common for each worker to have
personal retirement income.
How much is enough?
It would be easier to plan for retirement if each individual knew exactly how long
he or she would live, health status during retirement, and the cost of living during
retirement. Certainly lifestyles differ, but many will find that they must downgrade from their working years due to insufficient income during retirement. If
one spouse continues to work at a job that pays an income great enough to live on,
it would probably be wise to let any nest egg in existence continue to grow. The
more time an investment is given for growth the greater the compound interest
earned.
In times past, people tended to stay in one home far longer than they do today.
As a result the build up of equity once available for retirees is less likely to be
there. Where our grandparents did not have a mortgage in retirement, today’s
retirees are likely to have at least one, and sometimes two or more if they have
recreational property. When a young family plans early for retirement they have
time on their side. The longer the investment period the less money must actually
be contributed since interest has more time to multiply.
In retirement years some expenses will lessen while others enlarge. Once retired,
most people state they wish to travel, a generally costly activity. Therefore, even
though there may be less costs associated with working, others may develop that
are just as expensive, or even more costly. While it may not be possible to know
exactly what expenses will exist in retirement, it is common sense to at least be
adequately covered for daily living costs. If the home is not paid for, a mortgage
payment will exist, utilities, auto costs including gasoline and insurance, and other
items. A financial worksheet may help. Even though the young family may have
little idea of retirement costs, they know what it costs them to survive today.
Considering inflation it makes sense that costs will be at least equal to today’s
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costs. Initially, simply beginning the act of saving for retirement is enough. Once
the habit is part of the monthly expenses, then it can be expanded as wage
increases occur or other windfalls come along. At some point, there should be a
monetary goal but to just begin saving something is a necessary first step. Twenty
years before retirement and again at ten years before retirement, the couple must
work out an actual retirement budget to see if they are on track. It must be done
soon enough to correct any errors. If it is discovered that retirement income will
be woefully inadequate there is little time left to correct it at ten years prior to
retirement, so the twenty year check is very important.
The financial worksheet is used to determine many things, including waste of
money. It may point out financial habits that are detrimental to financial goals.
Credit cards are the greatest pitfall for younger families; it is so easy to buy on
time and so difficult to pay them off in full each month. If the savings account is
regularly dipped into to pay for routine bills, knowing this early in the planning
stage will help the family curb bad habits now and enjoy retirement later.
Inflation is one of the worst robbers of retirement savings. If the rate of inflation
stays steadily at five percent, prices will double every 14 years. Some items, such
as gasoline, rise much faster than inflation would have indicated. Since there is no
way to know how costs will affect retirement savings twenty years in advance it is
always better to have more saved than less.
Annuities; what are they?
An annuity is an investment that is made through an insurance company.
Although offered by insurers, they are not life insurance contracts; they are
designed for life rather than death. Annuities are sold (marketed) by a variety of
means, from the insurance agent knocking on the client’s door to banks and
brokerage firms. An annuity contract could be defined as a life insurance policy
without the mortality charges because there is no "net amount at risk."
Life insurance companies rate prospective policyholders with what is called
mortality tables. This is a base for calculating cost per thousand dollars of a life
insurance policy. Each year people grow older, so the chances of dying become
larger. The first table used by insurance companies was the American Experience
Table. It was based on statistics gathered between 1843 and 1858. During that
time, out of 1000 men age 35, statistically 8.95 died during that year. The second
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table the insurance companies utilized was the Commissioners' 1941 Standard
Ordinary Table based on death statistics between 1930 and 1940. During this
period of time the death rate for men at age 35 was 4.59 per thousand. In 1966, the
insurance companies were required to use the Commissioners' 1958 Standard
Ordinary Table based on death statistics between 1950 and 1954 when the rate per
thousand dropped to 2.51. Each year Americans live longer due to many factors.
It benefits consumers to have updated tables since it lowers the cost of coverage; it
benefits insurers to use older tables since it allows higher charges.
Choosing an insurance company that uses the most current mortality tables will
insure that your clients are receiving the cheapest premium rates. Insurance
companies are not required to go back to old policyholders when new mortality
tables emerge that would reduce their premiums. They will continue year after
year to charge at the old mortality table.
An annuity is allowed to grow within a contract without current taxation. It also
includes the charges for expenses. Life insurance earnings also grow on a tax
deferred basis but only a portion goes towards accumulation so an annuity is a
better investment vehicle. As far as accumulation is concerned the major
difference between an annuity and life insurance is the mortality charges.
There are three different types of annuities:
1. Immediate annuities, either variable or fixed rate;
2. Deferred annuities, either variable or fixed rate;
3. Accumulation annuities, either variable or fixed rate.
A fixed annuity has a set rate of return. The variable annuity lets the investor
choose from a series of portfolios that can be aggressive or conservative. As a
result the rate of return fluctuates. The insurance company gives the policyholder
certain assurances when they invest in the annuity.
The four parties to an annuity contract are: the insurer, the contract owner, the
annuitant, and the beneficiary. There are always four parties, although one person
may fulfill more than one role.
The insurer
No matter who sold the annuity, the contract agreement is always between the
policyholder and the insurance company. The insurance company is the insurer.
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The annuity contract contains assurances and the terms of agreement. It also
stipulates what can and cannot be done. These would include additional investing,
withdrawals, cancellations, penalties, and the guarantees. An agent will need to
understand each annuity contract sold by the different insurance companies. Since
products differ it is important that the agent as well as the policyholder understands
those differences.
The Contract Owner
The policyowner is the contract owner. It is their money; they decide among the
different options offered. An agent needs to be aware of the options offered so as
to give a well-rounded view of what is available. The policyholder has the right
and the ability to add more money (if the allowed by the insurance company or the
annuity contract selected), terminate the annuity, and withdraw a portion or all the
money and to change beneficiaries or the annuitant. The changing of beneficiaries
and/or annuitants requires an approval from the insurer along with the required
papers to be filled out. The contract owner can be an individual, a couple, a trust
or a corporation. The one requirement is that the owner must be an adult. A minor
can be named as long as there is a guardian or custodian listed. The contract owner
(policyholder) controls the investment. They can decide to gift or will a partial
amount of the entire sum to anyone or any entity at any time.
The Annuitant
The person named by the contract owner as the annuitant can be anyone currently
living and only one person can be named. It does have to be a person though, not a
living trust, corporation or partnership. The annuitant is similar to the insured in a
life insurance policy. If the annuitant is not also the policyowner, they have no say
in the contract, cannot make withdrawals, change names or terminate the contract.
The annuity will remain in force until the contract owner makes a change or the
annuitant dies. Like an insurance policy, when you purchase it on someone else,
which is the insured, the annuitant must also sign the annuity contract. Some
annuity applications do not require the annuitant's signature.
In selecting an annuitant, there is normally an age requirement imposed by the
insurance company. While most companies require the annuitant to be under the
age of 75, that age does vary among companies. Most companies allow the
contract owner to change the annuitant at any time with a stipulation that the new
annuitant must have been alive when the contract was first written. Changing the
annuitant is not as easy as changing a beneficiary. The insurance company must
approve of the change first. If the new annuitant is young, the change may be
made quite easily. If the new annuitant is older, mortality risks come in to play
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and the change may not be as easy. In any case, a contract owner who wants to
change annuitants must follow the procedures the insurance company indicates.
The Beneficiary
Simply stated, the beneficiary is waiting for the death of the annuitant. This is the
only way the beneficiary can prosper. Like the annuitant, (if not also the
policyholder) the beneficiary has no say or control in the management of the
policy. Whereas the annuitant must be a person, not an organization, the
beneficiaries can be trusts, corporations or partnerships, as well as friends,
children, relatives or spouses.
The annuity contract can name multiple beneficiaries. For instance, Charles, the
annuity contract owner, could specify that his wife receives 50 percent of the
proceeds; the Humane Society might receive 30 percent and the remaining 20
percent could go to a third party.
One owner must be "primary" and the other "contingent" unless the insurer
will permit co-ownership. Many companies no longer permit co-ownerships as
they used to. This is because of so many legal problems - especially in divorces.
Companies do not want to get dragged into such things. The same is also true for
annuitants. While it is still possible to find insurers that allow co-annuitants, most
prefer a single annuitant due to legal problems. Most applications do not even
show a line for co-annuitants, but insurers may still allow it if asked to do so.
The annuity contract can have two contract owners, such as a husband and wife.
Then the annuitant can be either the husband or wife or both. This would protect
the couple's assets in case one of them died. This is one area where total
understanding of how the annuity works is crucial. If any other beneficiary were
listed, for instance, a child or charity, the surviving spouse would not receive the
money. The contract owners need to have this well thought out so the annuity will
meet the goals intended. Beneficiary designations may be set up with a primary
beneficiary (the spouse) and a contingent beneficiary (the children).
A single person can thus hold multiple titles. Charles could name himself as the
annuitant and beneficiary as well as being the contract owner. If Charles elected to
name himself as the contract owner and the annuitant, with a loved one or entity as
the beneficiary, he would still have complete control of the annuity. Upon
Charles's death, the proceeds would pass on to the intended beneficiaries. Charles
would also retain the capability of changing the beneficiaries if he elected to. It
must be noted that while Charles would have the right to name himself as the
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annuitant and the beneficiary, it would not make sense to do so in any way. One of
the advantages of the annuity is avoiding probate. Naming him as the annuitant
and the beneficiary would nullify this advantage by reverting the money to the
estate, which would pass through probate and all the expenses incurred or go to a
contingent beneficiary.
Annuity Development
The word annuity means "a payment of money." The insurance industry
designed them to do just that. The annuity is simply a periodic fixed payment for
life or for a specified period of time, made to the individual by the insurance
company. One of the most notable industries to enter the insurance world is the
banks and savings-and-loan institutions.
In the early 1920's, the United States government began using annuities to fund
government retirement accounts, as did the labor unions. Due to the requirements
the government mandated, the insurance industry came up with two safety
features:
1. A guaranteed minimum interest rate built into the annuity contract.
2. The reinsurance network.
Backed by the insurance companies' reserves, a reserve system for annuities was
first introduced during the 1920s. The legal reserve system required then and still
requires now, that insurance companies keep enough surplus cash on hand to cover
all cash values and annuity values that may come due at any given time. It is the
reserves that enable the minimum interest rate guarantees to exist.
The reinsurance network was designed so that if there was a large run on the
money in the insurance industry, no one company would be required to take the
brunt of the loss. The insurance companies spread the risk out among all of the
companies that are offering similar products.
On October 19, 1987, the stock market crashed and since that day it has been
known as "Black Monday." Annuities were primarily unaffected by this event.
When the Great Depression hit the country in the 1920's, over 9,000 banks failed.
Stocks and bonds were not worth anything. The exception to the utter economic
disaster the country experienced was insurance companies. They had enough cash
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on hand to pay their policyholders. The government had required this. The
companies continued to pay their guaranteed minimum interest rates that had been
established years earlier. After the depression hit, new laws were passed by
congress requiring many other financial industries to provide similar safety
features on their products.
Variable annuities were first introduced in the U.S. in the early 1950s. One of the
best-known variable annuities is the College Retirement and Equities Fund
(CREF). Billions of dollars are invested in variable annuities.
From 1973 to 1978 the most popular annuity products carried a permanent seven
percent surrender charge. The only way to avoid this charge was to annuitize.
Then, as time went on, a few companies began to offer bailout options and
limited surrender penalties. Bailouts allowed clients to withdraw their money
without penalty charges if the interest rate on their annuity fell below the initial
rate. Once this bailout option hit the market, a new generation of products
developed.
In the 1980s The New York Stock Exchange member firms began aggressively
marketing bailout annuities. As interest rates hit all-time highs, insurance
companies quickly had to become superb asset managers rather than just good risk
managers.
The early 1980s saw the introduction of indices and two-tiered annuities. The
index rate annuity is a fixed annuity whose renewal rate fluctuates during the
surrender charge period based upon some independent market indicators. It might
be Treasury Bills or any variety of bond indices. This type of indexing is designed
to protect the consumer in a low interest rate environment. These products do not
tend to have bailout options since they are designed to accurately reflect the
changing financial climate.
Two-tiered annuities were designed to reward the loyal policyholder who
decided not to surrender their annuity by offering a higher first tier interest rate. If
the policyholder surrendered or transferred to another carrier, a lower interest rate
was retroactively applied; this was the second tier. The two-tier has a second and
permanent surrender charge in the form of the lower interest rate. The annuity may
have a substantial charge for withdrawals; a charge that may never disappear. This
may make it look as if the company is paying competitive rates, but if the
policyholder elects to withdraw, they may be credited with an extremely low
interest rate. The interest rate is only realized if annuitization is utilized through
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the initial insurer. This, then, locks the policyholder into the same company for
life.
Once an individual decides to invest in an annuity an application is filled out.
The application asks for basic information such as name, address, social security
number, and so forth. The social security number is, of course, asked for income
tax purposes in the event a distribution is made. The application also asks for
information on the chosen annuitant. The birth date of the annuitant is a
requirement so that the insurer can see that they are within the age limitations. The
application also covers investment options, the type of money (whether it is a rollover from another source, a retirement plan or a regular investment) and the
signature of the contract owner and the annuitant. After all the information is
completed and signed, the agent submits the application to the insurance company
with funds accompanying it.
In recent years agents must verify where funds originate since money laundering
is now a concern for the federal government. Money laundering is used by drug
runners, but also terrorists. By identifying the origins of the investment it is hoped
that some of these individuals may be identified.
A contract will be sent or delivered to the policyholder. The annuity contract
includes a cover sheet that summarizes parts of the application and points out what
type of return or what type of investment portfolio has been chosen. As already
discussed, the contract owner has the power to add money (unless prohibited by
the contract), change beneficiaries and/or annuitants, make withdrawals, or cancel
the entire contract.
Investment Options
As stated in the introduction there is three different types of annuities with options
within those types. To recap, there are immediate annuities, deferred annuities
and accumulation annuities. Within these three, there are the options of either a
variable or fixed period/amount. We will first be discussing Immediate Annuities
and their options.
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Immediate Annuities
The immediate annuity is just as it sounds; checks are issued by the insurance
company to the policyholder immediately upon investment. Immediate annuities
are designed for people who rely on receiving a specific amount of money on a
regular basis. One of the first decisions to be made once the policyholder has
chosen the annuity as an investment option is to choose whether it is to be fixed or
variable. The second decision involves how long of a payout period the
policyholder wants. The periodic check issued under the fixed annuity to the
annuitant will be a fixed amount for the duration of the payout period. The
duration of the payout period may be determined by stipulating to the insurance
company the period of time during which the policyholder wishes to receive the
checks. The period of time, which is chosen by the policyholder, could be, for
example, five, ten or 20 years. This depends upon the amount of money invested,
prevailing levels of interest rates and the period of time the policyholder selects.
If Charles invested $80,000 and wanted $1,000 a month for five years, not adding
in interest, Charles would be taking out a total of $60,000. Charles could not, of
course, choose to take out $2,000 a month for five years. This is because the
funds, the base invested amount, would not be there even if the interest rates were
sky high. The insurance company determines how many months payments could
be made in the amount requested by the policyholder for the time period also
requested.
Immediate annuity checks can be sent out monthly, quarterly or annually. The
amount of each check will not fluctuate; the specific dollar amount of the check, of
course, would depend upon the initial investment made. A chief consideration for
the policyholder is the amount of return (interest) being offered on the annuity.
When considering which company to suggest to clients, an agent should factor in
how much money the company is offering to give the policyholders each month.
Telling the policyholders of all the choices available will allow them to make the
most informed choice.
If Charles was told that an insurance company would give him $275 each month
for five years with an initial $10,000 investment he would want to then shop
around. Of course, an agent would want to shop around for the policyholder so the
commission may not be lost. One difference between companies is the rate of
return that each company is willing to offer. However, the rate of return should
never be the primary concern. Company stability is much more important.
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From the aspect of policyholder service, it pays to shop around before an agent
recommends certain companies. Both the agent and the policyholder will want the
best possible service. Companies are often very competitive even in the service
area.
A policyholder may be concerned that the money invested, and then paid out
during the payout period, may run out before they die. It is possible to select
payment for life, although that may yield a lesser monthly dollar amount. This is
called a Life Annuity payout option. It also may be referred to as a Straight Life
Annuity. Under the Life Annuity payout option, the insurance company keeps all
funds that remain when the annuitant dies. Nothing more would go to a
beneficiary. The policyholder, the annuitant, would be taking the risk. All life
annuities share a common characteristic: the insurer is betting that one or both of
the annuitants will die prematurely. The contract owner hopes to live for another
100 years. The policyholder can either win by living longer, or lose by dying
earlier than the company estimates. Either way, the beneficiary will get nothing.
For example, if Charles were to invest in a life annuity he would be betting that
he would outlive the amount invested or at the least break even. If Charles were to
die a few months after investing in the annuity, his beneficiaries would not see any
of the money invested. The insurance company would then take control of the
money. If though, Charles lived 100 years after the annuity contract was taken out,
he would come out on top.
The alternative to this is the Refund Annuity. This may also be referred to as
Lifetime with Period Certain Annuity. The policyholder can request that the
insurance company make payments for life, but to continue those payments for a
stipulated period of time if the policyholder should die prematurely. The
policyholder could, for example, insist the insurance company make payments for
life with a minimum of at least ten, 15, or 20 years or until the beneficiaries
receive at least the entire invested amount originally put into the annuity contract.
If Charles did not want to take a chance with his hard earned money, he may opt
for a refund annuity. Charles could then stipulate that if he were to die
prematurely, the balance of the annuity funds would continue to be paid to his
beneficiaries.
There is also the Joint-and-Survivor Annuity. With this type of annuity the
insurance company can guarantee payments for the lives of two people. Married
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couples use these most frequently. As with Immediate Fixed Annuities, Joint-andSurvivor Annuities can also be issued with minimum guarantee periods or the
refund-certain variety.
Immediate Variable Annuities
Any policyholder depending on a fixed annuity income can expect to have an
ever-decreasing standard of living because the economy is always experiencing
inflation. The variable annuity was designed to overcome the decrease in
purchasing power of the fixed annuity. The basic idea behind the variable annuity
is to invest the capital sum of the annuity into an investment portfolio of stocks
and/or mutual funds and anticipating that inflation will cause the stocks to
appreciate. That appreciation will provide increasing income to the annuitant that
will hopefully offset inflation. Although this sounds good, investors apparently
have not found the variable annuities attractive since they do not sell nearly as well
as the fixed kind. That could be due to the measure of risk involved or perhaps
agents just don’t present them as vigorously as they do fixed annuities. There
certainly is risk, since stocks may go up or down. Although variable rate annuities
are designed to offset the effects of inflation, there is no promise made that the
annuity will increase in value as inflation increases. Additionally, the variable
annuity does not satisfy annuitant demands for a consistent monthly income.
Because of the risks involved, many are not willing to gamble their future standard
of living.
A variable rate option, whether it is an immediate or deferred annuity, does not
guarantee any returns. The issuing insurance company does not advise the
policyholder on investing their money. The company does not share in the profits,
nor does it share in the losses. The same thing is true if the policyholder was to
buy a stock, bond or mutual fund. If the investment goes up 25 percent in one
year, the policyholder receives the entire gain. On the other hand, if the investment
goes down 25 percent, no one comes to the rescue. This doesn’t mean there is not
a place for the variable annuity in the investment field, because there certainly is.
The investor may know the risks involved in a variable rate, and still want it for its
flexibility. Like most investments, variable annuities should be just a single piece
of the entire investment strategy.
In the New Century Family Money Book by Jonathan D. Pond, he suggests that a
policyholder "divide the deferred or immediate-pay annuity purchases between
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fixed and variable annuities.
annuities."
The net result will be the holding of balanced
If Charles and Janelle opted for the immediate variable annuity because they
wanted their income to keep up with inflation, they are betting that the invested
capital will also grow so that their income will grow and keep up with inflation.
This, again, is a gamble. There are no assurances that the stock market will keep
up with inflation, nor do mutual funds give this sort of assurance.
Using Variable Annuities for Retirement Planning
Annuities work very well for people wanting to use them for funding a retirement
and accumulating wealth. The ability to compound growth tax-deferred is an
essential element. Variable annuity sub-accounts further enhance the long-term
investment opportunities because the policyowner has the choice and the
availability of diversification.
Annuities, in general, can meet the investment objectives of many types of
people, ranging from the affluent investor seeking tax deferral and long-term
investment wealth accumulation as well as the average investor seeking a more
competitive investment vehicle to fund their retirement.
Statistically speaking, most annuity investors are in the 50-plus age bracket,
which are conservative savers rather than investors. An investor by definition is
someone who is willing to accept calculated risks.
An investor is someone willing to accept calculated risks.
The market has plenty of people who are comfortable with guaranteed returns and
the guaranteed return of principal. They often use short-term investment strategies,
such as CD's, to meet their long-term financial goals and objectives. They have
minimal understanding of inflation-induced purchasing power loss or the benefits
of tax-deferred wealth accumulation. This means that if this market of people
could gain an understanding, it could open the way for increased sales.
Most annuity investors have at least four investment concerns:
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1. Adequate monthly retirement income.
2. Market risk of their annuity investments.
3. Depletion of assets for retirement living expenses.
4. Liquidity for major medical costs and other emergencies.
Addressing these concerns takes careful planning, persistence and educated
guidance.
Should a variable annuity be included in a retirement portfolio for long-term
investors? A short and simple answer would be yes. Annuities are excellent
vehicles for funding retirement, particularly when combined with a qualified
retirement plan.
The goal of variable annuity investors is to reach financial independence with
acceptable risk that includes an acceptable time period. With fixed annuities there
is no risk because the principal is guaranteed.
To meet these retirement goals, some basic steps are required:
1. Establish goals and objectives,
2. Implement a long term investment plan, and
3. Periodically monitor and evaluate the returns.
The need to accumulate wealth to fund
a retirement has never been greater.
In the past 20 years, the burden of individual financial security, particularly
retirement funding, has dramatically shifted from corporate employers to
individuals. Few investors have developed a definitive investment strategy or the
investment know-how to activate these strategies such as assets allocation, risk
management, and diversification to reach their goals.
In the book All About Variable Annuities by Bruce F. Wells, there is an 11-point
Financial Planning Checklist. Through questions, such as the ones below, we can
determine the needs of a prospective policyowner, their goals and financial
personality.
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1. What are my present and future investment goals?
2. What is my net worth?
3. What are my present and future income expectations?
4. What is my time line for meeting my investment goals?
5. What is my tolerance of risk?
6. How will my financial plan be funded?
7. Should investment advisor(s) join my team?
8. What are my current expenses and spending habits?
9. What will be my income requirements for retirement?
10. Are my legal affairs in order?
11. Are there special circumstances to consider?
The biggest risk to long-term investors is the loss
of purchasing power due to inflation, not market risk.
One of the most important considerations for long-term investors is inflation,
which can cause a serious loss in purchasing power. Inexperienced investors may
believe their biggest risk is the actual investment market. Not so. Accepting risk
is not unusual. It is part of everyone's lives. Investment risk is subjective and
highly personal, but the definition of investing includes accepting risks.
When determining an investor’s risk level, the important questions may be: what
is the investor's profile and what degree of risk are they willing to accept? The
answers to these questions are important to determine which type of investment
vehicle is utilized.
As one nears retirement their investment risk should be minimized since he or she
is then less able to absorb investment loss.
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Deferred Annuities
A deferred annuity is normally used as a way to accumulate a retirement savings.
A policyholder purchases it, and then watches their money grow. Only a few
deferred annuities allow the policyholder the option of taking a lump sum when
they retire rather than forcing them to annuitize. Even though a deferred annuity is
a tax-deferred saving plan, it does not mean tax-free. Eventually policyholders
will pay taxes when funds are withdrawn for retirement. The policyholder receives
no tax deduction on the amount of money initially invested to establish the annuity,
unless the annuity is used to fund an IRA. A traditional Individual Retirement
Account (IRA) allows the policyholder to deduct contributions made to the
account, although restrictions do apply. Roth IRAs do not allow the contributions
to be deducted from federal taxes.
There are two types of deferred annuities:
1. Single-premium Annuities, and
2. Flexible-payment Annuities.
Simply speaking, the single premium annuity is purchased with one lump sum.
The flexible payment annuity lets the policyholder purchase it with installments
over a set period of years.
If the policyholder chooses they can receive the interest income from the annuity
either through sporadic or scheduled withdrawals, if the deferred annuity plan will
let them do so. Deferred annuities can be constructed so that the policyholder can
request a portion of the income be given to them annually while the rest is
reinvested, much like a Certificate of Deposit (CD). In most cases, though, the
policyholder has the principal (the amount initially invested) and any earned
interest reinvested automatically.
The policyholder could, however, choose to terminate the investment or simply
withdraw a portion of the principal. This is subject to applicable fees, if any apply.
These would be stipulated in the contract.
As with the immediate annuities, a deferred annuity has the option of choosing
either a fixed or variable interest rate. Investors who purchase CDs do so because
they want the interest income or because they plan on rolling over the CD into
another CD or investment. The deferred annuities can be constructed to do the
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same things, accomplishing the same goals. The owner of the annuity can request
that a certain amount be sent to them annually or reinvested so a larger amount of
money is earning interest; a concept known as compound interest (interest
earning interest).
The deferred annuity can offer a great deal of flexibility. Besides automatically
reinvesting, the contract owner has the ability to terminate the annuity or withdraw
part of the principal, subject to possible costs. Deferred annuity contracts are not
as efficient as single premium life insurance policies in accomplishing the transfer
of wealth to a beneficiary. The annuity contract, while deferring taxation on
earnings within the contract until future use, never escapes that pent-up income tax
liability.
Equity-Index fixed Annuity
One of the newest types of annuities to reach the market in recent years is the
equity-index fixed annuity. This type of annuity enables policyholders to be
linked to the equity market while at the same time providing the policyholder the
safety of their principal. Fixed annuities have been primarily popular with the
younger-than-50 age group for long-term investing. The equity-index fixed
annuity has interest returns linked to an equity market index of the stock market.
Since this is a newer product, many agents and investors have veered away from
equity-indexed annuities.
As with anything, knowledge is the key to
understanding. Once an individual understands this annuity it often is seriously
considered as an investment. Since there are various types of indexed vehicles, it
may require some research to choose the best one for the client’s circumstances.
It can be difficult to compare equity-index fixed annuities to other types of
annuities. For instance, one cannot compare the base interest rate, the bonus rate,
the length and level of surrender charges, or the renewal rate history of the
company and products.
The equity-index fixed annuity differs from other annuities profoundly in that
there are no stated current interest rates or bonuses. Some annuity contracts have
surrender charges while others do not. Some have vested schedules and renewal
rates based on past market performance for that year. The equity-index fixed
annuity has interest returns linked to an equity market index. It may look as
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though this annuity product offers lower interest rates than other annuity products.
The equity-index fixed annuity only offers minimum guarantees. These minimum
guarantees are separate from the index returns. Despite all the differences equity
index fixed annuities are still backed by the insurance company; the minimum
guarantees provide security for the policyholder's investment. Like other annuities,
they are not exposed to risk from the market loss. If the stock market goes down
each year of the index period, the policyholder will not lose their principle as a
result of this occurrence.
As for the seemingly lower minimum interest rates offered, it is only a minimum,
not the maximum. The actual interest rate applied has often been much higher.
The basic purpose of the equity-index fixed annuity is to outperform other fixed
investment alternatives over time.
There is one element to look out for when determining which equity-index fixed
annuity to use: the liquidity of the contract. Some earlier contracts offered a ten
percent annual penalty fee if accessed after the first year while other contracts
allowed no access at all until the end of the of index period. The newer policies
offer 90 percent liquidity of the single premium starting at policy issue.
Accumulation Annuity
The Accumulation Annuity is a type of annuity that is similar to the deferred
annuity. Whereas the deferred annuity can either be started by putting one lump
sum in or making payments to the annuity to build up the principal, the
accumulation annuity is strictly offered on a systematic payment basis to the
annuity for a period of time. Then, at some later date, the policyholder can
annuitize (shift from accumulation to a monthly payout) when they are ready to
retire.
Which annuity is best?
The type of annuity that is chosen by the policyholder will depend on the
following four factors:
1. Time Horizon;
2. Other Owned Investments;
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3. Goals & Objectives; and
4. Risk Level.
The Time Horizon is when the policyholder plans on using the investment
proceeds. The longer the policyholder is willing to live with an investment, the
more they should concentrate on equity-building products.
Other Owned Investments must be considered when considering annuities. If
the policyholders have no other investments, a variable annuity may be too risky
for them and their future income levels. On the other hand, they may feel they can
invest well enough to better their income. One thing is certain: conditions can
change in many types of markets – and change suddenly. Diversification has
always been a fundamental in successful investing. If the policyholders'
investments are tied up in debt instruments, they should look at equity options
within a variable annuity.
Goals and Objectives would include how much the policyholder wants to
accumulate for retirement, sending a child or children through college or just to
buy a house in a few years. Whatever the policyholder's goal may be, it is
important to turn these into dollar objectives - something that can be obtained.
We can all dream, but a goal is necessary to successfully plan. Once this has been
established, and the policyholder knows their existing holdings, it must be
calculated how to attain that monetary figure (goal).
Risk Level is often considered a personal quality, since different people can
tolerate different risk levels. This level can go up or down depending on the
investment chosen. A policyholder needs to be comfortable with the risk levels
they choose. Of course, each investor must know and understand the level of risk
involved.
What is annuitization?
Annuitizing is simply defined as contracting for a series of payments from an
annuity. Annuitization provides an even distribution of both principal and interest
over a fixed period of time or for life. Annuitization only subjects a portion of the
amount withdrawn for that year to taxation. There are three risks involved:
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1. The annuitant dies too early and/or selects the wrong guarantee and therefore
receives less from the insurance company than they could have.
2. Once annuitization has been selected, the insurance company issues the
contract, and the policyholder has cashed the first check there is no turning
back.
3. The amount of the check in a fixed annuity will be the same each month for
the duration of the annuitization. Inflation therefore affects the spending
power of the annuity income. If inflation increases at five percent per year,
the dollars the policyholder receives from the annuity will purchase five
percent less each year so there is a loss of spending power. This decrease in
purchasing power could constitute a reduction in the annuitant’s standard of
living each year if there is not other income to offset inflation’s erosion in
spending ability.
Annuitization is a process chosen by the contract owner; it is not mandatory. The
contract owner can choose to have the checks issued monthly, quarterly or
annually. The amount of the checks will depend on the competitiveness of the
insurance company, the level of current interest rates, amount of principal that is to
be annuitized, and the duration of the withdrawals. We will discuss all four
variable items.
Competition between insurance companies can benefit the policyholder greatly.
Just as the interest rates vary among companies, annuitation does as well. Of
course, once the annuity is purchased it is too late to make these comparisons; it
must be done prior to purchase. Some insurance companies may offer very
attractive yields during the accumulation period but poor returns during
annuitization (distribution). Both items need to be compared.
Current interest rates have an affect on the payout amount for obvious reasons.
The amount of the checks received upon annuitization of a fixed-rate annuity
contract will be level; it will not go up or down with the interest rates, the stock
market, or the economy. When the policyholder decides to annuitize all or part of
the investment, the amount of the check will depend on the current interest rates.
If the insurance company invests in a conservative manner resulting in high
returns, a large portion of this could be passed on to the policyholder. The
insurance company or contract may also give the policyholder the choice of
annuitizing only a portion of the annuity contract rather than all of it. This choice
may not always wise since the insurance company may not pay competitive
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interest rates for annuitizing only part of the annuity. The amount of the check will
always remain level when annuitizing fixed rate annuities. The larger the amount
of capital annuitized, the greater each check will be.
The period of annuitization is the period of time or duration for which the
contract owner wants to receive checks; generally options vary from five years to
lifetime. For instance, a contract owner could choose a five-year annuitization
period; the invested funds plus interest would be converted into 60 equal payments.
Annuitization does not necessarily have to be for a specific number of years;
lifetime options pay until the annuitant dies.
Combining an annuity program with what is called Seven-Pay Life Insurance
can be a powerful move. The IRS will allow the policyholder to borrow money
tax-free from the cash value in a life insurance policy if certain conditions are met.
Insurance premiums must be paid in over a minimum period of time, hence the
"seven-pay test."
The seven-pay test must always be met: the insurance policy cannot be canceled
and the insured may not borrow all the cash value. If both of these tests are met,
money can be borrowed freely from the insurance company every year
indefinitely.
Annuitization can work well in conjunction with seven-pay universal or whole
life policies. A seven-year "period certain" immediate annuity funding a universal
life contract is a good option for anyone who has a lump sum ready to deposit,
wants to take advantage of the seven-pay life insurance test for future tax-free
liquidity and may also need a substantial death benefit. The advantages of this
combination include the policyholder making only one payment. The exclusion
ratio on the immediate annuity makes the distribution about 80 percent tax-free
and if the insured does it within the first six years, the beneficiary of the annuitant
receives the remaining payments.
To make sure the life insurance policy is funded properly the policyholder will
want to first make a lump-sum deposit into an annuity and request immediate
annuitization over at least a five-year period. Immediate annuitization means that
premiums are being paid where they should be, directly to the insurance company.
This takes care of the seven-pay test and means that money can be borrowed from
the life insurance policy tax free as opposed to tax deferred.
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Annuitization offers some great tax benefits. The benefits, though, are not all
considered to be tax-free. By using a combination of an annuity that is annuitized
and having the payments set aside to pay for life insurance premiums, the investor
can later take advantage of income that is 100 percent free of income taxes and
receives some life insurance as a bonus.
A policyholder will be able to add more money to the life insurance policy after
the seven policy years. With universal life, the policyholder can add some
attractive riders to the policy, such as long-term health care, catastrophic illness,
prime term, child or additional insured, and premium continuation for disability.
It may also be possible to fund a final divorce or other legal action with an
immediate annuity. With the cash refund option the cost would be only slightly
higher than a life-only annuity option. A cash refund option means that any undisbursed money will go to the beneficiary if the annuitant dies prior to complete
liquidation.
Some employer-provided retirement plans will not give the policyholder the
choice of annuitization, only the opportunity to choose among various types of
annuity guarantees. The policyholder would consider the income generated by
each choice or opportunity and then adapt the income received to his or her
personal situation. In the decision-making process, it may be wise to cross out the
choices that the policyholder does not like; this may help to narrow down the
choices and allow an easier conclusion. Since each situation is different the
annuity chosen must meet the requirements of the buyer. For instance, if one
spouse is ill but the other is healthy, a joint-and-survivor option could work well.
In deciding whether to annuitize versus taking lump sum cash disbursement, the
first step is to determine:
1. The amount of the payout;
2. What the lump sum cash disbursement could be used for; and
3. How much would be left to invest net after taxes.
If the policyholder does not need the money, then rolling it into an Individual
Retirement Account (IRA) may be wise. If it could be left to grow, that would be
an advantage. A person could then compare the income that would be generated
from the earnings in the IRA funds to the income offered under the payout annuity
arrangements offered by the employer. The younger the policyholder is when they
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retire, the more likely they are to find that the interest earnings in an IRA are
almost equivalent to the monthly income offered by the employer on an annuitized
basis. The amount of income generated in the annuitized basis should exceed what
the policyholder is able to receive in an arrangement where they use only the
interest on the capital sum, not the principal. The annuity is making payments to
the policyholder of both principal and interest. If there is little difference in
income, it is the fact that the rollover IRA, not annuitized, conserves the principal.
This will give the policyholder some flexibility.
Why would a policyholder want to annuitize?
Annuitization is a personal choice. An investor may be forced to annuitize if it is
the only way to provide a sufficient income. It may not be possible to conserve the
principal in a rollover IRA. Of course, a policyholder would find it preferable to
have a sufficient pension income, social security income and personal assets to
prevent them from having to annuitize. Annuitization is always susceptible to the
effects of inflation eroding buying power over time. Depending upon the payout
option chosen, there may also be the possibility of having the principal forfeited to
an insurance company due to premature death.
If a policyholder chooses a rollover IRA and tries to survive on just the interest
from the IRA, they may find that after a year or two the interest earnings are just
not enough. Because the policyholders are often older, it is highly likely that the
income provided when they annuitize would be higher than it would have been
when they originally retired. Annuities are based on one's life expectancy and, as
the policyholder gets older, the insurance company is able to pay more. When
dealing with immediate annuities the consequences of waiting are not detrimental
as long as the contract owner is careful to conserve principal.
The decision to annuitize can be an emotional one. It may be wise for the
policyholder to seek objective counsel from a CPA, a financial advisor, attorney,
and of course, trusted insurance agents.
A primary reason that people choose annuities is that the money grows and
compounds on a tax-deferred basis. Policyholders in annuities purchased before
1981 could choose to withdraw principal first and growth or interest later. By
utilizing such a strategy, no taxes were paid on any of the redemptions until such
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cumulative withdrawals equaled the contract owner's principal. Of course, this is
no longer possible.
Upon the annuitant’s death beneficiaries are entitled to the annuity money unless
a payout option was selected that eliminated them. These beneficiaries have four
options. They are:
1. Pay taxes immediately,
2. Make withdrawals during the next five years and pay taxes along the way,
3. Wait up to five years, make a complete liquidation, and then pay taxes, or
4. Annuitize and pay some taxes with each withdrawal.
If the fourth choice is exercised the beneficiary must choose annuitization within
12 months after the death of the surviving spouse. Annuitization means that the
beneficiary will receive specific amounts each month until their share, plus any
accumulated growth or interest, has been completely withdrawn.
These
withdrawals have certain tax benefits because the IRS considers a portion of each
check to be a return of principal and therefore not taxable.
Surrender charges exist in most annuities for the first few years, often up to ten
years. Surrender charges can be avoided if one of the following events occurs to
the policyholder:
1. Death;
2. Disability;
3. Annuitization;
4. Taking withdrawals up to 10 percent a year; or
5. Waiting for the surrender period to end.
Upon annuitization, an exclusion ratio is automatically determined. The taxation
of annuitized nonqualified annuity contracts is based on this ratio. The IRS uses
this ratio to determine the amount of each check received which is considered a
return of capital and therefore not taxed. The amount considered growth and/or
interest is fully taxed. The exclusion ratio varies depending on the life expectancy
of the annuitant, based on mortality tables or the set number of years the contract
owner chooses. The longer the expected period, the smaller the exclusion ratio
becomes.
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Since the policyholder directed the insurance company to distribute both principal
and interest from the contract in a series of equal periodic payments, the basis (the
original after tax investment) is paid out as a portion of each of those payments.
This portion is determined based on government tables and is not taxed. It often
represents 40 percent to 50 percent of the total periodic payment being received by
the policyholder. This percentage is found by calculating a ratio determined by the
ratio of the original investment in the annuity contract over what the expected
return is in total from the annuity contract. If the policyholder outlives the annuity
tables, there may come a time when they have received the entire cost basis back
from the annuity contract. If that time comes, all subsequent payments will be
subject to ordinary income tax in their entirety. This rule was incorporated in the
Tax Reform Act of 1986 and applied to annuities that had not been annuitized as of
January 1, 1987. Annuity contracts that have been annuitized before that date
enjoy the exclusion ratio for the rest of the annuitant's life and may continue to
exclude the same percentage even after the annuitant's entire cost basis has been
paid out. The rule adds an additional income tax for senior citizens in their mideighties. This hits them hard since inflation also eats away their retirement funds.
The bailout provision is very straightforward. After the guaranteed interest rate
period is over, if the renewal rate is ever less than one percent of the previously
offered rate, the policyholder can liquidate part or all of the annuity, principal and
interest without cost, fee or penalty. This provision gives the policyholder the
security of knowing that they will always be getting a competitive rate. As
previously stated in chapter three under the Bailout Annuity, this provision can
allow the policyholder versatility and forces the insurance companies to stay
competitive - hopefully.
As an example, if a contract owner was receiving a three-year guaranteed rate of
six percent, and at the end of those three years the new rate was 4.99 percent for
the next three years. The contract owner must decide whether or not to stay with
that company. They will want to investigate other companies. If they decide to
move the money, they have 30 to 60 days, depending on the company, to notify the
insurance company that the contract owner will be terminating the contract. They
will then receive the principal plus the compounded annual interest for the three
years. The policyholder would be receiving this bailout because the renewal rate
fell one percent lower than the previous locked-in rate. If, though, the new interest
rate offered were five percent, the policyholder would still decide whether or not to
leave the money where it is. The difference is that if they chose to take the money,
they would be subject to an insurance company back-end penalty.
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A free bailout provision is closely tied to the guaranteed interest rate provision of
a fixed-rate annuity. It can prove to be highly beneficial to the contract owner.
What are some annuity advantages?
There are many advantages in annuity investing.
The safety record of the fixed rate annuity is unequaled. No one has ever lost a
penny in these vehicles. Note that the variable annuity will not be mentioned. As
stated in previous chapters, this is because the interest can fluctuate daily. The
policyholder decides the portfolio(s) to go into and the dollar amounts.
The interest rate received in a fixed rate annuity is guaranteed. It is guaranteed
for a specific number of years depending on the contract the policyholder chooses.
The locked-in interest rate could be for one, two, five, seven, or ten years.
The principal of a fixed-rate annuity is guaranteed every day. The policyholder
can terminate the contract at any time. There are very few investments that can say
the "principal is guaranteed at all times." The only other types of investments able
to make this claim are ones up to $250,000 at financial institutions insured by the
Federal Deposit Insurance Corporation (FDIC) and certain types of insurance
contracts.
The FDIC is an independent agency of the U.S. Government.
established it in 1933 to:
Congress
1. Insure bank deposits,
2. Help maintain sound conditions in the banking system, and
3. Protect the nation's money supply in case of financial institution failure.
Additional duty was given to the FDIC in 1989 on insuring deposits in saving
associations. As a result, the FDIC insures deposits in banks, using the Bank
Insurance Fund (BIF) and insures deposits in savings associations using the
Savings Association Insurance Fund (SAIF). Both BIF and SAIF are backed by
the full faith and credit of the United States.
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Federal Deposit Insurance Corporation protects deposits that are payable in the
United States. Deposits that are only payable overseas are not insured. Securities,
Treasury securities (bills, notes and bonds), mutual funds, and similar types of
investments are not covered by the FDIC. All types of deposits received by a
financial institution in the usual course of business are covered.
Accrued interest is included when calculating insurance coverage (up to a stated
maximum). Deposits maintained in different categories of legal ownership are
separately covered. Separate insurance is also available for funds held for
retirement purposes such as IRAs, Keoghs and pension or profit sharing plans.
Until December 19, 1993, IRAs and Keogh funds were insured separately from
each other and from any other funds of the depositor. After December 19, 1993,
IRA and Keogh funds were still separately insured from any non-retirement funds
the depositor may have at the institution. But IRA and Self-directed Keogh funds
will be added together and the combined total will be insured for up to $100,000.
IRA and self-directed Keogh funds are also aggregated with certain other
retirement funds such as those belonging to "457 Plan" accounts, if the deposits are
eligible for pass-through insurance.
The FDIC coverage for pension plans and profit sharing plans receive passthrough insurance, which is the General Rule. "Pass-through insurance" means
that each beneficiary's ascertainable interest in a deposit, as opposed to the deposit
as a whole, is insured up to $250,000. In order for such a plan to receive passthrough insurance, the institution's deposit account records must specifically
disclose the fact that the depositor (the plan itself or the trustee) holds the funds in
a fiduciary (pertaining to or of the nature of a trust or trusteeship) capacity. In
addition, the details of the fiduciary relationship between the plan and the
participants, and the participants' beneficial interests in the account, must be
ascertainable from the institution's deposit account records or from records that the
plan maintains in good faith and in the regular course of business.
The General Rule applies to any deposit made by a pension or profit sharing plan
in any institution if the deposit was made before December 19, 1992. The General
Rule also applies to any new deposit made by a plan on or after December 19,
1992, if the deposit is made in an institution that meets the FDIC's standards for
"well-capitalized" institutions. Finally, the General Rule applies to any new
deposit made by a plan on or after December 19, 1992. If the deposit is made in an
institution that meets the FDIC's standards for "adequately capitalized"
institutions, but only if the institution also satisfies one of the following conditions:
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1. The institution has received a waiver from the FDIC to take brokered
deposits, OR
2. The institution notifies the plan in writing at the time the plan makes the
deposit that such deposits are eligible for pass-through coverage.
In all other scenarios, any deposits that a plan made on or after December 19,
1992, does not receive pass-through insurance coverage, but rather is insured as a
whole up to $250,000 in total.
All single ownership accounts established by or for the benefit of the same person
are added together and the total is insured up to a maximum of $100,000. The
Uniform Gifts to Minors Act allows an adult to make an irrevocable gift to a
minor. Funds given to a minor by this method are held in the name of a custodian
for the benefit of the minor. Funds deposited for the benefit of the minor under the
Uniform Gifts to Minors Act are added to any other single ownership accounts of
the minor and the total is insured up to a maximum of $250,000.
No joint account shall be insured for more than $250,000. Joint accounts are
insured separately from single ownership accounts if each of the following
conditions is met:
1. All co-owners must be natural persons. This means that legal entities such
as corporations or partnerships are not eligible for joint account deposit
insurance coverage.
2. Each of the co-owners must have a right of withdrawal on the same basis as
the other co-owners. If a co-owner's right to withdraw funds is limited to a
specified dollar amount, the funds in the account will be allocated between
the co-owners according to their withdrawal rights and insured as single
ownership funds.
3. Each of the co-owners must have personally signed a deposit account
signature card. The execution of an account signature card is not required
for certificates of deposit, deposit obligations evidenced by a negotiable
instrument, or accounts maintained by an agent, nominee, guardian,
custodian or conservator, but the deposit must be in fact jointly owned.
U.S. Government securities are only guaranteed for face value if they are held
until maturity.
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Discussing the FDIC requirements and coverage for investments made into such
insured accounts allows a better understanding of the next advantage of annuity
investing.
The reserve requirements for an annuity account are much higher than for a bank
account. For every dollar the policyholder puts into the annuity, the insurance
company must set aside over a dollar in reserves. The insurance company can only
use these excess reserves to settle the withdrawals and redemption of annuity
owners. The money cannot be used to settle insurance claims, pay overhead, settle
bad debts, or take care of any other non-related annuity item.
People may wonder where the insurance companies obtain the excess money to
supplement annuity deposits for reserve purposes. The answer: from other profit
centers. Annuity business represents the smallest source of revenue for the
insurance industry. Insurance companies generally derive much more income from
selling life insurance and other forms of insurance.
Most states require that insurance companies doing business in the state become
part of the legal reserve pool. This pool protects annuity investors and others who
purchase life insurance products or policies. Since this was already discussed in
another chapter, we will not go into it any further.
In the United States, there are over 2,000 different life insurance companies.
Collectively, the insurance companies own, control, or manage more assets than all
the banks in the world combined. This translates into financial clout that is
advantageous to the policyholders.
During the Great Depression, the U.S. Government did not bail out the banking
industry. Rather, it was the U.S. insurance companies who did so. If there were
ever a financial collapse in the U.S., the insurance industry would be second to the
last to fold. The government would be the last to fold. It has been said that if the
insurance industry were to collapse, we would look back at the Great Depression
with fondness.
Even though annuities themselves have a perfect track record, the companies
offering these products may not. Some insurance companies are safer than others.
In recent years we have seen companies fold, and though no one has lost a penny
in a fixed-rate annuity, these new developments have caused alarm. For this
reason people are concerned about the insurance companies themselves. As
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discussed in chapter five, rating services are a way of evaluating the better
companies. Please refer to the previous chapter for some of the major rating
services and the definitions of the ratings given to the insurance companies.
One of the primary reasons policyholders are attracted to and invest in annuities is
that an annuity grows and compounds on a tax-deferred basis. On the tax return,
the policyholder does not have to indicate the value, interest, yield or growth of the
fixed or variable annuity.
The only time taxes are paid on the annuity is when a withdrawal of growth or
interest is made on the account. It is taxed the year in which the withdrawal was
taken and only on the amount taken out. Remember, a policyholder cannot claim
that the money withdrawn is contributed dollars and therefore not taxable. The
IRS no longer allows this option for annuity contracts purchased after 1981.
Annuities purchased before 1981 could choose to withdraw principal first and
growth or interest later. This was discussed in detail in chapter four.
Since the economic structure changes in our society all the time, policyholders
might decide, at some point, to change insurance companies. Usually, this happens
because the annuity is no longer perceived to be competitive. When this
competitive rate diminishes, a policyholder can choose to change annuity contracts
simply by using a 1035 tax-free exchange. It is important to note that the reason it
is tax-free is that the policyholder cannot touch the money in any step of the
transfer process. The policyholder cannot have the check sent to them first before
forwarding it on to the new annuity contract.
As discussed before, the 1035 exchange is easy to do. The policyholder simply
chooses the new company, fills out the proper forms, sends them along with the
existing contract to the new company and the new insurance company takes care of
the rest.
The policyholder will not incur a tax event, although they may incur insurance
penalties for taking the money out of the annuity contract. This, of course,
depends on the contract itself. Normally if the money has been held in the annuity
contract for a period of time, penalties may be avoided. A policyholder can do as
many 1035 exchanges as they want; there are no limits. The penalties that may be
incurred from the insurance companies, however, would make this an undesirable
pattern to establish.
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The performance of fixed rate annuities provides policyholders a specific rate of
return for a specified period of time. This fixed rate is guaranteed for the period of
time chosen. The interest rate received depends on the annuity contract chosen. If
the correct annuity contract is chosen, the policyholder could get a rate that is
similar to or higher than a CD or money market account.
The performance of the variable rate annuities gives the policyholder several
different subaccounts from conservative to aggressive making the selection process
more difficult. The policyholder needs to decide what they are trying to
accomplish with their money. This will make the decision process simpler.
Remember, with a variable rate of return, nothing is guaranteed. Growth depends
on the subaccounts chosen. In chapter nine the course will discuss what some of
the subaccount options are.
The important thing to remember about fixed and variable annuities are that they
can give some tremendous benefits without sacrificing performance. The fixed
rate annuities give guaranteed returns with, on average, higher rates than other
investments with comparable safety. The variable annuities can give equal or
exceed the performance of the highest rated mutual funds.
Annuity management is structured so that the professional manager or
investment team overseeing the annuity is a specialist. The portfolio managers do
not talk to clients or do anything else that might interfere with the job they are
hired to do. These professionals are highly skilled and trained. They focus on a
certain segment of the marketplace.
Since these individuals do not sell the
products they can give their full attention to their management duties. There is no
guarantee of course, and variable products do carry risk.
Several independent sources track the performance of fixed rate and variable
annuities. Some of these sources are Morningstar, Lipper Analytical Services, and
VARDS. The Wall Street Journal and Barron's may also run articles that discuss
annuities and chart their performance.
When a policyholder invests in an annuity, no portion of the investment is taken
away for commission charges. While the agent may not like the lower
commissions, this is a big advantage for the policyholder. When the policyholder
invests, 100 percent of the invested amount goes to work for them gaining interest.
The policyholder will not lose any principal and/or interest earned to pay a
commission when the money is partly or completely withdrawn. The insurance
companies pay the commission to the agents.
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Annuities are referred to as no load or commission free since any commissions
paid comes directly from the insurance company. The commissions paid to the
agent depend on the company and the annuity chosen by the policyholder. Of
course, commissions are reflected in some way since the insurer must cover their
overhead, but it is not as obvious as in other financial vehicles.
The withdrawal options in annuity investing are versatile. The policyholder can
take out all or part of the money at any time. These withdrawals could be subject
to penalties under some circumstances.
Most annuity contracts allow withdrawals of up to ten percent a year without cost,
fee or penalty. A few companies allow up to 15 percent per year. The free
withdrawal is normally based on a percentage of the principal, not current value.
Whatever percentage the annuity contract allows, the policyholder must keep two
things in mind:
1. Close to 75 percent of all people who invest in an annuity never take any
money out, and
2. The restrictions on withdrawals eventually disappear.
If the policyholder needs to take out more than the allowed amount, they can do
so. It simply means that they may have to pay a penalty. The penalty amount
depends on the annuity contract and the insurance company chosen.
All Annuities are subject to 10% IRS tax penalty for
withdrawals of growth or income made prior to age 59 1/2.
Some annuity contracts may let the policyholder take out all their money at the
end of the year without cost, fee, or penalty; withdrawals during the year may dip
into part of the credited interest but do not dip into the principal. This is unlike the
penalties found in a CD. Other annuity contracts may impose a penalty for excess
withdrawals during the first five, six, or seven years. A small number may even
impose penalties on the lifetime of the contract.
This next advantage will only apply to variable annuities.
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When a policyholder invests in a variable annuity, it automatically contains a
guaranteed death benefit. It guarantees that, upon the death of the annuitant, the
beneficiary will receive the greater of principal, plus any additions, or the value of
the account at the annuitant's date of death (Since the principal is guaranteed every
day in a fixed rate annuity, there is no added benefit for an investment that carries
this assurance.). The guaranteed death benefit is based on the greater of
investments made by the contract owner or value on the date of the annuitant's
death, whichever is higher.
Since the variable annuity has this guaranteed death benefit, it makes it an ideal
investment for an older couple who want high income or growth to offset inflation.
This guaranteed death benefit lasts until the policyholder terminates the annuity
contract, annuitizes the contract, the annuitant dies, or the annuitant reaches the age
limitation of the annuity contract. That can be between ages 75 and 80.
Avoidance of probate is an annuity advantage for many people, although probate
is not necessarily a costly or time consuming process. The value of the annuity
may be included in the gross estate when valued, but it distributes outside of the
probate process. All annuities avoid the probate process (unless there is no listed
beneficiary designation). The beneficiary receives the investment immediately
without cost, fee, commission, or probate fees. Equally advantageous, there is no
delay. The beneficiary can receive the money within a few days of notifying the
insurer and providing proof of death.
The amount the policyholder spends on probate and executor costs depend upon
the gross value of the estate. This gross value is a compilation of all the assets;
clothes, boats, cars, stocks, bank accounts and real estate, which is not reduced by
the outstanding mortgages or debts that may exist. The lawyer who probates the
estate can even petition the court for additional fees.
Annuities have definite estate advantages. When properly set up, an annuity will
eliminate the delays and cost of probate. The annuity gives the owner of the
contract control of their annuity assets through restrictive beneficiary designations.
By adding the words "per stirpes" (which is Latin for "through the blood") to the
beneficiary listing, the owner's annuity assets will never be distributed outside of
their own bloodline even if the beneficiary listed has died before the owner died.
"Per stirpes" is sometimes referred to as an in-law-avoidance clause for this
reason. Social Security benefits may actually be increased when funds are
transferred to an annuity since annuity accruals are not minifying factors the way
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alternative investments often are. Many states also consider the annuity to
represent what is called "beneficiary-designated money." Under such a definition,
this investment may be much more difficult to attach in some states, should any
future litigation occur.
Are there any disadvantages?
As with any investment, due diligence should be practiced. Both the agent and
the prospective investor should know the advantages as well as the disadvantages
of any product. This means the agent must acquire a complete understanding of
the products. The disadvantages of annuity investing are few and may not even
apply to the prospective investor.
No matter what type of annuity contract the policyholder chooses, it is subject to
a ten percent IRS tax penalty for withdrawals of growth or income made prior to
age 59½. No penalty is imposed on the principal contributions when they are
taken out. There are four ways to avoid the IRS penalty. They are:
1. Death of the annuitant
2. Disability of the annuitant
3. Annuitization, or
4. The contract owner reaches age 59½, or older.
If the annuitant dies, it does not matter how old they were; all IRS penalties are
waived. Disabilities are defined in Section 72 of the Internal Revenue Code. The
death or disability of the annuitant, not the contract owner or beneficiary, will
prevent an IRS penalty. Annuitization will prevent any IRS penalty but the
contract owner must elect annuitization within one year after investing in the
annuity. The last way to avoid penalties is by reaching age 59½. The measuring
of life is for the contract owner, not the annuitant.
Annuities may not be the wisest choice for a young couple unless the annuity
investment is part of their retirement plan, such as an IRA, Keogh, pension or
profit-sharing plan or unless the contract owner is an individual or couple who will
not need the money in an emergency. Fixed or variable rate annuities may be ideal
for the older investors near or past the age of 59½.
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An annuity investment means that the money will grow and compound tax
deferred, not tax-free. Any and all income tax liability can be postponed
indefinitely. In the previous chapter we noted that if a spouse died and the other
was listed as the beneficiary, it would not incur a tax event. If the remaining
spouse then remarried, and named themselves as the annuitant and the new spouse
as the beneficiary, the money would be transferred to the new spouse upon the
death of the annuitant. When both spouses die, the beneficiaries can postpone
taxes for up to an additional five years. There are no ways to avoid taxes forever.
At some point, income taxes will have to be paid.
The tax liability is the difference between the amount invested and the value of
the annuity contract, multiplied by the beneficiary's tax bracket.
The eventuality of paying taxes may not be all that bad. The owner of the annuity
has the ability to decide when to withdraw. Hopefully they will be able to
withdraw when they are in a lower tax bracket.
Surrender charges can be a big disadvantage depending on the annuity contract
and insurance company. This penalty only applies if the policyholder takes out
more than the allowed amount of money from the contract within a set number of
years.
When a person invests in an annuity, they can take non-cumulative annual
withdrawals between ten and 15 percent a year, depending on the contract, without
penalty after the first year. An insurer penalty occurs if the policyholder takes out
an amount in excess of that free withdrawal privilege. The amount of the penalty
varies depending on the insurer's penalty schedule. When looking at different
annuity options, it may be wise to look at the insurer's penalty schedule. The
penalty period can vary also between companies.
There are ways to avoid the insurance company penalty schedule. They are:
1. The death of the annuitant,
2. Disability of the annuitant (may not be the case with all companies),
3. Annuitization,
4. Limiting withdrawals to those allowed under the free withdrawal privilege,
5. Waiting until the penalty period lapses, and
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6. Adopting a systematic withdrawal plan of up to ten percent a year.
The guaranteed death benefit, mortality and expense fees are features of all
variable annuities; fixed rate annuity contracts do not possess these charges. This
charge can range from 1.1 percent to 1.5 percent annually depending on the
insurance company and the term of the annuity contract. This fee is levied against
your account balance every year - annually. The fee the insurance company
charges can never be increased. The fee may be hidden in that it does not show up
on quarterly or annual statements. It is described in the prospectus. The
prospectus defines the different types of subaccounts within the variable annuity,
charts the previous performance of these investments, and lists any and all charges
that will be deducted from the variable annuity portfolio.
The mortality fee is a small percentage figure based on the total value of the
variable annuity contract. The greater the annuity account, the more the insurance
company will end up collecting. There are three good things that can be said of the
mortality charge:
1. It helps to pay for commission and overhead costs that normally would be
paid in the form of an up-front or ongoing sales charge.
2. It gives the insurance company an incentive to hire the best possible money
managers on each portfolio. The insurance company will make more money
as the account grows.
3. The mortality charge insures the integrity of the guaranteed death benefit.
This type of guaranteed benefit cannot be found with any other type of
investment.
Another charge that can be considered a disadvantage is the contract
maintenance charge, though this is minor compared to the mortality fees. The
annual contract maintenance charges can range from $25 to $50, depending on the
variable annuity contract and insurance company.
The maintenance charge shows up on the insurance company's fourth quarter
statement. It is deducted from the current value or the variable annuity at that time.
The maintenance fee is a flat charge no matter what the dollar amount of the
annuity is. This fee can never increase during the life of the contract.
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Pension Plans
Retirement planning has become a burden that employers are increasingly
shifting to their employees. Employers sponsor 401(k) plans where the employee
pays most the bill. If a person is fortunate enough to work for a company
providing its own pension plan, the employee remains there for a long time, and
the company stays financially fit for the duration, the person may retire with a
pension that goes a long way towards covering retirement needs.
Even if an employee is provided a pension plan through their employer, the
employee needs to investigate how generous the plan is. The pension may allow
after-tax additional contributions to the plan. This would increase the future
benefits received.
There are variations to the traditional company pension plan. Some of these are
the employee thrift and savings plans, and 401(k) plans. These plans usually
require that the employee make their contributions, which is matched either
entirely or partially by the employer's contribution. This is a positive aspect to
pension plans - the employee gets something for nothing. Not to mention the tax
deferral benefit.
Pension plans give the employee something for nothing:
employer contributions that either match
entirely or partially the employee's contributions.
Each company's pension plan is designed differently. Even so, plans generally
share certain features. The plans have defined rights, benefits, and eligibility
standards and they use predetermined formulas to calculate benefits. Federal
regulations, largely promulgated by the Employee Retirement Income Security
Act (ERISA), require company pension plans to conform to certain rules in order
for the employer's contributions to the plan to be tax-deductible.
There are two basic kinds of pension plans:
1. Defined benefit, and
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2. Defined contribution plans.
A defined benefit plan is determined in advance as to the benefits the employee
will receive, although the contributions made to the pension are not. Defined
benefit plans allow the retiree to budget the income accordingly. The employee
can expect a specific amount of benefits no matter how well or how poorly the
pension investments are performing. The defined benefit plans are risky for both
the employer and the employee. The risk for the employer is to deliver the pension
benefits upon the retirement of the employee. The risk for the employee is that
should the employer suffer a financial set back, they may not be able to provide the
projected benefits to the employee.
With the defined benefit plan, the amount of benefits will depend upon several
factors:
1. Age,
2. Years of service to the company, and
3. Employment compensation.
The specific formula that is used to figure exact retirement benefits is set up at the
time the plan is activated by the employer. During the employee's working years,
the employer funds the plan so that it can meet the predetermined level of benefits.
A defined contribution plan is also a risk for the employee. With this type of
pension, the employer makes a contribution to the account each year. When the
employee retires they are given a monthly sum based on the account balance.
These plans work well if the employee has a long working life, or is vested with
the employer, and the employer has made enough contributions to build up a
substantial retirement fund. Prior to 1986, ten years was considered the normal
vesting period. In 1986 tax laws liberalized what was considered to be a normal
time period. Now the normal vesting period is five years, although ten-year
periods still apply to multi-employer plans. A multi-employer plan is one in
which two or more employers contribute to a collectively bargained plan. A
defined contribution plan may not give enough income to the retiree to live on. It
does not limit how much should be set aside in the plan for the employee's
retirement.
The retirement plan participant will receive a summary of the type of pension
plan they are involved in at the time of employment or when a retirement plan
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instituted. The summary will outline the type of plan offered. If it is a defined
benefit plan, the formula that is being used is stated. This summary is known as
the summary plan description. If the employer has an administrator for the
pension plan, they can probably give a ballpark figure of the pension the individual
can expect to receive at retirement.
Of all the defined contribution plans that an employee might be offered, an
Employee Stock Ownership Plan (ESOPs) may be the riskiest. With this type of
plan investment, the better the company does the more money the employee
receives. But some companies go bankrupt, taking their ESOPs and pensions with
them. ESOPs are not insured by the Pension Benefit Guaranty Corporation. Most
ESOPs are made up of the company's stock entirely. Each employee has an ESOP,
which the employer ads stock to. The stock shares are frozen; the employee cannot
sell them. The employee receives the stock's value in shares or cash when they
leave the company or retire.
Vesting is the rate at which the employee's pension
contributions permanently accrue in the pension account.
As discussed in the annuity portion of this chapter, the retiree sometimes has the
option of taking either a lump sum payout at retirement age or an annuity. ERISA
requires retirees who have been married at least one year before retirement and
who will be receiving benefits in the form of an annuity to designate at least onehalf of the benefits as a survivor annuity payable to the spouse. ERISA does
permit the retiree to reject the provision for a joint-and-survivor annuity, but this
must be done in writing, accompanied by the spouse's signature and a notary must
witness this.
According to Consumer Reports Magazine, pension plans provide some amount
of retirement income for only 27 percent of Americans who are 65 years old or
older. The key phrase here is "some amount of income."
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Long Term Care Insurance
Defining Long Term Care
While definitions may vary depending upon the source, generally long-term care
is defined as prolonged care in a non-hospital setting. Such care may be
provided in a nursing home, one's own residence, or in some type of community
setting. The length of time such care may be required will depend upon the
medical condition. Tax-qualified plans require that such care be needed for no less
than 90 days. Most long-term care, according to the Department of Health &
Human Services, is custodial care, which is personal care rather than medical care.
States will define long-term care based on their state statutes. However, nearly all
definitions state that it is care provided at home, in various types of facilities
including a nursing home, in the community, or in assisted living facilities. It is
not care provided in a hospital and typically the definition specifically excludes
care in a hospital.
Most definitions of long-term care refer to "activities of daily living." These
activities include eating, toileting, transferring, bathing, dressing, and continence.
Some states may include ambulation although tax-qualified long-term care
contracts have eliminated ambulation as an activity of daily living.
Chronic illness, the type that continues for a long period of time, is often the basis
for needing some form of long-term assistance. That assistance may be performed
in the recipient's home or in some type of care facility.
Why buy a Long Term Care policy?
A primary reason for buying an LTC policy, commonly called nursing home
insurance, are the statistics: 40 percent of all Americans age 65 or older will spend
at least some portion of their lives in a nursing home. It may be a prolonged stay
during the last part of their lives or for just a few months while recuperating from
surgery or illness. Over 30 percent of 85 year old citizens live in a nursing home.
Half of all couples exhaust their entire life's savings within a year of one's spouse
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being admitted to an LTC facility. Costs of LTC facilities rise each year, often
outpacing inflation.
Since 1940, the odds of living to the age of 85 have doubled. By the year 2030, it
is expected that three out of five people will live to be 85 years old. In the past, the
inability to care for oneself tended to primarily result from illness or injury. That
is no longer true. Now the need for assisted care of some type results primarily
from simply growing older. People live on for years with such things as
Alzheimer's disease, arthritis and other conditions that do not require
hospitalization, but may require personal assistance.
Another reason to buy a long-term care policy was added by the enactment of the
Health Insurance Portability and Accountability Act of 1996, signed into law by
President Clinton. This law allows a portion or all of long-term care premiums to
be deducted from federal taxation if certain requirements are met.
Although Medicare will pay for some nursing home care, it is not sufficient.
Medicare pays for post-hospitalization stays in "skilled care nursing facilities."
Custodial and intermediate care is not covered by either Medicare or Medigap
policies, but this is the type of care most commonly required. Many Americans are
not aware of Medicare's limited coverage until it is too late.
There was a time when financial planning overlooked long-term care insurance,
since the importance was not realized. Today we realize long-term care must be
part of financial planning. While some individuals may still attempt to save a pool
of money earmarked for such care, many more are turning to policies designed for
that particular circumstance.
With the passing of the Deficit Reduction Act of 2005, there is another reason to
buy nursing home insurance: protection of private assets. A few states have had
this available for some years, but only recently has it become available for citizens
living in all states. Agents wishing to sell asset-protection policies (called
Partnership long-term care policies) must take specific Partnership training in most
states. Such plans offer dollar-for-dollar protection: for every dollar in long-term
care insurance benefits purchased, a dollar in assets is protected from Medicaid’s
spend-down requirements.
The cost of receiving institutionalized nursing care is very expensive. Costs vary
depending upon many factors, including region and type of care. Nursing home
fees often rise quicker than inflation. Few people can afford such high costs outChapter 4
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of-pocket. A congressional subcommittee on aging found that between 70 and 80
percent of all nursing home residents become impoverished within the first year of
confinement, having spent their life savings on the nursing home fees.
Long-term care contracts have become an accepted type of insurance, with sales
continually rising. There was a time when beneficiaries believed that Medicare
would pick up their nursing home costs, but today's retired population is more
realistic. Medicare pays only about 1.4 percent of the total nursing home costs.
This is not surprising since Medicare covers only skilled nursing care and only
under specific conditions. The "Medicare & You" handbook published by the
Department of Health & Human services states: "Most long-term care, in a nursing
home or at home, is custodial care (help with activities of daily living such as
bathing, dressing, using the bathroom, and eating). Medicare doesn't cover longterm care, since it can't cover custodial care when that is the only kind of care you
need.
Medicare Part A only covers skilled care given in a certified skilled nursing
facility or in your home. You must meet certain conditions for Medicare to pay for
skilled care when you get out of the hospital."
Defining Policy Benefits
Multiple insurance companies market long-term care policies. These policies are
commonly referred to as LTC policies. Many states have mandated specific LTC
requirements. As a result, specific statutes will vary from state to state. Even
within a given state, however, there will be policy differences, depending on the
types of policies offered. Additionally, a policy may be either tax-qualified or nontax qualified. A tax-qualified policy will have a "Q" on the brochure and contract.
Today's policies pay all levels of care equally: skilled, intermediate and custodial.
In other words, if skilled care is covered at $150 per day, then both intermediate
and custodial care must also be covered at the same $150 per day level. Of course,
older policies (issued before these requirements were passed) could still exist
although it seems unlikely.
What is the difference between the types of care?
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Skilled Nursing Facility Care: A level of care that requires daily
involvement of skilled nursing or rehabilitation staff and that, as a
practical matter, can't be provided on an outpatient basis. Skilled care
is care delivered by individuals with medical training under the
supervision of a physician. Examples of skilled nursing facility care
include intravenous injections and physical therapy.
Needing
custodial care, such as help with bathing and dressing does not qualify
for Medicare coverage in a skilled nursing facility. However, if you
qualify for skilled nursing or rehabilitation care, Medicare covers all
of the care in the facility.
Intermediate Nursing Care: This is a level of care that is more
intensive than custodial care but does not rise to the level of skilled
nursing care. Intermediate care is care typically administered by a
person with medical training under the supervision of a physician.
Custodial Nursing Care: Non-skilled, personal care, such as help
with activities of daily living like bathing, dressing, eating, getting in
and out of a bed or chair, moving around, and using the bathroom. It
may also include care that most people do for themselves, like using
eye drops. In most cases, Medicare does not pay for custodial care.
Long-Term Care Contracts
Long-term care policies are a type of insurance contract that pays for long term
care, in a variety of settings, according to contract terms. It is not always easy to
compare long-term care policies. Benefits in the contract will depend upon those
selected at the time of purchase. Some basic options include:
1. The daily benefit dollar amount or the maximum contract benefit,
depending upon the type of policy purchased. An integrated policy works
with a "pool" of money rather than a daily amount (although some integrated
policies use both).
2. The waiting period, also referred to as an elimination period.
3. The policy maximum benefit period.
4. Home care, which may require an additional premium.
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5. Elimination of a prior hospitalization requirement, which may require an
additional premium.
6. Inflation protection, which will increase the policy benefits on either a
simple or compound basis. Some states require a compound increase.
7. It is important to note how preexisting conditions will affect the policy. If
allowed by state statutes, insurers may not underwrite a policy at the time of
application. These insurers underwrite the policy when a claim is made.
The agent might be able to request underwriting at the time of application,
however.
8. Premium history over the previous five or ten years. "Level premium"
means that the policy premium will not increase as the insured ages. Most
of today's policies tend to use level premiums rather than age-rated
premiums, which do increase with age. Most policies can increase in price.
9. Look for the words Guaranteed Renewable.
10. A Waiver of Premium benefit.
The policyholder typically chooses the daily benefit amount at the time of
application. This means that the policyholder must choose an indemnity amount to
be paid should they enter a nursing home. The amount chosen typically can be no
less than $100 per day. A policy that pays $100 per day will not fully cover a
nursing home stay; in most areas costs are higher per day than that.
The waiting period is a deductible expressed in time not covered. It is also
referred to as an elimination period. This means that the first days of confinement
will not be paid under the terms of the insurance policy. The number of days not
covered depends upon the option selected by the insured at the time of application.
A common waiting period or elimination period is 30 days, but it could be much
longer. It is not unusual for a nursing home policy to have a 100 day wait before
benefits are payable. To understand in dollar terms what an elimination or waiting
period means, simply multiply the daily benefit selected by the number of days not
covered. For example, if a policyholder has a benefit of $100 per day and the
elimination period (deductible) in the policy is for 90 days, it would amount to
$9,000 (90 days X $100 = $9,000) plus any charges above the amount covered by
the policy.
Obviously, this is a large deductible. On the other hand, premium rates would be
significantly lower when large elimination periods (deductibles) are selected. If
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the insured does not mind covering such a deductible, perhaps larger waiting
periods are advisable. It is common to advise coverage only for catastrophic costs;
so large deductibles make sense to many consumers.
Each policy will have a maximum benefit period. This means that the benefits are
payable for a set time period per confinement. Most professionals recommend no
less than three years of coverage. The LTC brochures often list several choices.
These benefit periods determine the length of time (coverage) that the insured is
protected for while institutionalized in a nursing home. Since the average length of
stay is 2.5 years, a three-year plan is considered a safe choice. Many policies do
offer lifetime benefits. Since there are medical conditions, which disable a person
for many years, lifetime benefits can be important to some clients. Of course, the
longer the benefit period, the more expensive the policy will be.
Maximum benefit amounts may be expressed in dollar amounts rather than in
days or years. These contracts are called integrated policies. They may also have
a daily cap imposed. For example, Jim may have an integrated policy with a
lifetime cap of $100,000 and a secondary cap of $300 per day. Jim may use the
money in the policy pool any way he desires within the scope of the contract up to
$300 per day. Therefore, he may elect to hire someone to care for him at home
rather than in a nursing home as long as he does not exceed that daily cap. Any
expense over $300 per day must be paid by Jim personally.
Some policies also offer the additional option of home care, usually for an extra
premium. There are differing opinions as to the value of home care benefits added
on to a nursing home policy. When home care is added, the benefit is generally
half of the nursing home indemnity benefit. In other words, if the insured selected
a $100 per day nursing home benefit, then the home care benefit would be $50 per
day. In an integrated policy, it is not necessary to add a home care feature since
the point of such a contract is to allow the beneficiary to receive care in whatever
manner they desire up to the dollar amount purchased.
Part A of Medicare will pay for some home health care services. There is often
much confusion regarding home health care. Part A will pay the full cost of
medically necessary home health visits if the beneficiary is homebound. Coverage
includes:
1. Part time, not full time, skilled nursing care (note the fact that the care must
skilled).
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2. Physical therapy.
3. Speech therapy.
If the beneficiary requires any of these services, is confined to their home
(homebound), and is under the care of a doctor, Part A of Medicare may also be
able to provide other services which includes:
1. Part time or intermittent home health aide services for skilled nursing care.
Again, note that the care must be skilled, not intermediate or custodial care.
2. Occupational therapy.
3. Medical social services.
4. Medical supplies and equipment provided by a Medicare contracted agency.
Coverage can also be provided for a portion of the cost of durable medical
equipment provided under a plan of care set up and supervised by the physician.
There are gaps in Medicare's home health coverage. Items not covered include:
1. Coverage provided for full-time nursing care in the home. Medicare covers
only part-time help.
2. Drugs and biologicals;
3. Meals delivered to the home;
4. Homemaker services, such as cleaning or cooking;
5. General daily maintenance care, such as bathing or getting dressed.
The beneficiary must also pay 20 percent of the reasonable charge for durable
medical equipment, unless a Medigap policy is in place to cover the co-payment.
The amount of the visits by home health personnel is unlimited as long as the
patient meets all of the requirements set down by Medicare. The patient pays
nothing since Medicare will cover all eligible costs. There are conditions that must
be met before care will be given. Those conditions include:
1. A doctor must certify the need for home health care.
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2. The treatment requires only part-time skilled (not intermediate or custodial)
nursing care, physical, speech, or occupational therapy.
3. The patient is housebound, unable to do an outside normal routine of
shopping or other daily routine chores.
4. A doctor sets up the home health care plan that is provided by a Medicare
contracted home health care agency.
Medicare also offers help for those who are terminally ill. Hospice is covered
under Part A of Medicare. Hospice is care for the terminally ill. Hospice care is
given at home. Part A will pay for two 90-day hospice benefit periods, a
subsequent period of 30 days, and a subsequent extension of unlimited duration.
When a beneficiary enrolls in a Medicare certified hospice program, he or she
receives medical and support services necessary for symptom management and
pain relief. It is most common for these services to be provided in the patient's
home. When a Medicare certified agency provides the care, the coverage will
include:
•
Physician services
•
Nursing care
•
Medical appliances and supplies, which includes drugs for symptom
management and pain relief
•
Short-term inpatient care
•
Counseling
•
Therapies
•
Home health aides and homemaker services
Medicare's Part A and Part B deductibles do not apply to services and supplies
that are furnished under the hospice benefit programs. There are limited charges
for outpatient drugs and inpatient respite care. If care or services were needed for
a medical reason, for a condition that is not related to the terminal illness, then
regular Medicare benefits would apply with the deductibles and co-payments in
effect.
As with all benefits under Medicare, certain requirements exist. To be eligible for
hospice care under Medicare, the beneficiary must:
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1. Have been diagnosed as terminally ill, having only six months or less to live,
and
2. Receive the care from a Medicare contracted hospice program.
There are gaps in Medicare's hospice coverage:
1. The beneficiary is responsible for the limited charges for inpatient respite
care and outpatient drugs.
2. Medicare's deductibles and co-payments do apply if treatment for
conditions, other than the terminal illness, is obtained.
Medicare requires prior hospitalization in order to qualify for nursing home care,
but policies may or may not require prior hospitalization, as an option. Some
states do not permit policies to require previous hospitalization, so it is important
that agents know their own state requirements. When it is allowed by the
individual state, the insured may be required to first be in a hospital before entering
the nursing home. There may be additional requirements as well, such as a time
requirement of hospitalization, usually three days. The nursing home admittance
may have to be within a certain time period, often within 14 days of discharge
from the hospital. All of these requirements (as well as any additional ones) are
called gatekeepers. They "close the gate" on claims, which saves the insurance
company money.
Although insurers do cover Alzheimer's disease as long as it was not present at
the time of application, this is still something that should be specifically addressed
by the consumer before buying a long-term care policy. In fact, the consumer (and
the agent) should be aware of how all mental conditions are covered. Alzheimer's
disease is not actually a mental condition; it is an organic condition. That is why
policies cover it. It is important, however, to understand how the policy treats all
types of mental disorders since they are very common in the older ages.
Inflation protection comes under a variety of names, depending upon the
insurance company. This provision increases the daily indemnity amount of the
policy each year to reflect increased costs in the long term care community. This
is usually a policy option, which means that the insured pays extra to obtain it.
Inflation adjustment options may work differently from policy to policy, so it is
important to ask questions. Is the increase based upon the daily benefit amount
chosen at the time of application or is it based on the compounding daily benefit?
Does the inflation adjustment continue for the lifetime of the policy or for a set
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number of years (the first five years, for example)? Many states have specific
statutes that relate to this policy provision. Some states may only allow a
compound increase, while others allow either a simple or compound increase.
"Compound" is better than "simple" because increases are greater.
Preexisting conditions will determine not only whether or not the policy will be
issued at all, but also how those conditions are treated under the policy during the
first months. It is normal for a policy, of any type, to have a preexisting clause in
the policy. This clause will state when and if those existing health conditions are
to be covered under the policy. Some conditions in health will be totally
unacceptable by the insurance company. Other conditions may be rated up in
premium cost (if the state allows it), or excluded entirely from the policy (again,
only if the state allows it). It is becoming increasingly popular to use an "accept or
deny" underwriting method. In other words, the potential client is either accepted
or denied coverage, rather than excluding coverage for specific health conditions.
Premium rate-ups may still be used. It should be noted that state statutes might not
allow a company to exclude conditions under a long-term care policy. In those
states, all physical conditions must be covered if the applicant is accepted for
coverage by the insurance company. Be sure to check with your particular state.
If the policy is issued, there will still typically be a period of time under which
preexisting health conditions will not be covered. For example, most companies
will accept a person who has high blood pressure as long as it is under control.
Even though they have accepted the applicant claims that occur during the
beginning months of the policy that are directly related to the medical condition
may not be covered. That preexisting period will vary from company to company,
so it is necessary to read the terms of the policy on an individual basis. Of course,
in all cases state statutes must be followed.
The term "level premium" means that the policy premium will not increase as the
insured ages. It does not mean that the premiums will never increase, because that
is a possibility. In fact, we have seen some hefty long-term care premium
increases in the past couple of years. Some contracts have actually doubled the
premium rate in a single year. Level Premium simply means that increases will not
occur because the insured has a birthday and becomes older. There are long-term
care policies that do increase the premium level because the insured becomes
older. These are called age-rated policies. It is best to avoid this type since
premium levels can become excessive, especially when annual rates also take an
increase (which then means two increases: by age and by class).
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It is always important to buy policies, of all kinds, that are Guaranteed
Renewable. This means that the insurance company will always renew coverage
each time the premium is paid. Without this protection, a company could cancel
the policy if it canceled all other policies of that type in a given state. Insurers may
sell the block of business to another insurer if the block is not profitable.
Guaranteed renewal never means that premiums will not increase.
It is becoming increasingly popular to have Waiver of Premium in long term care
policies. This feature allows policyholders to stop paying premiums once they
have been admitted to a nursing home for a specific time period, usually 90 days.
Although often overlooked, this is a valuable feature.
It is not an easy job to sort out the various policies on the market. Since
brochures and policy outlines of coverage can vary in their layout, it can be
confusing. The insured relies upon the insurance agent for help in this area.
Therefore, it is important that the agent be well educated in the products that he or
she represents. Many states are now mandating specific education before an agent
is allowed to sell long-term care products. Check with your state's insurance
department for details.
Types of Care Facilities
Much of the confusion regarding Medicare payment of nursing home stays has to
do with the level of care received. There are three types of care: skilled,
intermediate, and custodial. Medicare pays only for the skilled level of care.
Medicare will not pay for either intermediate or custodial care. A patient is less
likely to receive skilled care and more likely to receive either intermediate or
custodial care. Some insurance policies, especially the older ones, may not cover
all levels of care, although most states now mandate that newer policies must cover
all three levels of care.
Qualifying For a Policy
All long-term care insurance policies have underwriting requirements. That
means that health conditions play a vital role in obtaining this type of protection.
Exactly how each company underwrites can definitely vary from company to
company. Some companies may even postpone actual underwriting until a claim
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occurs. Not all states allow this for good reason: when a claim is filed the insured
can find they have not benefits available. It is always better to know whether or
not a policy would be issued (from a medical standpoint) before a claim arises.
Some surprising medical conditions may be accepted by an LTC policy that
would never be accepted by a major medical policy. Since long-term care policies
underwrite from the standpoint of "Will this condition cause a nursing home
confinement?" conditions that would cause claims under a major medical policy
and, therefore, possibly cause a policy denial, may be accepted by a long term care
policy.
It is not surprising that a person who is already sick or showing symptoms of a
pending illness is not likely to be accepted for coverage by an insurance company,
including those covering long term care services. Most insurance companies try to
weed out those they consider a high risk, or undesirable. If an agent sees that an
applicant is not able to get around well, and must rely on aids such as a walker or
oxygen, he or she should probably not take the application. Chances are, the
insurance company will deny the applicant coverage.
No Policy Covers Everything
No insurance policy covers everything. This is also true for long-term nursing
home policies. Just as with other types of insurance, the consumer must pay
attention to those items or benefits that are excluded.
Policies do not pay for rest cures, or old-age retirement homes. These types of
residences are becoming increasingly popular. Residents in these communities get
private apartments, plus other services such as meals and housekeeping services.
Some of these retirement communities have nursing home arrangements available.
When such arrangements are included, prices are understandably higher. Some
communities charge a flat fee for entrance. The amount paid will determine many
other benefits, such as apartment size and maintenance costs. Even though a flat
amount is paid, there is generally an additional monthly fee, as well. Again, what
you pay depends upon what you get.
A person considering such an arrangement should be very careful about the
community selected. It is important that it continue to operate so that benefits may
be received. It is wise to check out the reputation of the community, the general
appearance, and so forth.
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Another indicator of performance is accreditation by the American Association of
Homes for the Aging (AAHA). It is a trade group based in Washington, D.C.
Accreditation is voluntary, however, and many fine communities simply do not
apply.
Generally, LTC policies will not cover confinements in mental hospitals, except
as specified within the policy, nor will they pay for drug or alcohol rehabilitation.
Most policies limit coverage for preexisting health conditions. That limitation
may vary from policy to policy so exact limitations need to be noted. A
preexisting condition is an illness or disease that existed at the time the policy was
applied for and issued, or in the time period prior to application. This clause is a
gatekeeper, which limits the insurance company's liability. In other words, it
prevents a person from buying a policy specifically because he or she knows she
needs it to pay for an existing condition. Just as a person cannot first hit the tree
and secondly buy coverage to pay for the resulting damage, an individual cannot
first become ill, and then secondly buy a policy to pay for their care.
How a preexisting condition is defined will vary from company to company, but
usually it is defined as any health problem experienced by the insured in the time
prior to buying the policy. It must be noted that medication is treatment. Some
companies may go back only six months, while others go much farther to define
preexisting conditions, so again, it is important to know what basis is used.
When an insurance company accepts an individual even though a preexisting
condition exists, the policy will not cover claims relating to that condition for a
specified time period. These periods range from six months to two years
depending on state statutes. As stated, medication is treatment, so if an insured has
high blood pressure, it is a preexisting condition even if it was controlled by
medication. The fact that the insured's pressure was normal at the time of
application does not matter since it was normal only due to medication that was
taken.
The more benefits selected, the higher the cost.
A major factor in determining premium cost has to do with the benefits selected.
The more a policyholder gets, the higher the cost. When considering this type of
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insurance coverage, it is foolish to be "penny wise, and pound foolish," as the old
saying goes. In other words, it is foolish to try to save a couple of hundred dollars
in premium with the result being thousands more paid out of pocket when a claim
occurs. It is best to get the necessary benefits at the time of application, when
health conditions are least likely to prevent the availability of benefits.
Activities of Daily Living
Simple old age and the related frailty is a major reason for long-term care needs.
The older one gets, the more likely the need for some type of care. As a result
insurers now use a set of daily living standards to determine how the policy will
pay benefits. Activities of daily living include eating, bathing, toileting
appropriately, transferring from beds to chairs and wheelchairs, and other features
that dominate our daily lives. A person's ability to perform these activities
provides underwriters with an indication of general physical and mental health.
As they relate to non-qualified plans, there will be seven activities generally
listed. They include eating, bathing, continence, dressing, toileting, transferring,
and ambulating. The federal tax-qualified plans have eliminated the seventh
activity of ambulating. As a result, those contracts containing home care benefits
are generally harder to receive benefits under.
Tax-Qualified Long-Term Care Contracts
Before anyone had ever heard of tax-qualified long-term care plans, insurance
policies could require the inability to perform a certain number of activities of
daily living (ADLs), which were spelled out in the policy. The actual number of
activities of daily living sometimes varied since not all companies included the
same activities. Typically, there were between five and seven listed. The number
of ADLs, which could no longer be performed by the insured, could vary. Some
policies required only one, while others required more than one. If a policy listed 7
activities and only required an inadequacy in performance of one, benefits were
easier to obtain than one which listed 5 ADLs with an inadequacy in performance
of one (1 out of 7 are better odds than 1 out of 5). Few consumers recognized the
importance of this. In fact, agents often did not recognize it either.
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Today, most non-tax qualified plans list seven activities of daily living, while taxqualified plans list six. It is possible for some plans to have a different number of
activities of daily living, unless the state has regulated them (and many have). This
alone gives benefit triggers a better chance with the non-qualified plans since they
include an additional ADL. The benefit trigger that has been eliminated in the
qualified plans is ambulating. Ambulating is the ability to get around adequately
without assistance.
Tax qualified long-term care contracts come under federal legislation while nontax qualified contracts come under state legislation. This is an important
distinction since it affects benefit payment and some gatekeepers. While state laws
vary, some basic comparisons can be made:
Non-Tax Qualified Plans
Medical necessity can be a benefit trigger
Activities of Daily Living:
2 of 5 ADL's trigger benefits.
Defined as needing "regular human
assistance or supervision."
Cognitive Impairment:
Not described as "severe"
Definition does not apply "substantial
supervision" test.
Tax-Qualified Plans
Medical necessity cannot be a benefit trigger.
Activities of Daily Living:
2 of 6 trigger benefits.
Defined as "unable to perform without
substantial assistance from another individual."
Cognitive Impairment:
Described as "severe"
Definition applies "substantial supervision"
test.
What do these terms mean to the policyholder? Because of some confusion as to
how they would affect LTC contracts, IRS Notice 97-31 established specific
definitions:
Substantial Assistance in the activities of daily living means hands on assistance
and standby assistance.
Hands-On Assistance means the physical assistance of another person without
which the individual would be unable to perform the activity of daily living
(ADL).
Standby Assistance means the presence of another person within arms reach of
the individual that is necessary to prevent, by physical intervention, injury to the
individual while the individual is performing the activity of daily living. The IRS
Notice gives the examples of being ready to catch the person if they fall, or seemed
to be ready to fall, while getting into or out of the bathtub or shower or being ready
to remove food from the person's throat if the individual chokes while eating.
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Overall, standby assistance is just what it indicates: being near to help when
necessary.
Severe Cognitive Impairment means a loss or deterioration in intellectual
capacity that is comparable to Alzheimer's disease and similar forms of irreversible
dementia and measured by clinical evidence and standardized tests that reliably
measure such impairment. The impairment may be in either their short-term or
long-term memory. It would include the ability to know people, places, or time. It
would include their deductive or abstract reasoning, as well.
Substantial Supervision is used in reference to cognitive impairment. It means
continual supervision, including verbal cueing, by another person that is necessary
to protect the severely cognitively impaired person from threats to their health or
safety. Such impaired people are prone, for example, to wander away. Substantial
supervision is needed to prevent this.
It is not possible to use the activities of daily living to measure severe cognitive
impairment. Individuals with such impairment are often able to perform all of the
ADLs without difficulty. Even so, they are unable to care for themselves due to
their cognitive impairment. Therefore, the ADLs are not used when assessing this.
State laws are not necessarily the same as federal requirements. In fact, it would
be surprising if they were the same. Non-qualified plans will meet the state's
requirements while qualified plans will meet the federal requirements.
Because states do differ, it is not always easy to state the differences between
qualified and non-qualified long-term care policies. Generally speaking, however,
it is safe to say that federally qualified plans are harder to receive benefits under
than are the state's non-tax qualified plans.
Understanding the Difference in Benefit Triggers
Few policyholders purchased their long-term care policy to receive a tax
deduction. They purchased their policy for health care protection. Therefore, if
the ability to use the policy is limited when health care is needed, was it really
worth having a tax benefit? Agents must be very careful about explaining the
benefit trigger difference when presenting policies. Some of the states initially
resisted approval of tax-qualified plans because they felt the benefit triggers were
more restrictive than their state requirements. Such was the case in California, for
example.
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It is vital that agents fully explain the differences between HIPAA’s tax-qualified
plans and their state’s non-tax qualified plans. By fully explaining the difference
at the point of sale, the agent is allowing the consumer to do several things:
•
Decide whether the tax benefit of the premium deduction will benefit
them personally;
•
Decide whether the loss of the ambulating ADL could affect them
personally (especially if home care benefits are important to them);
and
•
Fully understand the circumstances that will allow benefits to be paid
under their policy. Most policyholders want to understand this and it
is in the agent's best interest to be sure that they do.
Federal Criteria
The federally qualified (tax-qualified) plans do provide worthwhile benefits, even
though ambulating is not an ADL. Federally qualified plans that provide coverage
for long-term care services (nursing facility, home care, and comprehensive) must
base payment benefits on the following criteria:
1. A licensed health practitioner independent of the insurance company must
prescribe all services under a plan of care. The licensed health care
practitioner does not necessarily have to be a doctor. It can also be a
registered professional nurse or a licensed social worker.
2. The insured must be chronically ill by virtue of either: (a) being unable to
perform 2 out of the 6 ADLs, or (b) having a severe impairment in cognitive
ability.
3. The licensed health care practitioner must certify that either: (a) the
policyholder is unable to perform at least two of the six activities of daily
living, without substantial assistance from another person, due to a loss of
functional capacity for no less than 90 days or more, or (b) the insured
requires substantial supervision to protect themselves from threats to their
health or safety due to a severe cognitive impairment, such as Alzheimer's
disease.
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4. The licensed health care practitioner must recertify that these requirements
have been met every 12 months. The insurance company may not deduct
the cost of the recertification from the policy benefit maximums.
Although currently the insured must be either chronically ill by virtue of the
ADLs or due to cognitive impairment, it is possible that the federal government
could expand these requirements at some point. If that were to happen, each state
would have to adopt the new triggers as well.
Not everyone needs to purchase a long-term care insurance policy. Even those
that make their living selling such products recognize that some do not have
sufficient assets to warrant such a purchase. Premiums can be high if the
individual waits too long to make the purchase.
Assessing the Need
Individuals need to determine at an appropriate age whether or not the purchase
of a long-term care policy makes sense. Waiting until health conditions develop
may mean a higher LTC premium or not being able to purchase such a policy at
all.
Any method of investment or long term care funding that produces a pool of
money could be considered as an alternative to an insurance policy. It would not
matter whether the funding came from stock profits, an inheritance, viaticals, or
melted down gold teeth fillings. Funding is funding. If it produces enough money
to pay for long-term care services, then it is an alternative to an insurance policy.
Realistically Speaking
Few people actually set aside funds for long-term care nursing home needs.
Investing successfully is one thing and having the funds set aside purely for longterm care is another. The problem is one of timing. Generally, the need for longterm care comes as life is coming to a close. The chances of putting funds aside
and using it for nothing else are small. It can be done; it just isn't likely to be done.
Even so, it is possible to fund long-term care in ways that do not involve an
insurance policy.
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Most people now realize that Medicare will not handle the costs of long-term
nursing home care. Medicare does a good job with hospital and doctor bills, but
the limited amount of skilled care offered by Medicare is not adequate and cannot
be considered coverage on a long-term basis.
In addition, with few exceptions, private major medical insurance does not cover
long-term nursing home care. Only policies specifically designed to cover such
expenses typically do so. The general type of medical policies carried for major
medical coverage exclude long-term care benefits in a nursing home. Many state
insurance departments are encouraging the use of nursing home policies because
other types of coverage do not provide these benefits.
Receiving long-term care in an institution is expensive. The better the institution,
the more expensive the care will be. It is also more expensive in some areas of the
country than others. The time to find out what these costs will be is not when the
care is actually needed. Costs should be explored in advance of medical need.
Few people do this. We spend more time comparing automobile costs than we do
medical costs.
Most of us have no desire to pay the costs of a nursing home out-of-pocket. We
prefer to think that we will remain at home and someone, probably our children,
will come take care of us. Realistically speaking, this is often not possible for
many reasons including the inability of our children to leave their jobs or a lack of
training on their part.
For some, home care is not a possibility due to the type of medical care required.
While some may be able to pay for the cost of a nursing home out-of-pocket, it is
not necessarily the wisest course of action. Some individuals do elect to fund only
a portion of nursing home costs through savings, expecting to pay the balance from
current living budgets. There are multiple funding options; some are more sensible
than others, however. There are also misconceptions regarding funding options
that are available.
There are numerous books available on personal finance, but they seldom address
the costs of long-term care, except to suggest ways to go on Medicaid, shifting the
burden to taxpayers. Since states do not wish to be further burdened, they are or
have taken measures to prevent this if assets actually exist.
By the time a person needs nursing home care they are past the point of financial
planning, having already done so in his or her younger years. Their "financial
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planning" involves hanging on to what they already have while still enjoying life.
There may be some sort of nest-egg put away; but a nursing home confinement is
likely to gobble it up within a year.
When considering funds for long-term care, some types of protection should
already be in place. That would include coverage for hospital and doctor fees
beyond Medicare’s payment (a Medigap policy). There must also be funds to
cover the living expenses of the non-institutionalized spouse.
Many households end up paying, at least initially, for the long-term confinement
of their family member. Sometimes this "self-pay" is not intentional; they simply
did not plan ahead for this circumstance. In other cases, it was intentional. The
household members felt they had the ability to do so if the need arose, or they
simply did not believe that such a condition would ever exist for them personally.
It would always happen to that mysterious "other guy."
For those who did plan to self-pay, there was hopefully some thought put into it
beforehand. Perhaps the individuals looked to their family heritage and did not see
a past history of health conditions that would make a nursing home confinement
likely.
In addition to a review of their family's health history, they also should have
looked at the financial aspects of a long nursing home confinement. The financial
devastation brought on by a nursing home confinement can be minimized to some
degree. In some situations, it may even be avoided.
Asset Inventory
Certain steps should be taken immediately:
An inventory of the person, or couple's, net worth should be made. It should
include:
Monetary Investments:
• cash on hand
• checking accounts
• savings accounts
• CDs (certificates of deposit)
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•
•
•
•
•
treasury notes
bonds (corporate, Treasury, municipal, or convertible) mutual funds
stocks
IRAs
Business & Real Estate:
o business partnerships including limited partnerships
o real estate property, including investment-types
• Retirement Funds & Pensions:
o Civil Service
o foreign service
o military service
o railroad retirement
o corporate pension plans
o retirement plans of the corporate type
• Keogh profit sharing plans
• corporate profit sharing plans
Insurance Products:
• annuities
• cash value life insurances
• term life insurance
• medical policies, such as Medigap plans
• any other insurance that is carried
Personal Possessions:
• the personal home
• vehicles
• paintings and other artwork
• antiques
• rare books
• jewelry
• silverware, china or crystal
• any other valuables
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Liabilities
The previous list reflects assets. Against this list must go liabilities or debts. This
might include, but would not be limited to:
• Any outstanding mortgages, including rentals
• Auto loans, including recreational vehicles
• Credit card balances
• Private or personal loans
• Any other debts
Do not overlook any loans for which the person or couple has acted as a cosigner. If the borrower defaults, the co-signer will be liable for the debt.
When the resulting figure is known (assets minus liabilities), net worth is known.
Assets minus Liabilities = Net Worth
This resulting figure applies to either a single person or a married couple. Some
of the assets will be jointly owned while others will belong exclusively to one
spouse. The assets will also have to be viewed according to how the resident state
views them.
If the patient will be a private pay (at least initially), spending down may occur.
That means that the patient, in paying privately for his or her care, begins to
diminish his or her personal assets. This is likely to occur where the
institutionalized person does not immediately meet qualifications for Medicaid. At
some point, it is likely that the beneficiary will qualify for Medicaid, since this is
normally what eventually happens.
It may be wise to seek some type of professional advice in trying to protect some
portion of the acquired assets. There are many possibilities, some of which may be
applicable and some of which may not be, depending upon the individual
circumstances.
Estate Planning Tools
The non-institutionalized spouse should obtain a Power of Attorney. This is a
legal document granting another person the ability to act on behalf of another
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specified person. Typically, it states certain conditions under which this may take
place, and tends to end should the person become mentally incompetent. A
Durable Power of Attorney begins when a person becomes mentally incompetent.
A trust of some type may be applicable. There are many types of trusts and
many people willing to sell them. A trust document basically creates another
"entity", which holds the title to the property rather than the person. There are
many misconceptions when it comes to living trusts. When a revocable living trust
is used, it is unlikely that assets will be protected in any capacity. It has become
common for salespeople to say that a revocable living trust will protect the person
from such things as creditors, lawsuits, and even taxes. Any asset that may be
removed and used for the benefit of the grantor carries NO special protections. As
we know, a revocable trust allows assets to be used in any way desired. Therefore,
a revocable living trust WILL NOT protect assets from a long-term care nursing
home confinement.
Trusts, while not protecting assets, can still be a valuable estate-planning tool.
Some types of trusts, such as the irrevocable trust may especially be beneficial.
Only a professional in this field, preferably an attorney, should be consulted.
Many banks have trust professionals that may be consulted and they often tend to
give better advice than the mainstream council.
Certainly, a will needs to be in place. In fact, a will is one of the very first
documents that every person of legal age should have in force. Many professionals
advise that the will be registered at the local government office.
There are other documents that may also be used, depending upon the
circumstances. A living will is a tool used in some states to avoid prolonging life
by artificial means. A living will states that the use of extraordinary means of life
support systems may not be used to extend their life.
Guardianships are often used to protect minors or handicapped individuals.
Sometimes the individual being protected is the institutionalized spouse. This is
especially true if the person's mental ability has diminished.
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Asset Transfer
The ability to legally transfer assets may vary to some extent from state to state.
Usually this applies when Medicaid application will be made. It is legal to transfer
any or all assets of any person applying for Medicaid, providing that the transfer
has been completed 5 years prior to applying for Medicaid benefits. Trusts require
an even longer period of time.
Individuals may feel tempted to handle the preservation of their assets personally,
either because they feel knowledgeable enough, or because some type of
salesperson, friend or relative gave false or grossly limited information. This is
seldom wise. So many details go into finances that it really does usually take
professionals to cover all aspects of financial protection. A mistake in this area can
be extremely costly to all involved.
Government Sponsored Programs
AARP states that their studies show more than two thirds of Americans would
strongly support some sort of government-sponsored program for nursing home
care. When President William Clinton and First Lady, Hillary Clinton, addressed
our nation's health care needs, long-term nursing home care was not included. It is
reasonable to assume that the government is not likely to include it in any future
health care programs either.
Studies show the following results:
1. 64%, nearly two in three Americans, are "very concerned" about the cost of
long-term health care.
2. 53%, more than half of all Americans, are "not very" or "not at all" confident
that they would be able to pay for long-term care personally.
3. 73%, nearly three in four Americans, believe nursing home costs would
wipe out their savings.
The survey further stated that two out of three Americans (66 percent) have had
direct or indirect experience with the problems of providing long-term care for
family members. Despite these figures, the study also revealed that many
Americans are either misinformed or uninformed about the realities of who would
pay for their long-term care.
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Regarding long-term care, the survey showed a wide consensus emerging on
three components of a federal long-term care program:
1. Most Americans would be willing to pay up to $50 per month for
the "right package" of long-term care benefits. In reality, of
course, this may not be enough to cover the costs unless working
Americans of all ages paid into this fund.
2. Although other factors also play a role, the extent of nursing home
coverage is a key element for most of those polled.
3. Most Americans want a program that would be open to people of
all ages and income levels. This means that the 25 year old who
ends up in long-term care due to a car accident would receive the
same benefits as the 75 year old with a broken hip.
It is obvious that the solution most are looking towards is the purchase of
insurance products that will cover, at least partially, the cost of nursing homes.
Even state and federal agencies have begun to realize the need to promote private
long-term care insurance policies.
Reverse Mortgages
Until recently using one's home to pay for a long-term care confinement meant
selling it, getting the cash, and moving out for someone else to move in. Today, it
can mean something much different. Reverse mortgages offer the opportunity to
sell one’s home and still live in it. Not all banks participate and it can be difficult
to find the right contract, but it is an option that did not exist a few years ago.
For the person or couple who owns their own home or have a low remaining
mortgage, using a reverse mortgage to fund a nursing home stay (or anything else)
may be an option. A reverse mortgage takes the value out of the home and gives it
to the owners. It may be given in a variety of ways: monthly, quarterly, annually,
or even in a lump sum, depending upon the loan contract. It must be understood
that the owners are giving up their home, but in a unique way.
The homeowners are actually signing a loan against the value of their home. In
exchange, the lender receives the amount borrowed, loan interest and mortgage
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insurance costs when the house is sold. In the meantime, the homeowner has the
value to use as necessary.
What is available will vary greatly, so the consumer may have to do a great deal
of shopping to get the best opportunity. There are actually some drawbacks to
using reverse mortgages so contracts should be completely understood and all
questions asked beforehand.
1. The loan must be paid back at some point. Many consider a reverse
mortgage as a means of selling one's home while still living in it. This is
true to a certain degree. What may not be understood is that the lending
institution is not necessarily the entity buying the home. They may require
that the homeowner's do the actual selling. Therefore, if the home sells for
less than expected, the owners will be required to come up with the
difference.
2. Contracts differ on the repayment time. This can be a vital point. If the
repayment comes sooner than desired, the homeowners may end up having
to move out before they wanted to. Few contracts allow the homeowners to
stay until death. Normally, there is a stated time period for repayment,
which means they must sell and move out by that time.
3. Reverse mortgages can end up costing more than a traditional loan. The
interest is usually compounded, which means interest is charged on interest.
If the contract allows a long time before repayment, the interest charged can
be substantial. This should not be surprising. Those who lend on reverse
mortgages must feel that they have some advantage for doing so. Otherwise,
why would they do so?
4. There are fees to apply for a reverse mortgage. Those fees will vary, so it is
wise to shop around.
Sometimes locating a lender who will consider a reverse mortgage is not easy.
Traditional banks often do not participate. The county property tax office may be
able to offer some leads, as can the Area Agency on Aging. The National Center
for Home Equity Conversion may also be a good starting point.
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Paid Family Members
In some cases paying family members is a solution if long-term illness or injury
arises. Usually their care needs are the result of physical, mental or emotional
problems that makes living alone dangerous. The family members must be willing
to take on the job of caring around-the-clock for the elderly family member. Some
families willingly accept this chore and are able to devote the necessary time to it.
In some cases, help from outside agencies may be able to supplement the care the
family gives. Whether or not this outside help was covered by insurance policies
or government aide will depend upon multiple factors. For the sake of planning,
the family or individual should not depend upon payment from other sources.
Any individual who plans to rely upon their family for their care must understand
that they are taking a chance. No matter how willing the family may be today, it
will be difficult to access their availability in the years to come. Family situations
change; emotions change; financial circumstances change (the potential caretaker
may have to take a job, for example); and the family's willingness to take on the
chore may change. In addition, taking in a family member affects everyone in the
household, not just the actual caregiver. There must be ample room in the house
and financial resources must be available. Everyone in the family is likely to give
up something when an elderly person moves in.
For some, promising a financial reward in return for care is the avenue chosen. A
financial reward may be an annuity, stocks, or any vehicle that will pay the
caregiver at some specified point in time. The care may be tied into a will or trust
or a legal agreement may be drawn up. Whatever the case, there is still no
guarantee that it will work. In addition, if the potential caregiver is providing care
against their will, what kind of care will they actually be delivering? Most people
try to avoid a nursing home because they think their care will be less than they
desire. Their care would not be good even if a family member delivered it under
some circumstances. In fact, even well intentioned family members have been
known to deliver poor care. Nursing homes reports a substantial number of
patients coming from private homes have bedsores and other physical problems
that developed due to inferior care.
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Accelerated Life Insurance Benefits
Some companies are offering accelerated benefits in their life insurance policies.
These may be a part of the policy itself, or an attached rider. These benefits or
riders may not take effect immediately upon the onset of illness, and sometimes
put a limit on how much can be collected. Exactly how the life insurance benefits
pay for long-term care will be affected by many elements, including state laws that
may apply. Since a life insurance product does not put long-term care as its
primary goal, it is unlikely that the benefits will work as well as a long-term care
policy would.
Premium rates tend to be higher for products with accelerated benefits, usually
about two to ten percent higher. For this amount, the insurer will pay part of the
death benefit to the policyholder each month until the benefit is exhausted or a
preset maximum is reached. If the policyowner dies before the maximum benefit
is exhausted, the remainder of the benefits will go to the beneficiaries named in the
life insurance policy.
For those life insurance policies set up to allow accelerated benefits, there are
typically some codes which must be followed as dictated by the state where issued.
The words "accelerated benefit" must often be included in the title of the policy or
rider. Even though these benefits are accessible on an accelerated basis, the benefit
is not typically described, advertised, marketed, or sold as either long-term care
insurance or as providing long-term care benefits. Long-term care insurance and
benefits must comply with a strict code of requirements, which these accelerated
benefits generally do not meet.
The consumer must also be aware that there are possible tax consequences and
possible consequences on eligibility for receipt of Medicare, Medicaid, Social
Security, Supplemental Security Income (SSI), and other sources of public
funding.
Some states have specifically addressed accelerated benefits. Washington, for
example, requires the following statement in the disclosure form, which must be
provided at specific times:
"If you receive payment of accelerated benefits from a life insurance policy, you
may lose your right to receive certain public funds, such as Medicare, Medicaid,
Social Security, Supplemental Security, Supplemental Security Income (SSI), and
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possibly others. Also, receiving accelerated benefits from a life insurance policy
may have tax consequences for you. We cannot give you advice about this. You
may wish to obtain advice from a tax professional or an attorney before you decide
to receive accelerated benefits from a life insurance policy."
The disclosure statement must give a brief and clear description of the accelerated
benefits. It must define all qualifying events that can trigger payment of the
accelerated benefits. It must also describe any effect the payment will have on the
policy's cash value, accumulation account, death benefit, premium, policy loans,
and policy liens.
In the case of group life insurance policies, the disclosure statement is usually
contained in the certificate of coverage, or certificate of insurability, or in any other
related document furnished by the insurer to the members of the group.
The Largest Payer of LTC: Medicaid
Medicaid is likely to be the major payer of an individual’s nursing home costs. It
affects everyone because the real payer is not the government, but rather our
nation’s taxpayers. For every elderly person receiving Medicaid payment, there
are multiple taxpayers working to supply those funds.
What is Medicaid? It is a government program that pays for health care for our
nation’s poor. Any age qualifies, not simply the elderly. Even so, the elderly eat
up the largest portion of Medicaid funds due to their need for long-term nursing
home care. Ten years ago, Medicaid was paying $33 billion in nursing home
confinements. Added to that was an additional $8.1 billion for home care and
community based services. Today, it is even higher. It cannot be stressed enough
that our taxes fund Medicaid. Every dollar paid out of Medicaid for someone in a
nursing home is a dollar that cannot be used elsewhere for items that would benefit
a wider array of people. Medicaid is a grant program, not an insurance program.
Medicaid pays for two-thirds of those in a nursing home. Since Medicaid pays
only for those who are poor, one might be tempted to believe that two-thirds of our
elderly retired into poverty. In fact, the median income of an elderly couple is
around $3,000 per month so clearly they did not retire into poverty. They became
impoverished because one of them entered a nursing home. For those who lived
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comfortably in retirement, a nursing home confinement changes everything about
their lives.
The process of losing financial standing and reducing assets to qualify for
Medicaid benefits is called "spend-down." An individual cannot get help from
Medicaid unless this has occurred. The exception to this is those who have
purchased a Partnership long-term care policy, since it contains asset protection.
Partnership policies protect only assets, never income. Medicaid requires nearly all
assets to be depleted, although the home is exempt if there is a spouse or dependent
children residing in it. Under current requirements the equity in a home may need
to be depleted in order to qualify for Medicaid benefits, depending upon the state
of residence and the amount of equity that exists. Also exempt are the furniture,
one car, a burial plot, burial funds and a small amount of cash. Each state is
different regarding spend-down and the assets that are exempt. It is important to
consult an attorney that specializes in elder care law.
Asset Transfers for Medicaid Eligibility
Because a nursing home confinement brings such fear, an industry of "assethiding" has developed. Especially in states where there is an unusually high
amount of retired people, the legal profession is busy helping people give away
what they have in order to qualify for Medicaid. This might involve an irrevocable
trust (a revocable trust cannot hide assets), transferring assets to children or
grandchildren, and other techniques designed to make one appear penniless.
Lawful transfers of assets varies from state to state so, again an elder care attorney
should be consulted. Time limits may make asset transfers unworkable since there
is a five year requirement for asset transfers. In addition, assets that are transferred
to children or grandchildren can be totally lost under some circumstances, such as
a divorce.
Each state sets an average cost for nursing home care. The ineligible period is
based on the costs set down by the state. If the financial transfer would have
covered 5 months of care, then that is the time period of ineligibility. Whatever
amount of care could have been covered by the financial value of the gift that is the
amount of time lost for Medicaid benefits.
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EXAMPLE:
Care in a local nursing home costs $3,500 monthly. The community
spouse transfers $25,000 to her daughter within the 5 year period in an
effort to protect the funds. The state would divide the $25,000 by the
cost of the nursing home ($3,500) to determine the length of time she
is ineligible to receive benefits for the institutionalized spouse:
$25,000 divided by $3,500 = 7.14 months. Therefore, the ill spouse
could not receive Medicaid benefits for 8 months due to the
inappropriate transfer of assets.
Not all transfers are illegal causing periods of ineligibility. Certainly, gifts made
outside of the look-back 5 year period are not illegal.
It is also legal to transfer a home to a child of the applicant, if the child has lived
in the home and provided care to the beneficiary for the two years immediately
prior to needing care in a nursing home or receiving COPES benefits. It is also
legal to transfer the home to a sibling of the applicant who has an equity interest in
the home and who has lived in the home for a one-year period immediately prior to
institutionalization or COPES eligibility.
Transfers may be made to a spouse or to a trust for the sole benefit of the spouse.
This is also true for transfers made to an annuity for the sole benefit of the
community spouse.
Transfers may be made to a minor or disabled child or to a trust for the child. In
fact, transfers may be made to a trust for the sole benefit of any disabled person
under the age of 65.
Any transfer may legally be made in situations where the gifts will be returned to
the Medicaid applicant.
Transfers of assets are generally exempt when a Partnership policy has been
purchased. This is because Partnership nursing home policies are for the explicit
aim of preserving assets (but not income). Most states do not have Partnership
policies available, however, so the general population cannot take advantage of
them.
What many people may not realize is that many states have instituted penalties for
those who refuse to return illegally made gifts. The amount of penalty will depend
upon the state in which it occurred. In addition, illegal transfers that are not
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returned are deemed to be fraudulent conveyance, which gives DSHS the right to
petition the court to set aside the transfer and require the return of the assets given
away.
What if the recipient of the gift no longer has the assets they were given? DSHS
can waive the application of the transfer penalty if they feel undue hardship would
result. This might happen if the money had been spent and there was no way to
recover it. Probably DSHS would only waive the application of the transfer
penalty if it were felt that no intent to defraud Medicaid existed and if recovery of
the gift might cause the recipient or their family to face loss of shelter, food,
clothing, or health care.
Any Income Available
Financial planners have used various investments with the intention of funding
long-term care if the need arose. Often they promote the theory that the money is
there for long-term care needs, but if not needed, it is there for something else.
The problem with this becomes obvious. It is too easy to use the money for that
“something else.” Long-term care medical needs tend to be the last medical
requirement prior to death. Therefore, the only other use for the money should be
gifts to beneficiaries. Investments solely intended for funding long-term care
could work, as long as the money is not used for living costs. Money that is
intended for long-term care needs cannot be used elsewhere for any reason. If it is,
then the money is no longer available for long-term medical needs.
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Review Questions
1) A suggested aim for a retirement amount is _________ of their gross earnings
before retirement.
a) 70 to 80 percent
b) 10 to 20 percent
c) 50 percent
d) 100 percent
2) Most couples put their income together from one of the following sources:
a) Social Security
b) Company pension or Keogh plans
c) Personal Savings and/or Investments
d) All of the above
3) The four parties to an annuity contract are: the insurer, the contract owner, the
annuitant and the beneficiary.
(T)
(F)
4) No matter what type of annuity contract the policyholder chooses, it is subject
to a __________ IRS tax penalty for withdrawals of growth or income made prior
to age 59½.
a) one percent
b) five percent
c) ten percent
d) fifty percent
5) Medicare pays only for the __________ of care.
a) skilled level
b) custodial level
c) intermediate level
d) Medicare does not pay for long-term care.
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Chapter 5 - Disability Insurance
Disability Insurance
Not everyone needs disability insurance, but it is a fact that a worker is more
likely to be disabled than he is to die. Despite this fact, more life insurance is sold
than disability insurance.
Who Needs Disability Coverage?
"If you absolutely had to, you could do without life insurance. If state law didn't
demand it, you could probably also do without auto insurance. If you could
replace your home out of your earnings and savings, you could even manage
without homeowners insurance. Similarly, if you could handle unanticipated
medical bills without too much problem, health insurance would not be necessary.
But compared to all of the other policies, disability insurance is something you
most certainly should not be without, particularly if you are the family
breadwinner and the family depends on your income."
- Insurance - What Do You Need? How Much is Enough? by David W. Kennedy.
Every family breadwinner probably needs to purchase disability insurance, but
only a percentage of people do so. Even single people may need disability
insurance unless they could financially survive a disability (which often means a
family member willing to provide support). The burden typically falls on family
members, who may not be equipped to handle such large and often continuing
physical and financial burden. While life insurance is designed to replace lost
income due to the premature death of a family breadwinner, disability insurance
replaces income as well, just not due to death. Since disability tends to bring
additional burdens (medical costs, for example, especially if ongoing nursing care
is required), lost income is one of the challenges the family will face. As the
period of disability time lengthens, families may face the loss of their home, cars,
and medical coverage. It is little wonder that the disabled person begins to believe
he or she is worth more dead than alive (due to life insurance). Depression is
common in those with disabilities. It is also common for caregivers.
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When considering the purchase of disability insurance the occupation of the
family breadwinner is part of the consideration. Some occupations are more likely
to incur a disability than others. Disability insurance could be called income
replacement insurance since that is the point of buying it. Families are provided
with cash from their policy so they may financially survive the period of disability.
While some individuals may be lucky enough to have a job that continues to
supply income even if the worker is not on the job, it is unlikely the employer
could do this for long. At some point all benefits from the workplace would be
exhausted. Even if there are two working spouses most families require both
incomes to maintain their financial position. It plays havoc on any family when
income stops; when it stops due to injury or illness the problem is compounded by
the fact that a medical emergency of some sort also exists.
Today it is difficult to afford health care premiums; the agent is now trying to
introduce disability insurance as well. Agents realize there are only so many
dollars available for insurance. Even so, if there is the ability to purchase such
coverage it is definitely worthwhile.
Disability insurance differs in one major way from health insurance. Health
insurance pays for hospital and doctors' costs incurred as the result of an illness or
injury. Disability insurance provides the insured with money to live on while
recuperating. Auto insurance policies normally have a medical rider that can be
attached to the policy for added premium that would cover the insured, the
policyholder, and the occupants if an accident occurred. This may provide
additional help if the disability is the result of an automobile accident.
Income will be lost if the breadwinner is unable to work due to illness or injury.
This would especially be true if the accident occurred outside the workplace and
was not covered by workman's compensation. When the family has health
insurance much of the disability-related cost will be covered but it will not relieve
the other expenditures that continue: mortgages, home maintenance bills, auto
expenses, food, utilities, credit card debt, and other debts. Disability coverage has
the potential of replacing up to 80% of normal income. While the disability
insurance policy does not pay doctor or hospital bills, the money can be used for
such purposes if the family does not have adequate health insurance coverage.
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Why not replace 100% of the family's income?
Many consumers will assume that disability insurance replaces 100% of lost
income, but this is usually not the case. The reason is simple: if an individual
could maintain the same income without working, what would be the incentive to
re-enter the workplace? This is called a moral hazard in the insurance industry.
Additionally some expenses are related to going to work so the family should be
able to continue with most expenses on 80% of normal income. Expenses related
to the job might include commuting to and from work, restaurant meals, clothing
or uniforms, dry cleaning, and other job-related items.
Typically disability insurance proceeds are not taxed. The family will, as a result,
be paying less in taxes or perhaps none at all. The money received from disability
coverage is usually considered tax-free as long as premiums were paid by the
insured with after-tax dollars. For IRS to consider the disability income tax-free,
the family could not have listed the DI premiums as a deduction on their yearly tax
submission. In all cases, it is important to consult with a tax specialist. This
course should not be taken as tax advice since there is no intent to offer any. State
laws differ and federal laws change periodically. It is always important to stay
abreast of tax laws as they relate to insurance, but an agent should never act as a
tax advisor.
How much coverage is needed?
Any family’s most valuable asset is their income. Although all financial advisors
recommend keeping three months living expenses in an emergency fund, too few
people actually have done so. Even if there is such a fund, many disabilities go on
for a year or more. Clearly, emergency funds are not expected to cover a longterm disability.
Generally speaking, disability coverage should equal 60 to 70 percent of the total
current gross salary. If the disability benefits are received tax-free and the benefits
fall among the 60 to 70 percent mark, then the disability income will compare
favorably with the current after-tax income received. Because work-related
expenses will be eliminated as a result of the disability, a family may be able to
survive on even less income than they previously had.
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Some experts suggest buying just enough insurance to cover the home mortgage
and automobile costs, including any car payments that might exist. The insurance
premiums can then be kept affordable and the family's major assets are covered.
This avenue works best in families where both spouses work since utilities, food,
clothing, credit card debt and other bills must still be paid. The major portion of
the family's debts would be covered by the disability insurance, so the working
spouse can probably earn enough income to support the family's other bills.
The disability coverage should equal 60 to 70 percent
of the total current gross salary.
Many insurers set limits on the amount of disability income that can be
purchased, especially for those earning more than $100,000 (often limiting
coverage to no more than 60 percent of income). A good agent will know how
these limitations apply or if he or she is not certain, call the insurance company to
find out. Since the insurance industry is continually improving products there are
usually good options available through the various insurers. A qualified agent will
be able to offer many types of products finding one that best suit the individual and
their family.
Social Security
Another hurdle an agent may have to overcome is the misconception that Social
Security (or Workman's Compensation) will cover the family adequately without
the need to purchase disability insurance. So to overcome this hurdle, an agent
needs to understand some complexities of Social Security. There are two different
disability benefit programs under Social Security:
1. Social Security Disability Insurance (SSDI), and
2. Supplemental Security Income Program (SSI)
Individuals disabled for five months or more may be eligible for Social Security if
they meet all qualifications. It is important to apply to Social Security well before
the waiting period has expired since the qualification process can be long and
tedious. To qualify for Social Security disability a person must prove they are
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expected to be disabled for 12 months or longer, or their death is imminent. If
qualification is possible Social Security will not fully replace their income; it pays
only a portion of their monthly income and there are monthly limitations in place.
The person must be disabled for a full 12 months before they can collect anything
from Social Security, regardless of how dire their present circumstances may be.
A disability policy that starts paying benefits earlier would supplement any
available Social Security income. There is no guarantee of receiving Social
Security disability benefits and in fact, many applications are initially rejected.
The Social Security Administration's (SSA) definition of a disability is strict to say
the least. The Social Security Administration defines a disability as: "the inability
to do any substantial gainful activity (SGA) by reason of any medically
determinable physical or mental impairment (or combination of impairments)
which can be expected to result in death or has lasted or can be expected to last for
a continuous period of not less than 12 months." This means that the individual
must be unable to do their previous work or any other substantial gainful activity.
The Social Security Administration defines substantial gainful activity (SGA) as
work that involves performing significant and productive physical or mental duties
for pay. SSA uses residual functional capacity (RFC) to determine if the
individual can do other types of work besides the job they held when disabled.
This would include activities that the individual might be able to perform in a work
setting despite their impairment.
The determination process and medical requirements needed to prove an
individual's disability are the same for both SSI (supplemental security income)
and SSDI (Social Security disability insurance). The main difference between the
two programs is that SSDI's eligibility is based on the amount of income
accumulated from prior work, while SSI's eligibility is based on financial need.
Beside eligibility, some other differences between SSDI and SSI are:
1. Unlike SSDI, supplemental security income (SSI) has no disability waiting
period. SSI payments are based on financial need. The presumption that an
individual has the resources to handle the short-term health problems does
not exist.
2. Under SSI, an individual may qualify for an immediate disability payment if
the condition is obviously disabling and the individual meets the SSI income
and resource limits.
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3. Individuals qualifying for SSI benefits usually receive food stamps and
Medicaid, which helps pay doctor and hospital bills. SSDI is based on
wages turned in through FICA. If the benefit amount received from SSDI is
higher than qualification allows, they are not eligible for food stamps and
Medicaid programs.
4. Different work incentive rules apply to SSI recipients. With SSDI, if the
individual earns more than $500 monthly, both eligibility and cash monthly
payments may end. The only exception to this would be if the person were
under a Trial Work Period. Benefits would then stop the 9th month
worked within a 60-month period. The Trial Work Period allows people to
work on a trial basis. If the disabled person works a couple of months but
cannot continue he or she may stop work without worrying about their SSDI
benefits. With SSI, benefits continue as long as income limits are not
exceeded. These income limits vary so it is important to check with your
locality. Social Security raises the income limits nominally each year.
To apply for Social Security Disability Insurance (SSDI) an individual must first
contact their local office. SSA will ask some preliminary questions and then
forward Disability and Vocational Reports for the individual to complete. The
individual must complete these forms regarding both their financial and medical
history. SSA will use this to determine the individual's case type. Once SSA has
received the forms, the local SSA office will set a date for a telephone interview.
Once that is completed, a copy of everything discussed is sent to the individual to
sign and return it along with any other requested information.
Once all the paperwork is received, it is then forwarded to the state Disability
Determination Section (DDS where the individual's case is assigned to a claims
examiner. All medical sources are then contracted to supply a report about the
individual's disability. If too little medical information is provided the individual
may be asked to visit another physician at no cost to the applicant. The individual
will be notified if their case has been denied. If the individual's case is denied, the
paperwork is then returned to their local SSA office for 60 days or until the
applicant requests a reconsideration appeal.
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Workman's Compensation
Worker's Compensation covers work related injuries. This type of disability
payment varies widely based on state law. The maximum is 66.6 percent of the
individual's pre-disability gross wages or 80 percent of take-home pay, not to
exceed a specified ceiling. Employers buy worker's compensation for their
employees; the self-employed have to buy their own.
Degrees of Disability
There are also different types or degrees of disabilities. They can range from a
severe disability to a short-term disability. There are five different classifications
of a disability. They are:
1. A Permanent "total" disability
2. A Long Term "total" disability
3. A "total" to "partial" or recurrent disability
4. A Progressive "partial" disability
5. A Short Term "total" or "partial" disability
A permanent disability is one that is irreversible. It could be the loss of both
eyes, the hearing in both ears, a loss of limbs, or a loss of speech.
A long-term disability (LTD) is a broader classification. These types of
disabilities have a long-term effect on the individual's life. Long-term disabilities
typically prevent an individual from returning to their normal job or are severe
enough to prevent the individual from performing any job for which they are
qualified.
A total to partial disability is characterized by falling back into their disabilities
after going back to work. The insured's disability is reoccurring.
A progressive disability causes the most unpredictable effects because they are
often sporadic. Individuals affected in this way can sometimes work full or parttime or in the extremes, not work at all.
A short-term disability (STD) is temporary. In this classification, three types
exist:
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•
Total disability,
•
Partial disability, and
•
A combination of partial and total disability.
These short-term disabilities are varied and include conditions that will mend or
eventually correct themselves but temporarily causes the disability of the
individual since he or she cannot perform their job-related duties. While the
disability is classified as short-term the financial costs can be devastating to a
family.
Many disability policies are basically the same, but there are enough differences,
especially in the definition of “disabled” that it is important to completely read the
policy. If something is not covered that the family needs or wants riders can be
offered to meet most needs.
The precise amount of needed benefits may hard to ascertain. It is important to
sit down and figure annual living expenses. This needs to be a very detailed
account. If extra or excessive expenditures can be eliminated, the benefit amount
and therefore the premium amount can be lowered. Once a figure is established,
subtract all sources of income. This includes investments and Social Security,
which the person may be eligible for once disabled.
A family considering how much they will need should also look at existing
insurance policies to determine if disability riders on other policies such as life,
auto, or homeowners insurance will pay premiums for these policies during a
period of disability. This, of course, would alleviate quite a bit of needed income.
These riders could be expensive. Careful planning will help families make the
most financially promising choice. Some lenders may require such insurance on
their loans.
It is important to remember all aspects of income and monthly expenses when
determining how much the family will need to financially survive in case of an
emergency. In practical terms, the family may only be able to afford minimum
coverage to cover the mortgage and basic living expenses. Trying to cover
everything, such as future education, medical, dental, or recreational expenses, are
generally unnecessary and can put a financial burden on the family. Practicality
should be the first concern. If premiums are too high, any additional financial
requirement would probably cause the disability policy to lapse anyway. Setting a
premium the family can live with in good and bad times is important. As for
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college expenses, if the insured does experience a disability, likely their children
would qualify for financial aide of some sort.
There is no single policy that is right for everyone. There are no absolutes. The
agent and applicants will make decisions based on income, debts, and available
premium dollars in the family’s budget. Some will decide to only cover the
mortgage and major debts while others will elect to fund up to 80% of their
income. It is all a matter of choice.
How Soon Should Benefits Begin?
Insurance companies offer the insured different times at which benefits would
start paying. The DI policy could start paying benefits as soon as the insured is
disabled but these policies are very expensive. To reduce the cost of the DI
coverage a policyholder could select a waiting period that allows the insurance
company to defer benefit payment until a period of time after the disability occurs.
There are several options, including 30, 60, 90 or 120 days. This is referred to as a
waiting or elimination period. The longer the waiting period, the less expensive
the policy will be. For families that have practiced diligent savings that could
initially be relied upon, opting for the longer waiting periods will significantly
lower their premium outlay. Professionals recommend no less than three months
of living costs be set aside in an emergency fund, but nearly everyone agrees
having more is better. Those that can survive on savings for a year will always
have an advantage over those who can only live for a couple of months from their
savings.
Insurance companies typically pay DI benefits at the end of the month in which it
is due, so with a 90-day waiting period, the insured would receive the first payment
120 days after the start of the disability.
How Long Should Benefits Last?
Disability insurance policies have many options available, which the applicant
would select at the time of application. A person can have a policy that will limit
the length of time they can collect benefits from one to five years, or even collect
until age 65 if the applicant qualifies. The shorter the length of time benefits must
be paid, the cheaper the policy. Some insurance companies limit benefits on
certain occupations; some occupations may not be insurable at all. For example,
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people who are self-employed or who work for multiple companies simultaneously
may have difficulty qualifying for a disability policy.
Some blue-collar workers may not be able to purchase benefits paying to age 65
due to the type of work they perform. For example, people who are in construction
may not be eligible for benefits to age 65. Their benefit length may be limited to
specified time periods, such as five or ten years. White collar jobs normally do not
have these limitations on benefit periods.
Whatever benefit length is chosen, the premiums must be affordable. It would be
pointless to issue a policy that was too expensive since it is likely the insured
would not continue paying the premiums, causing the policy to lapse.
Some insurers may not allow certain occupations
to purchase lifetime disability benefits.
Companies vary in their underwriting criteria so agents are wise to shop the
marketplace prior to presenting a policy, especially for some of the more hazardous
job categories.
Managing the DI Benefits
It is important to consider disability benefit management. The Social Security
Administration will not issue benefits until 12 months of total disability have
lapsed while individual DI coverage (individual or employer-provided) may have a
90-day or longer waiting period before the insured receives benefits.
Many individuals purchase short-term disability policies that pay for a qualified
disability from the first day and continue for up to six months, depending upon the
policy purchased. Some employers provide both short-term and long-term
disability plans but if there is not an employer sponsored plan, individual policies
may be purchased. Most short-term plans do not last longer than six months.
Short-term disability plans work well for those who are unable to set aside an
emergency account of at least three months wages. While professionals agree that
no less than 90 days of cash should be available for periods of disability or
emergencies, more is always better. Ideally, a full year’s living expenses should be
set aside.
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When combining long-term and short-term disability benefits, try to make the
waiting period of the long-term plan equal to the maximum benefit period of the
short-term plan:
Short-term policy pays from the first day ending after 6 months of benefits.
Long-term policy begins making payments after a six-month waiting period and
ends after a long-term period of no less than five years.
Where is DI coverage available?
Disability insurance may be purchased through private insurance companies or
acquired through employer-sponsored plans. Just because an employer sponsors a
plan, however, does not mean that the employer also pays the premiums. Often,
the employer merely negotiates a better group rate, but the employees must pay the
premiums. When the employer does not offer group plans, individual coverage
must be purchased.
There is sometimes disability benefits offered through other avenues, including
riders on existing insurance coverage. Even some credit cards provide very basic
amounts of disability, but be aware that such riders seldom contain enough
coverage for living expenses. Typically, the amounts included are intended to
cover the credit card payments, not other debts.
Employer Provided Disability Coverage
Employers that offer group rates are always the first stop when acquiring
disability benefits. While these company-sponsored plans are nearly always
worthwhile, it does not mean they will provide adequate benefits. Often it is
necessary to supplement the amount of disability benefits provided by the group
plan with a privately purchased policy.
The first step is inquiring into company-sponsored benefits and the second (if the
company has such a plan) is asking the important question: how much and for how
long? If the employee does not know both the benefit and the duration of the
company plan it will be hard to make comparisons with other coverage available or
to purchase a supplementary private policy.
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Because employer-sponsored group disability income insurance is generally less
expensive than private coverage it makes sense to utilize it if it is available.
Another advantage is that the employer is working as an advocate for the employee
when dealing with the insurance company.
As in all things, there may be some disadvantages for group coverage, including:
•
Lack of control: the employer decides available benefits, which may be
too low for the family’s actual needs;
•
There may be policy restrictions. Restrictions might include amounts
and durations of available benefits, the definition of a qualified
disability, and how the disability policy integrates with Social Security
benefits or any other sources of DI benefits.
•
Employer-sponsored coverage of any type usually ends when
employment ends. While there are provisions for continuation for a
limited period for health insurance under specified conditions, this is not
likely to occur for disability protection coverage. It may be possible to
convert the group coverage to individual coverage, but the premium will
be higher.
Many professionals feel employer-sponsored disability insurance do not provide
the control that is vital to adequate coverage. While this is true, the cost is usually
low enough to make acceptance of the coverage worthwhile. He or she may then
supplement what is provided with individual coverage. Since any policy is only as
good as the benefits selected every employee must look at the employer-benefits
offered, including the definition of “disability.” If the definition of disability is too
restrictive it might be wiser not to accept the company policy and use the
premiums that would have been spent on a private policy that will pay benefits for
a less restrictively defined disability.
There are many policy terms that can be restrictive in a policy. Does the DI
policy reduce benefits if other insurance is in place? If so, it may be best not to
participate in the company plan since Social Security benefits might affect how the
policy pays, as well as any private insurance purchased. Private DI policies may
also contain this provision so it is important to check any policy purchased for
limitations as well as exclusions. Employer provided plans might also reduce
benefits if the policyholder is receiving their employer's retirement benefit.
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The employer-provided DI plans may not cover the employee's income
adequately. It is not unusual for employer-sponsored plans to provide limited
benefits, perhaps no more than 40 to 60 percent of gross income. Benefits based
on net income would provide fewer benefits. Benefits based on gross income may
be adequate without supplementing the policy with individual coverage, especially
if 60% of gross income is covered. These are always personal decisions that must
be made by the policyholder with assistance from his or her agent.
Some disability income policies may contain a provision guaranteeing levels of
both benefits and premium rates throughout the lifetime of the policy. Depending
upon pricing and other factors this is often an advantage to the policyholder.
Association Group Disability Insurance
A person may be a member of an organization or association that offers group DI
benefits to their membership. These plans often offer lower premiums. Members
usually are not subject to medical underwriting so existing or probable health
conditions will not be a determining factor for coverage. Every member of the
group is entitled to coverage, regardless of their health conditions. No single
person's coverage can be canceled; individual termination is not possible, but the
entire group could be canceled by the insurer under specified conditions.
Like the employer-sponsored group disability plans, membership groups may also
offer too little coverage or have a restrictive definition of “disability.” Some
disability definitions require the insured to be unable to do any job, not just the job
currently held. For example, the insured may no longer be able to continue as a
chef due to a hand injury, but he or she could wash dishes in the restaurant.
Therefore, under a restrictive definition of disability, the insured would not qualify
for benefits.
Some membership group coverages may offer benefits for only a limited period
of time. Such policies will do well for short-term conditions but will not be
adequate for long-term conditions. As always with any type of group insurance
policy, individual members do not have control over how the plan is formulated or
if it continues to be available. Member contracts may be canceled by those in
charge even though the membership wants to continue coverage.
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There are various types of eligible groups for DI coverage. The most familiar
type of group is the singular employer group where the employer offers their
employees group coverage. These are employer-sponsored plans, although
premiums are not necessarily paid by the employer.
Since the minimum size of an eligible group (usually ten), is governed by law the
company may be too small to offer coverage to their employees without assistance.
Smaller employers can band together to have the same DI benefits as larger
companies have. When this happens it is called multiple employer trusts
(METS).
Unions, which are comprised of groups of employees in related fields, can offer
their constituents DI coverage. Federal law mandates that a trust be formed to
handle or administer the DI benefits for unions.
In recent years, we have seen a rise in creditor-debtor group insurance offered by
the lender to the borrower. This type of insurance is not limited to DI benefits; it
may include such things as life insurance, hospitalization policies or other specialty
products. The purpose of both the life insurance and the disability insurance is to
protect the lender to whom the policy's benefits are paid if the borrower becomes
disabled or dies before the debt is paid. As stated before, some mortgage
companies have started offering policies to pay the house payment if the
breadwinner becomes disabled.
The common denominator for all group coverage is the association or company
the actual contract is delivered to, with members receiving certificates of
insurability. This might be an employer, union, association, credit card
association, or group borrowers of a lending institution. All traditional group and
mass-marketed group plans must try to avoid adverse selection; this occurs when
members are made up of those who are most likely to collect benefits rather than a
profitable mix of healthy and potentially sick members. When a group is primarily
made up of those collecting benefits the premium rates are likely to rise. As the
rates go up healthy members are the ones most likely to discontinue the coverage,
leaving an even higher number of sick or injured members in relation to healthy
members. This can be a disastrous cycle for both the insurer and the group
members.
When compared to other types of insurance coverage, few people own disability
insurance. This is especially true for group coverage. Two big selling points of
group plans should be the lower individual premium cost and less restrictive
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underwriting. Many businesses, unions, and other groups offer group health and/or
life coverage, but relatively few offer disability coverage. Where medical
insurance is considered a necessity the same need is not placed on disability
income coverage and that is unfortunate. As a result, this should be a field of
concentration for field agents.
Individual Coverage
Some professionals feel individually owned disability insurance coverage may be
desirable over group coverage. Why? There is less danger of policy lapse as the
individual makes job changes. In America, the average American changes jobs
frequently compared to other countries. Most individually issued disability
policies may not be canceled during the entire insured's working life and stipulate
that the insurer may never, during that period of time, charge the insured any more
than is specified in the policy on the date the policy was issued. This type of
policy is referred to as non-cancelable and guaranteed renewable coverage. Since
rates tend to be based on issue age, the younger the applicant the less expensive the
policy will be purely from an age standpoint (other factors may affect the cost of
coverage).
Annually renewable disability income (ARDI) policies work much like term
insurance in that the price starts low and increases a little every year. The
traditional DI policy costs more initially, but the premium is fixed throughout the
policy's entire life. ARDI policies allow people to get coverage who may not have
been able to afford DI coverage in the past. Depending on the insured's age,
premiums can be cut 25 to 50 percent off the initial cost. Hopefully, as ARDI
policies become more and more expensive, the insured's income will also be rising.
The prospective policyowner is going to want the highest quality of plan
available. This includes the options and riders available; it also includes the
insurance company selected. This type of policy will probably be kept in force for
many years; the insurer’s financial rating is very important to any type of longterm coverage. Agents are the individuals most likely to select the insurer a policy
is issued through. While we would like to believe consumers pay attention to such
selections field agents are well aware that they are unlikely to do so. Instead they
rely on the professionalism of their agents. Therefore agents can follow some
guidelines to insure the best company will be recommended:
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1. The policy should define “disability” as being unable to perform the duties
required by the insured’s present occupation. Policy definitions of disability
vary widely, with some paying benefits only if the insured is unable to work
at any occupation. Some occupations that the insured may be able to
perform may pay far less than his or her current occupation.
2. Insurance companies can be aggressive in seeking business.
This
aggressiveness can be a great advantage for an insurance agent since
different insurance companies offer competitive rates, options available and
policy term. The market and products are always changing; it is important
to keep up with those changes. This allows insurance agents to offer the best
policies to their clients.
3. The financial standing of an insurance company can never be overstated. A
policyholder is obviously going to want the insurance company to be around
when they need to collect benefits. There are several sources a person can
go to investigate the financial standing of an insurer.
Many of the diseases and injuries that once killed people are more likely to
disable them today, which contribute to the rise in disability claims. The Health
Insurance Portability and Accountability Act of 1996 that President Bill Clinton
signed into law in August of 1996 prevents health insurance coverage from being
dropped if a person can no longer work. While this was landmark legislation, the
premiums must be paid by the insured rather than the employer. Without a
disability income policy, the individual may not have the means to pay his or her
health care premiums. When the worker buys a DI policy that is guaranteed
renewable for life it may mean the difference between health care coverage and
having no coverage at all.
There are mandatory provisions required in a health or disability policy. Since
they were discussed in detail in the earlier chapter dealing with health insurance,
this is just a list of what the twelve mandatory provisions are. The Uniform
Individual Accident and Sickness Policy Provision Law (also called uniform or
standard policy provisions) mandate these be included in every policy. The twelve
mandatory provisions are:
1. Change of Beneficiary
2. Notice of Claim
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3. Claim Forms
4. Entire contract and changes
5. Premium grace period
6. Legal Actions
7. Payment of Claims
8. Physical Exam & autopsy
9. Proof of Loss
10.Policy Reinstatement
11.Time limit for Paying Claims
12.Time limit on Certain Defenses
Amendments by the various states to the standard provisions law diminished the
degree of uniformity among them.
To solve this dilemma, the NAIC
recommended the Uniform Individual Accident and Sickness Policy Provisions
Law in 1950 for adoption by the states. The new law contains twelve mandatory
and eleven optional provisions. These were also discussed in a previous chapter,
but still apply to disability income policies. The eleven optional provisions are:
1.
Occupation change
2.
Age misstatement
3.
Other insurance with the same insurer
4.
Expense insurance with other insurers
5.
Income insurance with other insurers
6.
Relation of earnings to insurance
7.
Unpaid premiums
8.
Cancellation
9.
Conformity with state statutes
10. Illegal occupation
11. Intoxicants and narcotics
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The Uniform Individual Accident and Sickness Policy Provision Law include
other health insurance requirements, in addition to the mandatory and optional
provisions. Requirements include:
1. The entire monetary and other considerations must be expressed in the
policy.
2. The font used in the policy must be at least ten-point in size. The type of
font will also make a difference but new roman is a common type used. This
is ten-point times new roman font.
3. The insurer must not give undue prominence to any portion of the text (an
example of undue prominence could include bolding, which would look like
this: undue prominence to any portion of the text).
4. General exceptions and reductions shall be grouped under a descriptive
head.
5. A policy in violation of the act shall be construed to conform to the act.
6. No policy provision can restrict or modify the provisions of the act.
7. Supplying claims forms, acknowledgment of notice of claim, and the
investigation of a claim are not waiver of defense against the claim.
8. The policy remains in force for any part of a policy term that exceeds the age
limit, and acceptance of a premium after that term keeps the policy in force,
subject to any cancellation provisions in the policy;
9. If misstatement of age leads the insurer to accept premiums beyond the age
limit, liability is limited to a premium refund; the act does not apply to
workman's' compensation, reinsurance, blanket or group coverage, and life
insurance or annuity riders covering total disability.
Approaches to Selling
There are various approaches when marketing a disability insurance policy. One
way is to scare the prospective insured with gruesome details of disability stories
or even just the scary statistics. Most professionals prefer to demonstrate the
logical use of disability coverage to protect one’s family in much the same way life
insurance is used; either one protects lost income due to death or disability.
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Evaluating need is always important. While it is unlikely that most people would
have enough savings to maintain their living style during a long disability some
people may not need disability insurance. Most agents and financial planners have
a set of questions they use to evaluate need. These might include:
1. Could the applicant pay all of his or her bills for up to a year from their
current savings?
2. What occupation is the applicant actively working in? As we know, some
occupations have a higher rate of disability than others. Does he or she plan
to continue in their current occupation? If so, whatever degree of risk exists
for that occupation will increase with age since advancing age is also a risk
factor for becoming disabled.
3. For applicants that own their own business, could the business continue
earning income without them? Some types of business could continue while
others would suffer lost of income almost immediately. An insurance
agency is a prime example of this, especially if the agent/owner is the person
supporting the business. While insurance renewals would likely continue,
would new business continue? If new business would not be written, could
the individual and his or her family survive on the policy renewals? If the
agent is not able to service his or her clients would the insurance carrier
allow the agent to keep their renewals indefinitely or would they be given to
an active agent?
Description of the Optional Provisions
There are other provisions that can be included in disability policies. Not all
provisions will be offered by all insurers so agents must be familiar with the
policies they are recommending. Some of the provisions may reduce or increase
premiums.
Waiver-of-Premium Provision
Normally all DI policies have a waiver-of-premium provision. A waiver-ofpremium clause allows the insured to discontinue making premium payments
following a disability that continues for a specific length of time. The length of
time is normally 90 days, but this can vary. Some insurers use the elimination
period instead. If the premiums are paid up to that time, the policy cannot
thereafter lapse during the total disability period. If the insured has paid his
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premium in advance and waiver-of-premium satisfaction occurs during this time,
normally the insurer refunds any premiums paid ahead. This provision is
invaluable to a disabled member who will likely be using all his or her resources to
help support the family.
Non-occupational Provision
A non-occupational provision states that the DI policy will not pay any benefits
if workers' compensation or similar compulsory benefits for employed people are
payable for a condition otherwise covered by the DI policy.
Transplant Provision
Few DI policies contain this provision. It states that if the insured is temporarily
disabled due to donating an organ to be transplanted to another person, the insurer
will then recognize this as a disability covered by the policy. The amount received
by the insured will be as much as it would be for a total disability benefit.
Rehabilitation Provision
The rehabilitation provision is designed to help the disabled individual to return
to work. This benefit may be offered by the insurance company even when the
actual provision was not written into the issued policy. The reason is simple: it
may save the insurance company money. Typically insurers offer vocational
rehabilitation or even schooling to establish a new occupation that the disabled
individual may manage in spite of his or her disability. If the insured has lost a
limb, they may even pay for prosthesis if it enables the insured individual to return
to work in their current occupation or a related occupation.
Non-disabling Injury Provision
The non-disabling injury provision pays for medical expenses for an injury that
does not cause total disability. Most DI policies do not cover the insured’s medical
expenses.
Preexisting Conditions Provision
Like most types of policies, Disability income policies will exclude coverage for
preexisting conditions. The exclusion normally lasts for a specified time period,
which is stated in the policy. Once this specified time period has passed related
disabilities would be covered by the policy. This period of time can be anywhere
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from 12 to 24 months following the effective date. Although state statutes vary,
generally a condition is not totally excluded by a policy; if the condition caused an
unacceptable risk, the insurer would simply deny the coverage.
Free-Look Provision
State law provides policyholders with ten days to review a new policy. If the
policyholder decides he or she does not want the policy it may be returned to the
agent or insurance company within those ten days with the request to cancel the
policy; if premium has been paid it will be refunded. The request for policy
cancellation must be submitted in writing; generally insurers want the
policyholder’s signature on a cancellation request so the writing agent would be
unable to write the letter on behalf of the client.
Common Riders
The following may be riders or options available to the insured. There are
substantial differences among companies offering these options.
Return of Premium Rider
The return of premium rider appeals to people who feel they might never be
disabled since it promises to return a portion of the premium under specified
conditions. This rider is not cheap. Some professionals do not recommend it due
to the cost. In order to return premium, the policy has to be in force for the full
term; to receive back the full percentage no claims may have been submitted.
COLA Rider
The Cost-of-Living Adjustment (COLA), also referred to as the inflation rider,
provides for an annual upward increase in the benefit based on a certain
percentage. This increase is determined in some proportion to the increase in the
annual Consumer Price Index (CPI). The insured must be disabled for one full
year for the increase in benefits to take effect. This option is available on longterm plans only. COLA riders vary from insurer to insurer. Agents must check to
see how the increases are calculated. Most riders have limitations; they may rise
only to a specified point. While these riders can be very expensive, should the
insured suffer a long-term disability, such as ten years, it would certainly pay for
itself.
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Social Security Rider
Social Security does not pay disability benefits until the person has been disabled
for five months and the disability is expected to last 12 months. A social security
rider can be added to the policy to pay the insured a certain amount (above the
regular benefit) each and every month for each month that the insured does not
collect Social Security benefits. The Social Security rider also requires a 90-day
waiting period, so the insured will only collect benefits for months four and five
(assuming a six month waiting period). Keep in mind there is no guarantee Social
Security benefits will be granted, which means this rider might be a good one to
have. This rider may only be available on long-term plans and may be payable to
age 65, depending on policy terms. As always, the policy must be consulted for
exact details.
Purchase Option Rider
The purchase option, also known as the guaranteed insurability rider, allows
an insured to buy more coverage as they get older, or at the onset of some event,
such as marriage or the birth of a child. Some types of life changes makes
protecting income more important, which is the case when there are others that
depend upon the wage-earner. In order to qualify for the purchase option rider, the
insured's income must have increased significantly. The insurer will require proof
of the increased income. The amount of wage increase will determine the amount
of benefit increase. Since the insurer never intends to make disability more
attractive than non-disability, benefits are never more than actual wages and
typically less by at least twenty percent. This rider is also an expensive one.
The purchase option rider is especially pertinent for young applicants since their
wage is likely to increase significantly over their working years. Statistically the
odds are greater for a person to be disabled at some point, as they grow older.
Therefore, two things happen: income rises and secondly risk rises as the insured
ages. If the insured decides to purchase a higher benefit amount the rider allows
them to do so without proving insurability. The first benefit increase option period
available differs from insurer to insurer but all contracts will specify the points of
increase; typically it is one or two years. After that, additional options are made
available every two to three years up to a specified age dictated by the policy.
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If the option period happens to be when the insured is currently disabled, the
insurer may allow the increase in the policy. The increase would take effect on the
current disability with most disability insurance policies. As always, refer to the
policy.
Residual Disability Income
If the insured works while residually disabled, the insurer will pay a monthly
benefit amount in proportion to the percentage of the insured's loss of income.
Family Income Rider
The insured could receive a stipulated amount of additional monthly income from
the end of the elimination period to the end of a stipulated period of time, which
begins on the date of issue. This rider can be used for specific limited term
financial obligations such as mortgage payments or college funding.
Accidental Death and Dismemberment Rider
The accidental death-and-dismemberment rider contains a provision for the
payment of lump sums for the loss of sight or limbs instead of the weekly or
monthly income benefits, but only if the disability is caused by an accident.
Blindness and dismemberment benefits are often given prominence in the
disability insurance policy and could be mistakenly regarded as an added rider.
The policy may give the insurer the ability to substitute a lump sum payment for
continued income payments. It may not be as broad as a policy providing longterm income payments for sickness as well as accidents. Some insurers will allow
the insured to choose how they are paid: one lump sum or installments.
The accidental death benefit is payable through the policy if death occurs:
1. Before the insured's 70th birthday,
2. Directly & independently of all other causes,
3. As a result of accidental bodily injuries, or
4. Dies within 90 days from the date of the accident.
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Most policies exclude death from suicide whether sane or insane, death resulting
from war, death resulting from disease, or when death occurs outside the Earth's
atmosphere (it is hard to imagine this occurring).
The Accidental Death-and-Dismemberment Rider may appeal to people who
feel their current life insurance protection is inadequate or want higher limits for
accidental death benefits. Since this rider is inexpensive to purchase, it may suit
the family's budget if they cannot yet afford life insurance on the primary
breadwinner or on the secondary wage earner. As life insurance rates go, adding
accidental death benefits costs very little. For those under the age of 40 accidents
is the cause of death in more than 50 percent of the cases so it may even make
sense to add this type of coverage in some circumstances.
This rider provides extra insurance protection but only on a limited “accidental
death” basis. It is important to impress upon applicants that while younger people
(under age 40) are more likely to die from an accident than from sickness, standard
life insurance policies are the type most professionals recommend since death can
occur from natural causes as well as from accidents. It would make more sense to
provide protection from all causes rather than from limited causes.
The insurance industry is always trying to meet the needs of the policyholders and
stay competitive with the marketplace, offering new riders and options as state
statutes allow. While everyone should read any policy they purchase, it is
especially important that agents read the policies they sell. It is surprising how few
agents do so.
Occupational Classifications
Occupations are classified into five different groups according to the degree of
hazardous duties involved. This may be one of the most important parts of
underwriting a prospective insured. The underwriter of the DI policy must assess
not only the applicant’s occupational title, but also the nature of the duties
performed in that occupation. When the applicant applying for disability insurance
performs several different duties the occupational classification is based upon the
most hazardous duty performed.
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Dividing occupations into classifications does benefit those performing the
underwriting but may also restrict or eliminate the availability of policies for some
of the riskiest occupational classes.
The classes are defined below:
Class 4AS includes certain professionals and corporate executives. The corporate
executives must meet the following criteria:
1. Primarily performs office duties with little or no travel;
2. Compensated by salary rather than hourly wages;
3. Employed by a well established, stable firm for at least two years earning a
specified salary annually.
This category includes, but is not limited to, Certified Public Accountants,
anesthesiologists, architects, gynecologists, dentists, and psychologists.
Class 4A includes a number of selected professionals, including physicists that
partake in no lab work, engineers who work in an office or only as a consultant,
accountants working for an accounting firm, chemists that consult or work in an
office, and civil engineers performing office work only.
Class 3A includes people who are engaged mostly in mental work, primarily
those with clerical duties or office-only duties. This category includes clergymen,
comptrollers, computer operators, court bailiffs, anesthetists, draftsmen who work
only in an office, speech therapists, travel agents, statisticians, stockbrokers,
rabbis, real estate agents/brokers and typists.
Class 2A includes those who are supervisors, technicians, merchants with no
delivery or repairing duties, those with special skills, and others not performing
what are generally described as manual labor, although duties may require some
physical activity. Some of the professions included in this category are
taxidermists, timekeepers, bill collectors, chiropractors, apartment house managers,
counter clerks, geologists in the field with no hazardous work involved, grocery
managers, locksmiths, hotel/motel clerks, and newspaper reporters.
Class 2B includes people in occupational classifications 2A and 3A who do not
meet minimum income requirements, but who are employed by a professional
organization to which disability coverage is provided.
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Special Circumstances
Government employees (Federal civil service) are not eligible for disability
insurance because of the accumulating sick leave and disability benefits
automatically available to them.
State, county, and municipal employees (including public school teachers) are
ineligible for disability insurance policies due to the substantial benefits available
in their pension plans. Individual underwriting consideration may be given for
limited coverage amounts provided full information, including their retirement
plan booklet, is submitted to determine benefit eligibility.
Disability Insurance coverage is not generally available to individuals who work
from their residences. People who are in a category called Business at Residence
may be given an exception if only some duties are performed at the residence, with
a significant amount performed elsewhere. Normally, exceptions of this type allow
only a 60 to 90-day waiting period (less than that would not be granted but a longer
waiting period would be permitted). This situation does not apply to doctors,
dentists and attorneys who have established offices at their residence, nor to
manufacturers' representatives who use their residence as a business address but
whose duties require them to spend nearly all their time calling on clients.
Disability insurance coverage is not available for some occupations normally
designated NE (Not Eligible). Since those considered ineligible for disability
coverage is not uniform to all insurers, it is important to shop around. Insurers
may amend the list periodically as well. Sometimes an occupation is not covered
by DI policies because it is performed from the residence although coverage may
still be available under specified circumstances. Professions that may have
difficulty finding coverage includes car salesmen and dealers, authors, actors,
singers, entertainers, air traffic controllers, acupuncturists, bartenders, barbers, bus
drivers, butchers, cooks/chefs, flight attendants, musicians, guards, detectives,
policemen, janitors, and teachers that work in homes.
Is underwriting necessary?
Underwriting is the process of reviewing potential risks involved with issuance of
a policy to a specified applicant. If the applicant’s risk is initially acceptable then
underwriting is further concerned with the term of the risk; the longer the issued
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policy’s benefits, the greater the insurer’s risk will be. A primary purpose of
underwriting is to maximize earnings by accepting a profitable distribution of risk.
Adverse selection can occur if these risks are not properly balanced. In other
words, the insurance company does not want too many of those most likely to use
the policy’s benefits in relation to those least likely to do so.
A person might ask: “Since insurance is based on the law of averages, why not
accept all prospective insureds and trust the laws of probability?" While this
would theoretically work, it is not practical to base policy issuance on it for one
simple reason: those most likely to need benefits are also the most likely to seek
out insurance coverage. For the laws of probability to work, all individuals within
a group must apply for coverage and that is not likely to happen. The healthiest
members are the least likely to apply for coverage because they are the most likely
to doubt the need for it.
Prospective insureds are not selected at random, nor do they have the same loss
expectancies. Applicants with loss expectancies substantially higher than provided
for under the standard rate will either:
1. Be charged a higher premium rate or
2. Be declined for coverage.
When applicants do not meet the standard rate they must typically pay higher
premiums for the insurance company to accept them and remain solvent. When
underwriting is required for policy issuance this is called selective underwriting
since the insurance company does not automatically accept all applicants. Some
states do not allow insurers to have various premium rates for the same policy;
they must either accept or deny the applicant. Disability policies are among those
that are most likely to be allowed to have various rates since underwriting is so
closely tied to the risk represented by various elements, such as job category, age,
and history.
Underwriting helps achieve equity in premium rates, thus a broad range of
insureds are charged a proportionate amount with their loss expectancy. With DI
policies, classifications are made to differentiate among exposures that are used for
rating purposes. With other types of insurance the classifications may be broad to
facilitate accurate loss predictions and to control rating expenses.
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Insurance companies must develop a workable selection process to classify
acceptable exposures accurately and maintain enough insureds that balance out
high and low loss exposures. The insurers must set a limit for the degree to which
an applicant's loss expectancy can exceed the average without rejection or being
assigned to a higher premium classification. The primary purpose of this risk
selection by the insurance companies is to obtain a profitable distribution of
policyholders.
The Agent's Role in Underwriting
As with any type of insurance, the field agent asks preliminary questions to
appraise the risk exposure of the prospective insured. In fact, many agents have
completed extra schooling for such designations as Chartered Life Underwriter
(CLU) or Chartered Property-Casualty Underwriter (CPCU). Agents who
complete this extra class work and pass a series of examinations are awarded these
designations, regardless of the functions they perform in the business. Not only do
the agents attend more schooling to be eligible for these designations, they are
required to meet additional CE hours to keep these designations above the staterequired CE hours.
Agents perform limited underwriting functions since they are limited by the
information available to them during the application process. When writing any
kind of policy agents must be aware of the role the application plays. It is the
starting point for the underwriters; therefore, it is very important that the
information gathered is correct. When an agent learns of existing health conditions
or for DI policies, an occupational risk this must be reported to the underwriters
through the application forms. If the risk appears too high for the insurer to accept,
agents have a couple of choices:
1. Turn the application in with a check from the prospective insured. The
insurer's underwriting department then has the decision to issue the policy
with different terms or premiums.
2. Turn the application in on a COD basis, waiting to see if the insurer accepts
the risk before collecting funds (if the insurer allows COD applications; not
all do). The only purpose of turning in a COD application would be the
elimination of the refund process if the applicant is declined coverage.
Some applicants may be reluctant to tie up their funds without a guarantee of
coverage. As with the first option, the insurer's underwriters make the final
policy issuance choice.
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3. If the field agent has the expertise and experience to recognize the
applicant’s degree of risk is uninsurable, then he or she may simply refuse to
submit the application for coverage to the insurance company. Obviously it
would be necessary to explain to the applicant why coverage would be
denied. Most agents would also do some research for a company that might
accept the degree of risk presented unless the risk is so substantial that the
agent knows of no company that would issue the coverage. Insurers
generally issue a list of unacceptable risks so agents are able to demonstrate
to the applicants why an application is not being completed.
The Underwriting Process
Underwriting includes both preselection and post-selection of risks.
Preselection involves gathering pertinent information concerning the risk and
deciding to accept or reject the risk of the prospective insured. Once this risk is
accepted, the insurer must then practice post-selection. Post-selection is the
process of reviewing insureds and dropping those that are no longer desirable.
Post-selection is available only if the policy is cancelable, not guaranteed
renewable or state law permits the insurer to cancel the policy.
Once the agent has submitted the application to the insurer it is given to the
underwriting department. The underwriter then obtains information about the
prospective insured to make an equitable and profitable decision. Some applicants
show a higher probability of loss than other applicants. The process of obtaining
applicant information may also help identify cases of possible adverse selection.
The underwriter must deny or approve an application based on obtainable
information. The information is restricted by the cost and difficulty of gathering
these facts. The most important types of information are:
1. The applicant's past loss experience,
2. The financial standing of the applicant,
3. The applicant's living habits,
4. The physical condition of the applicant, and
5. The character of the person requesting insurance.
To gather this information, the underwriter relies on the sources available to
them. The sources chosen are a function of the particular risk, practicality, and
cost. The sources listed below may not apply directly to DI coverage, but is
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included to give an overall picture of the underwriter's sources. These sources
include:
1. The Agent: Agents provide underwriters with valuable information
beginning with the basic application information. Agents may be required to
submit a report containing the application along with their recommendation
as to the probability of risk. An underwriter may deny or accept some types
of insurance applications solely on the agent's recommendation, but for
disability insurance coverage additional information is usually sought.
2. Medical Exam: A medical examination is required for most DI policies.
The insurance companies can request specific testing or medical
examinations related to a particular condition the applicant disclosed on the
application. The application has only basic medical questions that are used
by the underwriters as a starting point. The underwriters may request an
attending physician statement (APS) from physicians the applicant has
consulted in the past and present.
3. Inspection Reports: An inspection company provides underwriters with
valuable information. These companies provide insurers with a nationwide
investigating service. The inspection companies submit reports concerning
an applicant. A typical insurance applicant would be amazed at the amount
of information, accurate and inaccurate, these investigating companies can
uncover. Since some of the information gathered by these companies can be
inaccurate, several states have passed laws to permit consumers to examine
information collected by credit rating bureaus. A federal statute, the Fair
Credit Reporting Act, became effective in 1971 allowing the consumer to
require disclosure of information on file and the sources of the information.
If the consumer disputes some data in the report, the credit bureau must
reinvestigate. The law also requires insurers to notify applicants on whom
reports have been requested, and to specify if the insurer uses the report as a
basis for denying the coverage or even charging a higher premium. The
insurer must notify the applicant of this and provide them with the name and
address of the reporting agency.
4. Underwriters Laboratories, Inc.: To best explain how important
Underwriter Laboratories has become to the insurance industry, we must
first become acquainted with their history. This company began as a
cooperative organization of Western Fire Insurers at the time of the
Colombian Exposition of 1893. The world's fair was noted for the first
large-scale use of electric lighting. Insurance underwriters who were asked
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to insure the flimsy, combustible buildings of the exposition organized a
group to investigate the best ways to wire the buildings to prevent the risk of
fire. This organization tested methods of wiring and the electrical
equipment. The insurance companies, realizing the value of this work,
expanded it so that now the mammoth testing organization exists today.
This organization has been in business for so long that there is virtually no
fabricated device or material in existence that has not been tested. Items
meeting their high standards are permitted to bear the UL label. The UL
label has become a hallmark of safety. Underwriters Laboratories, Inc. is
especially important for the underwriting departments of property and
liability insurers.
5. Medical Information Bureau (MIB): Underwriters can refer to the files
prepared by the MIB, a cooperative organization of life insurers formed to
centralize information of special interest to members about physical
conditions or previous applicants for life insurance in a member company.
The files do not record the action taken by the insurer on the application.
One of the services provided by the MIB that might be of interest to insurers
offering DI policies is the Disability Income Record System (DIRS).
DIRS is a record of applications for DI coverage that requests lengthy
benefit periods and/or monthly benefits that exceed specified amounts. The
purpose of this program is to avoid excessive coverage.
6. Other Sources: There are many other sources of information for
underwriting purposes. Insurers often consult engineers who provide safety
information.
Commercial underwriters may seek information from
companies publishing financial ratings and data useful for evaluating moral
hazards and the applicant's ability to pay premiums. There are many other
sources of information that may be utilized by insurers.
Moral & Morale Hazards
A moral hazard is the possibility that an insured may deliberately bring about a
loss in order to receive insurance benefits. Moral hazards usually arise from a
combination of moral weakness and financial difficulty.
If, during the
underwriting process, evidence indicates the applicant may defraud the insurer no
further underwriting will take place; the policy will simply be denied.
Underwriters are always alert to the presence of moral hazards; they look at an
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applicant's credit report, excessive inventories, large unpaid bills, working capital
deficiencies, and so forth. From past experience underwriters know what to look
for.
Moral hazards are mostly found in the property and health fields, but they may
even appear in life insurance.
Morale hazards are closely related to moral hazards (note the different
spellings). Morale hazards (with an ‘e’ on the end) arises from indifference
concerning loss, often brought about by the security of the insurance, which leads
to carelessness. Morale hazards are difficult to underwrite: people leave cars
unlocked, keys in the ignition, garage doors open in the middle of the night, and so
on. Morale hazards may tend to merge into moral hazards.
Underwriting moral and morale hazards in disability risks involve considerable
difficulty. Malingering and fraudulent claims have tended to swell the cost of
benefits far beyond the expectation upon which premiums were predicted. Overinsuring can bring about temptation to extend periods of disability that would
unquestionably be shorter without insurance.
Reasonably estimating the amount of income needed during a disability is not
always easy but taking short cuts can be a mistake. Many insurance contracts limit
the payments to an amount that will indemnify the insured for the loss. Overinsurance for medical care costs is infrequent because most individual policies are
based on services provided, or on actual reimbursement for expenses paid by the
insured. Policies tend to specifically state that they will not pay if another entity
does or they will pay only any remaining unpaid amounts.
The number of DI policies that an insured obtains or the total amounts payable is
likely to be limited similar to medical policies. Disability insurers developed
provisions similar to the “Other insurance provision” (also called the “Income
insurance with other insurers provision”), to prevent disability income from
becoming profitable or comparable to working. Underwriters realize that income
received without working can be attractive. Over-insurance creates a continuing
moral hazard in the disability income insurance field. If over-insurance were
allowed to continue an insured may be tempted to prolong their disability. A
provision particularly important for the long-term guaranteed renewable policies is
the “average earnings provision”. The amount payable at any time is typically
reduced if the insurance in force from all policies exceeds a specified percentage,
such as 85 percent, of the gross earned income of the insured at the time of the
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disability, or their average monthly earnings for the two-year period preceding
disability, whichever is the greater. The reduction is proportionate and a minimum
monthly benefit may be included.
Avoiding over-insurance is best achieved when the disability income policy pays
no more that the net take-home pay (after taxes). Underwriters may limit the
amount of disability income insurance written to approximately 80 percent of the
insured's gross income and may also use the average earnings clause to prevent
over-insuring.
The Underwriting Decision
After obtaining the relevant facts, the underwriters analyze the information to
make their decision. The reliability of the information is considered along with all
other underwriting factors. At this point the underwriter has three options:
1. Accept the prospective applicant (standard risk),
2. Offer the applicant modified coverage (substandard risk), or
3. Deny coverage all together (uninsurable risk).
Most people understand the two extremes: accepting the individual as a standard
risk or denying coverage entirely. When the underwriters will accept the applicant,
but at higher premiums due to the risk they represent, agents may find themselves
having to explain health or occupational hazards to their client. The applicant then
must decide whether he or she is willing to pay the higher premium to obtain
coverage. These changes can include more than higher premiums; the adjustment
may be in the form of added provisions that usually exclude coverage in some way.
An insurer could add an exclusion rider. The rider basically does just that: it
excludes or eliminates coverage otherwise provided for in the insurance policy.
The positive aspect of exclusion is that it keeps premiums within a reasonable
level.
In short the underwriting process can be a combined force. There are
understandably conflicts between underwriting and production. An agent's job and
livelihood depend upon producing as many contracts as possible.
The
underwriting department's job is to obtain a safe and profitable distribution of
exposure units. Agents would like borderline applicants to be accepted but
underwriters may do otherwise; therefore it is essential that underwriters and
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agents work together. When agents provide accurate and complete information on
their applications, underwriters will come to trust them. Insurers want to issue
policies; that is how they stay in business, but they must also be able to trust the
information they receive.
The underwriting process is closely related to reinsurance and the underwriter
must know how their ability to accept risks is both broadened and limited by
reinsurance available to the insurance company themselves. Reinsurance is the
transfer of insurance from one insurer to another. It is the insurance purchased by
insurers.
Social Insurance
Social Security legislation provides for programs of social insurance and public
assistance. There are at least ten programs embraced by the general term social
security. They are comprised of five forms of social insurance and five forms of
public assistance.
Social insurance plans include:
1. Federal Old-Age, Survivors, Disability, and Health Insurance (OASDHI);
2. State Workers' Compensation, several of them federal;
3. Federal & state systems of unemployment compensation;
4. State sponsored temporary disability income insurance (not provided in all
states); and
5. Health insurance.
The health insurance aspect was not added to the OASDHI program until 1966,
when Medicare legislation was passed.
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SSDI & SSI
Social Security Disability Insurance (SSDI) is also referred to as the Title II
program. The Supplemental Security Program (SSI) may be referred to as the Title
XVI program.
American citizens may apply for either or both of these up to age 64, if certain
qualifications are met. The individual must file a disability application while they
are disabled or no later than 12 months after the disability has ended. Social
Security pays individuals disability benefits under these two programs. This
chapter will discuss the qualifications for SSDI first, followed by the qualifications
for SSI.
Qualifying for SSDI
The most common disability benefits program that working adults qualify for is
SSDI. Under this program, monthly installments are based on income earnings in
the 40 quarters prior to the disability. A quarter is defined as a period of three
months ending March 31, June 30, September 30, or December 31 of any year.
When an individual applies for benefits, a representative from the Social Security
Administration (SSA) will conduct a telephone interview to review the earnings
and generate a report that informs them if they have enough income earned to
qualify for an insured status. “Insured Status” means a sufficient amount of
income was made to qualify the individual for application to receive SSDI benefits.
If the individual is found not to be of insured status then not enough income was
earned to qualify for SSDI benefits. The person then could apply for SSI disability
benefits instead.
Qualifying for SSI
To qualify for SSI, applicants must be 65 years or older, blind, or disabled
without sufficient income or resources to maintain a standard of living meeting the
established federal minimums. The purpose of SSI is to assure a minimum level of
income for people who are impaired, unable to work and have no other sources of
income.
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A person may be able to apply for both SSI and SSDI if they have worked long
enough to be insured under Social Security, even though they may not have
sufficient amounts of income or resources. When an individual is eligible for both
programs it is called a concurrent case. The income of a legally married spouse is
considered for purposes of SSI qualification.
Earlier the differences between SSI and SSDI programs were discussed. The
following is a review of these differences. They are:
1. Unlike SSDI, no disability waiting period is required under SSI since SSI
payments are based on financial need; the presumption that a person has
resources to handle short-term health problems does not exist.
2. Under SSI, a person may qualify for an immediate disability payment if the
condition is obviously disabling and the applicant meets the SSI income and
resource limitations.
3. Those people qualifying for SSI benefits usually receive food stamps and
Medicaid, which helps pay doctor and hospital bills.
4. SSI recipients fall under different work incentive rules. One difference is
that cash benefits and Medicaid continues as long as the SSI income limits
are not exceeded. Under SSDI there are minimum income requirements; if
the recipient exceeds those specified limits their benefits will cease.
The determination process and the medical requirements needed to prove a
person's disability is the same for both SSDI and SSI. The major difference
between the two programs is the eligibility requirement: SSDI is based on income
earned from prior work experience, while eligibility for SSI is based on financial
need.
Following Application for Social Security Benefits
Once the individual has established their inability to work due to physical or
mental impairment, have contacted the local SSA office by phone and completed
the preliminary questions, the SSA office will mail Disability and Vocational
Reports to the applicant, which must be filled out. These forms detail both the
financial and medical history of the applicant. Once they have been filled out and
returned SSA will determine the case type. The SSA office will then set a date for
a telephone interview. Once the interview has been completed, the individual will
receive a copy of everything they discussed. The applicant will be asked to sign
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this copy (which verifies all that was previously reviewed) and return it along with
any other information requested by SSA. Once all the paperwork has been
received, it is then forwarded to the state Disability Determination Section (DDS).
At DDS the claim is assigned to a claims examiner. All medical sources are then
contacted to supply a report about the individual's disability and the individual may
be contacted for more information. If the examiner does not have enough medical
information, the individual will be asked to visit another doctor at no cost to that
person.
If the claim is denied, the applicant will receive notice in writing. The paperwork
regarding the claim is returned to the local SSA office and held for 60 days or until
a request for reconsideration is made (an appeal). If the individual does decide to
appeal the case, he or she has 60 days from the date of the denial letter to submit
their appeal form.
Once SSA has received the completed appeal forms, they then send the case back
to DDS where it is assigned to a different claims examiner. The new claims
examiner will reevaluate the case and may request additional medical reports if the
applicant visited any new doctors since the submission of the initial application.
If the appeal is denied, the denial notification will again be made in writing. The
applicant then has 60 days to file an appeal with an administrative law judge
(ALJ). This appeal is usually a face-to-face hearing in front of a judge. Many find
this more advantageous than the phone interview since the judge can see for him or
herself the physical condition of the applicant. At this level of the appeal, the
applicant may represent him or herself, hire an attorney, or use an authorized
representative, who may be a friend or relative. After the hearing has been held the
judge has 90 days to issue a decision. The process can take longer if new medical
evidence is presented or if the judge feels more evidence is needed before making
the final decision.
If yet again the claim is denied, the only avenue left is to hire an attorney and take
the claim to the Appeals Council level for review.
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The Definition of Substantial Gainful Activity (SGA)
The Social Security Administration defines substantial gainful activity (SGA)
as work involving the performance of significant and productive physical or mental
duties for pay. Any substantial gainful activity usually requires the ability to:
1. Walk, stand, sit, lift, push, pull, reach, carry or handle items;
2. See, hear and speak;
3. Understand, carry out and remember simple instructions;
4. Use personal judgment;
5. Respond to supervision, co-workers, and normal work situations; and
6. Deal with changes in a routine work setting.
The Social Security Administration also considers the individual's age, education,
work experience, and residual functional capacity when evaluating the disability.
A disability, either physical or mental, must be proved by medical evidence
consisting of signs, symptoms, and laboratory findings.
Since October 19, 1980, the SSA does not consider any physical or mental
impairment or any increase in severity of a preexisting impairment that arises in
connection with the individuals confinement in jail, prison or other penal
institution or correction facility for a conviction of a felony committed after the
above date when considering a claim. SSA considers an offense a felony when:
1. The offense is a felony under applicable law, or
2. In jurisdictions that do not classify any crime as a felony, it is an offense
punishable by death or imprisonment for a term exceeding one year.
The individual's conviction will also invalidate any prior determination
establishing a disability. An individual may be eligible for benefits upon release
from prison provided they are suffering from a disability at that time.
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Residual Functional Capacity (RFC)
Residual functional capacity (RFC) is composed of activities that a person is still
able to perform in a work setting despite the impairment. SSA uses the RFC
assessment to determine if other types of work can be done. A limited ability to
perform certain physical activities such as sitting, standing, walking, lifting,
carrying, pushing, pulling, reaching, handling items, stooping or crouching reduces
the individual's ability to do past work and other work. A limited ability to
perform certain mental activities such as understanding, remembering, carrying our
instructions, and responding to supervision, co-workers, and work pressures also
reduces the individual's ability to do past work and other work.
Life and the Application
Claimants must be alive at the time the application is filed. There are a few
exceptions, however:
1. If a disabled person dies before filing an application, a person who is
qualified to receive any benefits on the deceased's earnings record may file
one. The application must be filed within three months after the month in
which the disabled person died.
2. If a person who paid burial expenses for which a lump-sum death payment
was made but dies before filing an application for the payment, the
application may be signed by a person who could receive the payment for
the deceased's estate.
3. If a disabled person files a written statement showing intent to claim benefits
with SSA before their death, an application then may be filed:
a) By or for a person who would be eligible to receive benefits on the
deceased's earnings record;
b) By a person acting for the deceased's estate; or
c) If the statement was filed with a hospital, by the hospital if:
• No person described in paragraphs a or b of this section can be
located; or
• If a person described in paragraphs a or b this section is located
but refuses or fails to the file the application, unless the refusal is
made to avoid any harm to the deceased person or the deceased's
estate.
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The Social Security Administration maintains a listing of impairments it
considers severe enough to prevent an individual from performing any substantial
gainful activity and that fall under their rules of disability. It should be noted that
the impairments listed in this section are permanent or are expected to result in
death. Impairments that are not expected to end in death must have lasted or be
expected to last for a continuous period of at least 12 months.
The Listing of Impairments is divided into two parts. They are:
1. Part A: This applies to individuals 18 years old and older and may also
apply to those under the age of 18 who have a disease that affects both adults
and children similarly.
2. Part B: This applies only to individuals under the age of 18. This section
contains additional medical requirements applicable in instances where Part
A does not give appropriate consideration to childhood disease processes.
The disability must be supported by medical evidence that consists of symptoms,
signs, and laboratory findings.
Symptoms:
This consists of the applicant’s own description of their physical or mental
impairment. This statement alone is not enough to establish a physical or mental
impairment, of course, but it is the starting point.
Signs:
This consists of anatomical, physiological or psychological abnormalities that can
be observed apart from claimant's symptoms. Signs must be shown by medically
acceptable clinical diagnostic techniques. Psychiatric signs are medically
demonstrable phenomena that indicate specific abnormalities of their behavior. It
must also be shown by observable facts that can be medically described and
evaluated.
Laboratory:
This consists of findings that are anatomical, physiological or psychological
phenomena that can be shown by the use of medically acceptable laboratory
diagnostic techniques. Acceptable diagnostic techniques include chemical tests,
electrophysiological studies (electrogram, electroencephalogram, and so forth),
roentgenological studies (X-rays), and psychological tests.
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Supplemental Security Income (SSI)
Medical requirements needed to prove disability are the same for both SSDI and
SSI, but supplemental security income is based on financial need. The basic
purpose of the SSI program is assure a minimum level of income for people who
are age 65 or over, blind, or disabled, and who do not have sufficient income or
resources to maintain a standard of living at the established federal minimum
income level. SSI is not just for adults; anyone who qualifies may receive SSI
monthly checks, including blind and disabled children.
Who is eligible for SSI?
To be eligible for SSI benefits an individual must meet all of the following
requirements:
1. Be age 65 or older, blind, or disabled;
2. Be a resident of the United States and one of the following:
a) A citizen or national of the U.S.
b) An alien lawfully admitted for permanent residency in the U.S.
c) An alien permanently residing in the U.S. This group includes aliens
residing in the U.S. with the knowledge and permission of the INS and
whose departure INS does not contemplate enforcing. It also includes
certain aliens who are residents of long duration. It does not include
immigrants.
d) A child of armed-forces personnel living overseas.
3. Not have more income or resources than is permitted.
Even is if an individual meets all requirements, he or she may not be eligible to
receive SSI benefits if they do not apply for all benefits for which they may
qualify. This includes existing annuities, pensions, retirement benefits and
disability benefits. If the applicant does not apply for their other benefits (without
good reason) within 30 days from the date they receive SSA's notice, that person
may be ineligible to receive SSI.
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In addition, if the person is found to be eligible to receive other benefits after
having already been approved for SSI, the SSI benefits will stop and payments
already administered will have to be paid back beginning with the month they
received notice from SSA.
Commonly Asked Questions
How do SS benefits affect disability insurance?
When Social Security disability benefits exist each DI policy must be consulted to
see how provisions apply. Agents who work exclusively with disability income
policies may be in the best position to know how benefits interact, but even agents
who do not work exclusively with disability income contracts can consult the
policy for determination. The policyholder should be informed at the time of
policy application that disability payments will be reduced if other income is being
earned for the same disability. If the insured was not informed of this provision
the agent will be in the awkward position of having to do so when a claim is filed.
Policies will state how benefits are paid in relation to other policies or benefits.
For instance, an insurance company may state: "We will provide the social
disability amount shown on the policy schedule, reduced by an amount equal to
any monthly legislative disability benefits received." It is likely that applicants will
want a more detailed explanation and it is best to receive this prior to a disability
actually occurring.
What if a person is eligible for Worker's Compensation or state disability
payments?
Most professionals feel people should apply for SSDI or SSI disability benefits
immediately if their disability is expected to last more than 12 months or is
potentially permanent. They should immediately apply for SSDI or SSI disability
benefits even when they are receiving worker's compensation or state disability
benefits. It is not wise to wait until the benefits end to apply since it will take at
least six months for the initial SSDI or SSI paperwork to be processed. If the
individual qualifies for Social Security disability benefits, SSA will take into
account any funds that have been received under either of these two programs
when calculating the retroactive payments.
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How does Workers Compensation affect disability insurance?
We have not talked about workman's comp because it is administered by the
individual states. The key thing to remember is that workman's compensation only
covers occupational injuries. The key word here is occupational. If an individual
is driving to or from work and gets in a car accident workman's compensation will
not cover the disability. Since workman's compensation is administered by the
individual states, procedures and benefits may differ. The basic principals are the
same but waiting periods, benefit amounts and periods, maximums, and so forth
may vary from state to state.
How workman's compensation affects the disability coverage will again depend
on the policy. Some policies exclude coverage for any injury covered under
workman's compensation. Workman's compensation may effectively replace
enough income for some workers, depending upon their normal income and living
expenses. Because workman's compensation only covers on the job injuries there
is likely to still be a need for private disability insurance to cover disabilities that
are not related to the job.
How does Social Security and Workman's Compensation affect each other?
Normally, a person receiving workman's compensation benefits will not be
eligible for SSDI or SSI simultaneously. Workman's compensation would pay the
individual for the maximum benefit period allowed by law. If at the end of that
time period the individual is still disabled, they may then qualify for and receive
SSDI and/or SSI benefits.
If the individual’s workman's compensation benefits are not adequate, the two
may be combined and then paid at the same time to provide 80 percent of the
individual's average earnings. Workman's compensation would be considered the
primary payee, paying the maximum allowed amount and SS would be
supplementing the income to raise the percentage to 80 percent of normal earnings.
A potential policyholder will need to consider all these facets when deciding on a
benefit amount with disability coverage.
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Review Questions
1) There is no such thing as family DI policies.
(T)
(F)
2) A person has to wait until they have been disabled for a full 12 months before
applying to Social Security for benefits.
(T)
(F)
3) ALJ stands for:
a) allergic reaction justification.
b) administrative law judge.
c) administrative legal judge.
d) advise legal judge
4) The Trial Work Period allows people to:
a) work on a trial basis.
b) test jobs before accepting them.
c) short term work after benefits have been denied.
d) attend seminars paid for by the state welfare offices.
5) Residual functional capacity (RFC) is composed of activities that:
a) people attend weekly.
b) affect everyone in the welfare system in the U.S. and Canada.
c) a person is still able to perform in a work setting despite the impairment.
d) a person cannot perform in a work setting despite the impairment.
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Chapter 6 – Paying for College
Paying for College
In today’s times of rising fuel and food costs plus worries about building a
sufficient retirement account, the thought of also having to set aside money for
college tuition can be overwhelming. The cost of college is steadily rising and
income following college is not always what the graduate thought it would
be. Ideally, parents should begin planning for college from the moment of their
child’s birth, but this is seldom financially possible. When children are born,
parents are often dealing with the expenses of home purchase, buying automobiles,
and financially establishing themselves. If the parents are lucky they have began
building an emergency fund and perhaps even a retirement account.
There are many options for college from the lower cost community colleges to
Ivy League institutions, like Harvard. This may be one of the family's biggest
investments, especially if they have more than one child going off to college.
The first thing to do when planning for college (or any large future cost) is to start
some sort of systematic savings plan. As with any systematic saving plan an
amount must be decided upon as well as the saving time intervals (each payday or
monthly, for example). While it does make sense to investigate current costs,
parents must be aware that higher education costs have risen faster than many other
items, so the possibility of the total savings being inadequate still exists. Even so,
it is better to be a partially funded student than having no funding at all. Each year,
if possible, the parents should increase the amount they are saving to reflect the
rise in tuition and other related costs. Since schooling has become so expensive,
seeking an appropriate savings vehicle will also be important. While excessive
risk is not advisable, using a vehicle with just minimum interest earnings may not
be advisable either.
College Planning Hint: start a systematic savings plan.
An issue of Parents Magazine suggested: "be consistent about keeping to the
plan, and set a realistic investment goal." The article’s author talked to Certified
Financial Planners (CFP©) for investment suggestions. These professionals stated
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that "some parents believed stock mutual funds are too risky for college savings
but over time stocks have proven to be dependable. The real risk is not earning
enough from the money to beat inflation and make the nest egg grow. Over the last
69 years stocks have averaged a 10.5 percent annual growth rate. Bonds have
grown only 5.6 percent a year, while mixed stock-and-bond funds have increased 8
percent." The article went on to give suggestions for saving for college costs,
including:
1. Start early - Experts agree that families should start saving for college costs
when children are born, if possible.
2. Be consistent – Whatever savings vehicle is selected, save
consistently. Even if the amount saved at regular intervals (such as each
payday) is less than desired, the action of doing so consistently will become
a habit. Buying shares at regular intervals with fixed dollar amounts is called
dollar-cost averaging. One month the investor may be able to buy more
shares than another, but the result is that most of the shares are probably
going to be bought at a lower cost.
3. Select a solid fund - Agents should make sure the companies selected have
received favorable ratings from more than one source. Many experts suggest
investing in recognizable household names with the fund's expense ratio
being no more than one percent.
4. Decide whose name to invest in - Most experts agree wholeheartedly on
this point: save in the parent’s name. That way if the child does not go to
college, the parents have the right to do with the money what they see fit. An
advantage of this is that grants may be more attainable for the student.
5. Don't neglect the 401(k) – While 401(k) plans are not usually associated
with college funds, it may work well. Families need to contribute the
maximum amount allowed to their 401(k) plan before starting an investment
plan of their own. Why? When it comes time to pay for the child's tuition,
the family can take a loan from the 401(k) plan and pay the interest back to
themselves.
6. Be realistic – As in all types of savings or investment plans must allow for
success. There is no point in setting a goal so high that failure is sure to be
the result. Trying to pay an entire Ivy League college bill may also not be
possible; be realistic on how much of the college bill is possible. Many
people earn their own way through college. Some experts recommend the
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family save one-fourth of their child's college bill and pay an additional 1/4
from their income at the time the child goes to college. The balance will be
the responsibility of the student.
It would be impossible to have a realistic goal without some research into college
costs. Even though we know it will cost more in twenty years than it does today,
knowing current costs provides a starting point. Other items will also be involved
with college, such as room and board, personal expenses, books, general supplies,
and perhaps travel and transportation expenses. While it may not be possible to
save for every conceivable expense, looking at the entire picture will help in
setting realistic goals.
Tuition and fees are always going up. Costs have been increasing at least six to
seven percent each year. Additionally, inflation may erode the savings that are held
for college if the savings vehicle used does not produce enough interest earnings to
offset it.
Room and board can very expensive if the child stays on campus in a dorm
room or close to campus in an apartment. If the family lives close to the chosen
college this may be avoided; if the child can support themselves or live with
friends to reduce living costs this may also be a way of lowering costs.
Personal expenses include just about anything the student may need or want,
including utilities, telephone or cell phone, cable TV, dorm or apartment
furnishings, clothing, grooming items, or entertainment expenses. College is
typically a time for learning how to do without the luxuries afforded at home.
Books and supplies can be expensive. The student may be able to find used
textbooks for sale but there is a great demand for them. Additionally, class
curriculum changes from year to year so many books quickly become obsolete. A
computer is a necessity for college in many cases. Who knows where technology
will take us in 20 years.
Travel and transportation have huge possibilities for variation. If the student
lives with their family while attending college, transportation costs may be higher
than if he or she lived on campus. If the college is out-of-state, there may be airfare
involved back and forth for holidays or special circumstances. In some cases it will
be necessary to purchase a car for the student, especially if he or she is living at
home and driving back and forth to classes. If a car is involved there will also be
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insurance, maintenance and gasoline expenses. If public transportation is available
and practical that is often the best financial solution.
Estimating College Expenses
Estimating college expenses typically involves charting potential costs and
writing them down. Any type of form may be used, even one as simple as the
following (designated chart 6A):
Tuition & Fees
$
Room & Board
$
Books & Supplies
$
Travel & Transportation
$
Personal Expenses
$
Meals
$
Miscellaneous
$
Cost of Attendance for 1 year:
$
Going to a college near the student’s home not only reduces most transportation
costs, but many other types of costs as well. Colleges may give native sons and
daughters financial incentives for going to local state schools. If this is the case,
the student may be required to have a grade point average of at least 3.0 in high
school and the family income may be a factor in receiving the cost reduction. The
income level requirement varies from state to state. There may be an additional
deduction if the family has a second child enrolled. There may also be an
additional deduction for children of alumni. All possible deductions should be
sought out to reduce the costs.
College Planning Hint: Ask the college if four years must be paid for when
advance placement classes are taken.
It may be necessary for the student to take a part time job to help with college
expenses. Many college students pay for their own personal expenses through part
time jobs, for example. Some professionals suggest students pay at least 25
percent of their college expenses. This may mean the student must take a part time
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job; save money prior to entering college from jobs during their high school years,
or reduce college expenses by taking advanced-placement classes during high
school that apply towards their total college education. Students should confirm
that the college selected will allow him or her to wave introductory courses when
advance-placement classes were taken. Students should talk with their high school
counselor about other options for gaining college credits during high school.
In some cases there may be savings in taking more college courses
simultaneously, but this will depend upon several factors. Most colleges charge
based on the number of credit hours so the savings would not be in that portion of
expenses. Savings would be realized from graduating sooner and entering the
workforce quicker.
Since parents begin saving for their children’s college many years prior to
actually entering college it is necessary to try to estimate the amount of funds that
will be needed. While it may not be easy to know how costs will increase there is
a formula that may give a general idea:
Current cost of attendance for 1 year:
$
Multiply by inflation factor:
X
Future Cost of attendance for 1 year: $
How much does a family need to save?
The research has been done and the family has determined the amount they feel
must be saved for their child’s college education. The next step is determining
how much must be saved each month. Often this is more a matter of the amount
than can be saved rather than the amount that must be saved. Starting a systematic
savings plan is one of the best ways to save for college, especially if the family is
disciplined enough to stick to such a plan. Even though the family may not have
the resources currently to save adequately for their child’s college, as time goes by
it is likely that more may be contributed, making up for initial shortfalls. When
time is adequate it is possible to save less because interest earnings will also
contribute to the total amount saved. As a result, even though less is saved, it may
end up being adequate.
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Although earlier is best, it is never too late to start a college fund. Whatever
amount is set aside will assist the student.
What is the best way to invest for college?
The point of investing is to earn enough interest to keep up with inflation so that
enough funds will be there when they are drawn upon. This is true if one is
planning for retirement, college, or anything that requires a sum of
money. Individuals will want to earn as much money as possible with the least
amount of risk and taxation. Investments that allow funds to grow tax-deferred
will be the most advantageous, of course, since growth is not then subject to
taxation until the funds are withdrawn.
Selecting an investment vehicle may be one of the most difficult elements of
college savings. One possibility is selecting investments that correspond to the
child's age. If the child is under age 14, the family may want to go for
growth. Growth stock and growth mutual funds minimize current taxation and
give the family an opportunity to keep up with inflation. Once the child reaches
age 14 the stock may be sold. The capital gains will be taxed at the child's lower
rate. The funds can then be invest in relatively conservative income producing
assets, such as Certificates of Deposit or bonds that will mature as the student
needs them.
When deciding which savings vehicles to use or which investments are right for
the family's needs, consider three points:
1.
Risk: There is always the danger that the accumulated funds will be
worth less in the future. How could this happen? If inflation rises
faster than interest earnings the funds lose buying power, which
means there is less money. Americans often lose sight of much
inflation impacts their financial lives; college savings is affected by
inflation as much as any other type of fund.
2. Return: This is the amount of money the family earns on the savings
plan or investment through either interest earned or dividends
collected. This is important since return is the family's reward for the
money they set aside. The more return, the less out of pocket expenses
the family will experience when the child enters college.
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3.
Liquidity: This refers to the accessibility of the college fund. Is the
student able to access the money held in the investment? Some
investments require a specified term, meaning the funds are not
available until a certain point in time is reached. If funds are
withdrawn prior to the specified term, there will typically be a
penalty. Some penalties are levied by the investment vehicle; some
are levied by taxing authorities. The amount of the penalty will vary,
but they should never be casually dismissed since they may erase all
earnings the investment accrued.
4.
Time Frame: This is the number of years the family has to save or
invest before the child needs the money for college.
Bank Accounts
Banks traditionally pay very low interest rates (which may not even keep up with
inflation), but they do offer some other advantages. Banking institutions can be
very convenient for depositing small monthly amounts, such as an occasional cash
gift from grandparents, small dividend checks, and interest checks. The money can
be transferred from the bank account once the account has grown large enough to
meet the minimum requirements of another higher-yielding investment.
Families should check around at different banks to see what charges might apply
if a minimum balance is not kept, as well as monthly fees and the interest rates
paid to the account. The interest rates offered by a full-service bank may be lower
than a savings bank or savings and loan institution. If a minimum balance is not
kept in a savings account, the bank may charge a service fee on the account. We
are seeing more bank fees than in the past so it is important to be aware of any fees
that will be charged. Banking institutions offer more than saving accounts and it
may be wise to check out all options.
Certificates of Deposit (CDs)
Certificates of Deposit grow faster than regular saving accounts because the
interest rates are higher. The minimum investment normally is $500. The longer
the term of the certificate, the higher the rate paid on the account. For example, a
seven-year certificate will pay a higher rate than a 90 day certificate. CDs are
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FDIC insured, like regular savings accounts. It is important for a family investing
in banking institutions to understand what FDIC coverage is and any limitations on
the coverage.
The FDIC is an independent agency of the U.S. Government. It was established
by Congress in 1933 to:
1. Insure bank deposits,
2. Help maintain sound conditions in the banking system, and
3. Protect the nation's money supply in case of financial institution failure.
Additional powers were given to the FDIC in 1989 to insure deposits in saving
associations. As a result, the FDIC insures deposits in banks, using the Bank
Insurance Fund (BIF) and insures deposits in saving associations using the
Savings-Association Insurance Fund (SAIF). Both BIF and SAIF are backed by the
full faith and credit of the United States.
The Federal Deposit Insurance Corporation (FDIC) protects deposits that are
payable in the United States. Deposits that are only payable overseas are not
insured. Securities, Treasury securities (bills, notes and bonds), mutual funds,
annuities, and similar types of investments are not covered by the FDIC. All types
of deposits received by a financial institution in the usual course of business are
covered.
The basic insured amount is $250,000. Accrued interest is included when
calculating insurance coverage. Deposits maintained in different categories of
legal ownership are separately covered. Separate insurance is also available for
funds held for retirement purposes such as IRAs, Keoghs and pension or profit
sharing plans. Until December 19, 1993, IRAs and Keogh funds were insured
separately from each other and from any other funds of the depositor. Following
December 19, 1993, IRA and Keogh funds were still separately insured from any
non-retirement funds the depositor had at the institution, but IRA and self-directed
Keogh funds are added together and the combined total is insured for up to
$250,000. IRA and self-directed Keogh funds are also aggregated with certain
other retirement funds, such as those belonging to 457 Plan accounts, if the
deposits are eligible for pass-through insurance.
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The FDIC coverage for pension plans and profit sharing plans receive passthrough insurance, called the General Rule. Pass-through insurance means that
each beneficiary's ascertainable interest in a deposit, as opposed to the deposit as a
whole, is insured up to $250,000. In order for such a plan to receive pass-through
insurance, the institution's deposit account records must specifically disclose the
fact that the depositor (the plan itself or the trustee) holds the funds in a fiduciary
(pertaining to or of the nature of a trust or trusteeship) capacity. In addition, the
details of the fiduciary relationship between the plan and the participants, and the
participants' beneficial interests in the account, must be ascertainable from the
institution's deposit account records or from records that the plan maintains in good
faith and in the regular course of business.
The General Rule applies to any deposit made by a pension or profit sharing plan
in any institution if the deposit was made before December 19, 1992. The General
Rule also applies to deposits made by a plan on or after December 19, 1992, if the
deposit was made in an institution that meets the FDIC's standards for "wellcapitalized" institutions. Finally, the General Rule applies to any deposit made by a
plan on or after December 19, 1992, if the deposit is made in an institution that
meets the FDIC's standards for "adequately capitalized" institutions, but only if the
institution also satisfies either on of the following conditions:
1. The institution has received a waiver from the FDIC to take brokered
deposits, or
2. The institution notifies the plan in writing at the time the plan makes the
deposit that such deposits are eligible for pass-through coverage.
In all other scenarios, any deposits made by the plan on or after December 19,
1992, do not receive pass-through insurance coverage, but rather is insured as a
whole up to $250,000 in total. Individuals and plans cannot increase FDIC
coverage.
All single ownership accounts established by or for the benefit of the same person
are added together and the total is insured up to a maximum of $250,000. The
Uniform Gifts to Minors Act is a state law that allows adults to make irrevocable
gifts to minors. Funds given to minors by this method are held in the name of a
custodian for the benefit of the minor. Funds deposited for the benefit of minors
under the Uniform Gifts to Minors Act are added to any other single ownership
accounts of the minor and the total is insured up to a maximum of $250,000.
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U.S. Government securities are only guaranteed for face value if they are held
until maturity.
All Certificates of Deposit (CD) carry a penalty for withdrawing or liquidating
prior to the maturity date. Since there are a wide variety of maturities available it
is important to select a CD that meets the needs of the investor. Tying up money
in a single long-term CD may not be a wise choice in some cases, regardless of
fund ownership. The CD has a fixed yield, which leaves the investment at the
mercy of rising inflation rates. A family could avoid this if instead of buying one
$5,000 CD, buying five $1,000 CDs that come due at different intervals. This way
some of the money would be available to move to investments offering higher
interest rates if necessary.
College Savings Bank
The College Savings Bank is a certificate of deposit whose interest rate is linked
to the rising cost of higher education, as measured by the College Board Index of
costs for 500 independent colleges. The College Savings Bank was started in
Princeton, New Jersey in 1987 along with the CollegeSure CD.
This is a unique concept in that the interest paid on this FDIC insured certificate
of deposit is guaranteed to meet the rising costs of college. The CDs are sold in
units or portions of units. One full unit at maturity is equal to one full year's
average cost for tuition, fees, room and board at a four-year private college (the
most expensive). Each unit is guaranteed to pay at maturity one full year of
average college costs, even if the costs of college soar.
The CDs are sold in maturities from one to 25 years. All the CDs are timed to
mature on July 31. If the family buys four full units, they will want to time the
maturities for consecutive summers when tuition is due. When the family buys a
unit CD, the price is slightly above the current index value of one year of college,
but at a deep discount to the estimated cost of one year of college at maturity. Each
year’s interest is credited to the CD bringing it to full face value at maturity.
If the family cannot afford a full unit at one time, they can purchase a partial
unit. It is possible to begin with a minimum $1,000 investment in the College
Savings Bank CD and add money regularly in minimum additions of $250. The
College Savings Bank even has a payroll deduction program that allows for
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amounts as little as $25 per pay period to be deposited. Investors can coordinate
with the College Savings Bank for the university or college they want Junior to
attend, calculating approximately how many units or partial units they will need for
each year of college and the amount of money that needs to be saved each month
to meet their calculations.
Interest on these investments is credited on July 31 each year and is calculated
retroactively for money on deposit during the previous year. The interest
compounds annually. There is a minimum guaranteed rate on the CD of not less
than the college inflation rate minus 1.5 percent. There is also a floor of four
percent interest in any year in which the rate would have dropped lower. The
interest rate on the CD is taxable, and the family may be able to do better with
Series EE savings bonds whose interest rate varies with inflation and offers more
tax advantages than the bank CD.
The certificates of deposit are FDIC insured up t $100,000 per depositor.
There is a substantial penalty if the family takes an early withdrawal. There is a
ten percent penalty if money is taken out in the first three years and a five percent
penalty thereafter until the final year when the penalty declines to one percent.
Bonds
The subject of bonds is not insurance related. It may, however, be considered a
part of financial planning. Most states do not allow continuing education on
information like stocks, bonds or mutual funds unless related in some way to
insurance sales. We will just briefly go into them.
College Planning Hint: Make sure the bond maturity date coincides with
the child's college entry date; if the family sells early they may take a loss.
Zero-coupon municipal bonds, also referred to as "zero-munis" may be well
suited for college funding. This type of bond does not pay semiannual interest. A
person purchases this from state and local governments and government agencies
at a substantial discount from the face value and then receives the full amount
when it comes due (matures). Municipal securities are basically IOUs or debt
obligations. A technique that can be used with Zero-coupon municipal bonds or
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Stripped municipal bonds, which is basically the same, is to stagger the maturity
dates so that they come due over the four-year college attendance. The family
could also invest in a unit trust which pools many different zero-coupon issues.
One problem with zero-coupon Treasury bonds is that they require payment of
taxes on the imputed interest. Families will end up paying taxes on money they
have not yet received. If the investor does not consider this an issue, then it is a
worry free investment. A family may be able to find zero-coupon municipal bonds
whose imputed interest is not taxable because it is a tax-free investment in the first
place. No interest is charged to the bondholder until the investment matures at
which time all the accumulated interest is paid at once. The interest earned on
municipal investments is exempt from federal income taxes, with a few
exceptions. In many instances, they are also exempt from state and local taxes.
Series EE Savings Bonds are safe investments. They can also be purchased so
that maturity coincides with college attendance. Interest on bonds purchased after
January 1, 1990, receives tax advantages based on income. Tax advantages apply
only if these bonds are used for tuition expenses in the same year. These bonds
must be purchased in one or both of the parents' names; they cannot be owned by
the child. The interest rate will be increased as the average return on five-year
Treasury bills increases. The tax-free features of Savings Bonds should make their
actual yield comparable to CDs or money market funds.
Baccalaureate or "college saver" bonds are municipal bonds pure and
simple. These are sold by states as college-savings vehicle. One of the main
advantages is the tax-exempt interest. Families need to consider all their
investment options of course; they may be able to do better elsewhere. The state
may include an added sum to the yield if the child chooses an in-state
school. Families may want to go with a Baccalaureate bond if they think their
income will be too high to use the tax exemption on Series EE bonds. Series EE
bonds provide inflation protection through their variable interest rates, which the
Baccalaureates do not. The Baccalaureates will, however, yield more if interest
rates gradually trend down.
Life Insurance
Families may want to consider life insurance as a way to save for college
expenses, although this is not a traditional use for life insurance. Many financial
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experts would consider life insurance a poor choice given the other options
available. Still, it may work for some individuals.
Some may suggest a Universal Life insurance policy to pay for college. Families
must be aware that the interest earned in such a plan may be lower than earnings in
other investments. Why would someone suggest a life insurance contract as a
savings vehicle? It might be suggested because of the tax-deferred saving aspect
of life insurance contracts. At college time, the investor may withdraw funds tax
free and will not be required to repay them, unless he or she wishes to. The
investor must have a disciplined payment schedule for this avenue to work
effectively. If the insured dies, the death benefit would also be available for
college funding.
The two disadvantages for families saving in this manner are the low interest
earnings. In addition, commission charges and other fees may reduce the family's
invested amount for college reducing the cash in the account in the early years of
the policy.
In the book Making the Most of your Money by Jane Bryant Quinn, she states: "At
the bottom, the very design of insurance policies conflicts with the goal of college
savings. Insurers try to maximize death benefits rather than cash values - but cash
is what suffering parents need the most."
As stated in the first chapter, most life insurance is normally purchased by
families to protect them in case the breadwinner dies. There are mortality charges
on life insurance that may not make this the most economical investment for
college. Life insurance can also be expensive for the insured, depending upon age,
health, and other factors. The funds used may be better invested elsewhere.
If the family is looking for more life insurance as well as college savings, they
can purchase a cheap term insurance policy and devote the rest of the money to
growth investments. The term insurance policy can be terminated after the children
leave for college if the need for life insurance no longer exists. If the insured dies
there will be death benefits for those left behind, which might include college
funding.
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Annuities
There are many different opinions regarding the use of annuities for college
funding. Some feel they work well while others feel they are a bad choice due to
the tax implications that may occur. The wise agent will research the use of
annuities, provide the information, and then allow the client to make their own
choice.
Deferred annuities may be used to accumulate money for college expenses as
well as any other goal, such as retirement planning. An advantage to using the
annuity is the tax-deferred growth rate. The investor will not pay any taxes until
the funds are withdrawn in part or whole.
The primary disadvantage of using an annuity are the penalties for withdrawing
funds prior to age 59 ½. In most cases the individual will have to pay a ten percent
penalty on the growth of the annuity investment. The penalty will typically be paid
on the growth, not on the principal. Some annuity contracts will allow borrowing
funds, often without penalty. This is to the family's advantage if they need the
money prior to age 59 ½.
Annuities come with different options that can be tailored to meet the needs of
families who select this type of financial vehicle for college funding.
Annuity Options:
Chapter four discussed some of the items below. This is a recap:
With the Single-Pay Deferred Fixed Annuity, the contract owner pays the
insurance company the intended investment; generally insurance companies
require funding be no less than $5,000 initially. Some contracts allow additional
funds to be deposited, while others do not. The owner could add to the initial
amount that was invested anytime prior to annuitization if the contract so allows.
The Accumulation Annuity is similar to the deferred annuity except payments
are made over a period of time rather than investing one lump sum. The
Accumulation Annuity is strictly offered for systematic payments over a period of
time. Then, at some later date, the policyholder can annuitize (shift from
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accumulation to monthly payout) when they are ready to retire, or in this case, pay
for the college expenses.
Two-tiered annuities reward the policyholder who stays with the company by
offering a higher interest rate. This would be the first tier. If the policyholder
surrenders or transfers funds to another insurance company, a lower interest rate
would be retroactively applied. This would be the second tier. The two-tier has a
second and permanent surrender charge in the form of the lower interest rate. The
annuity may have a substantial charge for withdrawals; a charge that may never
disappear. Remember, this may look as if the company is paying competitive
rates, but if the policyholder elects to withdraw they may be credited with an
extremely low interest rate. The first-tier interest rate is only realized if
annuitization is utilized through the initial insurer. This locks the policyholder into
the same company for life. Bottom line is that comparing two-tier rates with other
annuities can be very difficult or misleading.
The Wrap-Around Annuity, also referred to as a Switch-Fund Annuity, exists
when a life insurance company joins a mutual fund organization managing several
mutual funds with different goals and different investment policies. The insurance
company provides the annuity contract and the mutual fund company provides the
investments. This type of annuity allows the policyholder the freedom to specify
which of the mutual funds they wish to invest in.
In 1982 IRS issued a tax restrictive ruling on the Wrap-Around Annuities. The
IRS may refer to the Wrap-Around Annuity as an "Investment Annuity." The
Investment Annuity or the Wrap-Around Annuity are terms for arrangements
under which an insurance company agrees to provide an annuity funded by
investment assets placed by, or for, the policyholder with a financial custodian.
The assets are placed in a specifically identified investment (mutual fund). It is
normally held in a segregated account of the insurer. IRS has ruled that under such
arrangements sufficient control over the investment assets are retained by the
policyholder so that income on the assets prior to the annuity starting date is
currently taxable on the policyholder rather than to the insurance company. With
the exception of certain contracts grandfathered under Rev. Rul. 77-85 and Rev.
Rul. 81-225, the underlying investments of the segregated asset accounts of
variable contracts must meet diversification requirements set forth in the
regulations. (IRS Sec. 817 {h})
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CD-like Annuities are a hybrid of the Single Premium Deferred Annuities
(SPDA). However, the CD-like Annuities give the policyholder the liquidity and
rate of return most often seen with traditional Certificates of Deposit that are
marketed by banks. Unlike CDs, these annuities have all the advantages of the
SPDAs, which include tax-deferred growth, guarantees of principal, and the
opportunity to convert the account value to a guaranteed income for life or
specified period of time. SPDAs are designed to be used as tax-deferred
investments for the long-term; CD-like Annuities are geared for the short
term. They normally offer longer guaranteed interest periods as well. Some CDlike Annuities may allow additional deposits, depending on the contract and allow
partial penalty-free withdrawals from the account during a specified option period.
The additional deposits and the withdrawal options are often referred to as
"windows of opportunity." The most common CD-like Annuities run for periods
of either one, three or five years. The window of opportunity generally lasts for 30
days after each guaranteed interest period.
Certainly, the largest selling point of the CD-like Annuity is the tax-deferred
growth with liquidity coming after a relatively short period of time.
When a family does choose annuities as a part of their college planning, they can
be the most efficient when college expenses are at least eight to ten years
away. This allows adequate time for tax-deferred growth.
Before choosing annuities as an investment for college funding the tax
implications need to be looked at and considered in respect to other investment
options. Many financial planners feel annuities should only be used when the
listed annuitant will reach age 60 or more prior to the child entering
college. Therefore, it may be best to list a grandparent as the annuitant.
College Planning Hint: The tax implications should be heavily weighed
BEFORE using an annuity as a college investment.
Mutual Funds
Buying shares in mutual funds offers diversification, and will not tie up funds in
the stock of one or two companies. The mutual fund investment is diversified
among many companies, ranging in number from 30 to more than 100. This
translates into reduced risk.
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The stock market requires an individual to buy a certain amount of stock of at
least 100 shares to keep the commission reasonable. Some mutual funds have no
minimum for additional investments, and some have minimums of only $50 to
$500. Most mutual funds offer automatic reinvestment of all dividends and capital
gains.
As with all investments, there are advantages and disadvantages. We have
discussed some of the advantages. A disadvantage is the lack of control over the
prices at which they buy and sell shares. When purchasing stocks, you can request
a "good till canceled" buy order. This means that if a stock is currently selling at
$50 per share the investor could enter a "good until canceled" order for $45. The
broker will buy the stock for the investor only if and when it drops to $45 per
share. An investor could similarly enter a "good till canceled" sell order at a higher
price than the one currently quoted. This means that if the investor is currently
holding a stock worth $50 and wants to sell when it reaches $60, the "good till
canceled" sell order lets the broker do this when it reaches $60. A mutual fund
investor cannot do this with their shares. Some mutual funds will let the investor
buy the shares by phone at the day's closing price, though most require a check to
be in the mail in advance of purchasing. The number of shares purchased depends
on the closing price of the shares on the day the check is received. This is also true
when selling mutual fund shares. Normally the shares will be sold at their value on
the following day’s closing market value. Other funds may require a signature guaranteed letter of instruction for withdrawals - but the selling price again is
determined at the market closing after the letter has been received. In these cases,
the stock value could have dropped considerably.
These disadvantages may not be important in connection with the college
investment. If the contributions are spaced out over a period of years, and the
dividends are reinvested over the life of the account, the fluctuations in the share
prices are likely to average out and the assets may grow nicely.
The money market mutual fund is similar to a CD in that it maintains the
investment in dollars rather than in shares and it pays a higher rate than a bank
savings account. The differences may be attractive for an investor. The moneymarket mutual fund has no fixed term. This means that an investor can withdraw
all or part of the investment at any time simply by writing a check against the
balance. The fact that the interest rate fluctuates constantly can be a positive or
negative thing depending on how the economy is doing. Typically the interest rate
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paid is higher than the locked-in interest rate of the CD. The interest can be paid to
the investor or automatically reinvested. The investor can make deposits and/or
withdrawals at any time. Some money market mutual funds do set deposit limits
which may range from $50 to $250 or more and do not permit withdrawals of less
than $250 or $500.
UGMAs or UTMAs
The Uniform Gift to Minors Act (UGMA) allows money to be given to a child
under 18, who has set up a custodial account. Uniform Transfer to Minors Act
(UTMA) is an account that can be set up through a banker or broker. This is an
inexpensive technique to transfer assets to a minor without the necessity of any
monitoring by the courts. The UTMA is a newer version of the UGMA, depending
on the state of residence.
These accounts do have drawbacks. Under the UGMA, the parents are limited to
the gifts of cash or securities. The assets also automatically go to your child when
they turn 18. If the recipient prefers a Porsche to a college education there is little
that can be done. Under the UTMA, which applies in approximately 30 states,
distribution of the assets can be deferred until the child reaches age 21 (25 if the
family lives in California). The UTMA account allows the family to transfer a
wider range of property that includes real estate, royalties, patents and paintings.
When looking at these investments for college, there may be some short-term tax
benefits for putting the investment in the child's name. It is always important to
consult with a tax specialist to understand any short-term benefits that might exist,
as well as any financial pitfalls that might occur. Parents may then want to consider
transferring most of the investment into their name. The biggest reason for this is
that the formula for determining financial aid requires the child to contribute up to
35 percent of their savings. Parents are expected to contribute just 5.6 percent of
their savings as part of the family contribution. For example, a college fund with
$10,000 in the child's name will be required to contribute $3,500. If the same
money were in the parents’ name, they would only be required to contribute
$560. These investments are ideal when college doesn't hit for 15 to 20 years.
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2503(c) Minor's Trust
If the family is a high wage earning family, they may be able to pass the money to
the children through a minor's trust which is known as a 2503(c) Trust. This
should only be used when substantial amounts of cash are at stake (at least
$50,000). The expenses of setting up the trust are approximately $500. The first
$5,000 earned by the trust, no matter what the child's age, is taxed at 15
percent. Any amount above $5,000 is taxed at 28 percent. The trustee, which is
normally a parent, controls the income and principal until the child reaches age
21. In a 2503(c) trust the child only has 30 to 60 days from the time they turn 21
years old to demand the assets from the trust. If the child fails to do so the trust
continues until the time specified in the trust agreement.
Prepaid Tuition Plans
There are quite a few states that now offer programs that allow parents to prepay
tuition for a state school. Depending on the child's age, the parents can make
payments now, which are substantially discounted from the expected tuition fees
when the child actually attends college. The student is guaranteed full tuition
payment, no matter what the cost is in the future or a certain number of course
hours when the child is ready to go to college. Some prepaid plans include room
and board.
The biggest advantage of a prepaid tuition plan is that no matter what inflation
does to college tuition costs, the family has prepaid and is not affected by the
inflated costs. The price guarantee may only apply to state colleges so it is
important to understand what program has been purchased.
There are, of course, disadvantages to this. When the student enrolls in college he
or she will have to pay income tax on the difference between the parents' original
deposit and the current cost of tuition. Another disadvantage may occur if the
child decides to attend an out-of-state college. Each state has different refund
policies, but most are expensive. The family will receive back the principal most
of the time. State and college tuition plans may limit the child's choice of colleges
to those in their state or to specific colleges that offer the plan.
The prepaid tuition plans are a good idea for families who believe they will not
build up enough cash value in other investments and are sure their son or daughter
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will be attending an in-state public college. The family would lose the price
advantage however if they borrowed the money for the prepaid tuition plan. The
interest they would be paying on the loan would offset the prepaid advantage. On
the other hand, if the family does take a loan out to pay for a prepaid tuition plan,
they are paying today’s rate of tuition, not the actual cost when the child goes to
college. It might make sense to borrow the money to pay in advance, especially if
the family will need a loan in any event. To borrow a four-year sum under a single
loan check home equity credit lines, the borrowing plans offered by the school,
and/or the New England Education Loan Marketing Corporation, 50 Braintree Hill
Park, Braintree, MA 02184.
College Planning Hint: Find out how much money a family would get back
from a prepaid tuition plan if the child drops out.
Families may be able to find these plans from colleges, groups of colleges or
banks. Prepaid college tuition plans invite alumni and others to register their
young children and prepay their four years of school. This can be done either by
tuition only or tuition, room and board. These prepaid plans are similar to the one
already mentioned. For a small sum of money now the family is guaranteed
college tuition will be considered fully paid. Another advantage is that the family
has practically guaranteed college acceptance for their child. If this plan is
purchased for one college only, this does limit the child's choices. There are plans
that allow the student to choose from among a several different colleges. If the
child chooses a college outside of this group the family will have to get a refund on
the money they invested.
There has been talk of working on a universal prepayment plan which all major
colleges and universities would join. It would allow prepayment without choosing
a specific college at that time. The money would be managed like a college
endowment fund, presumably earning more than one could earn on their own. The
tuition guarantee would eventually be applied to any college the child chooses.
Financial Aid
Families can receive help for the expenses of college by qualifying for financial
aid or if the student is exceptional, they may qualify for scholarships or grants. The
student may want to talk to their high school counselor about different scholarships
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offered. Understanding the process of financial aid can help the student's chances
for qualifying for it.
While the child is working on the admission applications, parents need to work on
gathering their own information. The student’s parents will have to fill out what is
called a Need Analysis Form. This can be obtained from the high school guidance
counselor. Check to see which forms are required by the college. All
undergraduates applying for aid will have to fill out a Free Application for Federal
Student Aid (FAFSA). Many private schools and some state schools may also
require a Financial Aid Form (FAF). All these forms basically request the same
information.
After the application is turned in a company then performs what is called a "need
analysis." This is done to determine what portion of the income and assets the
family can keep. They also decide what portion the family can afford to give
towards college tuition initially. The amount calculated according to a standard
formula is called the Expected Family Contribution (EFC).
The need analysis company then sends their report to the family and, in most
cases, to the college the child has applied to. If the student applicant is accepted,
the college's financial aid officers (FAOs) decide what they think the family can
afford and what they need in the way of grants, work-study and loans. This figure
is not carved in stone; families can negotiate with the FAOs. FAOs do not always
make their best offer first. The more information families can provide, the better
the chances of convincing them the need is greater than they have estimated.
To further help a family's efforts to qualify for financial aid: buy a new car! Yes,
that is correct.
"Buying a new car or making another expensive purchase just before you're
about to send a kid off to college may seem like the last thing any responsible
money manager would do. Actually, it may be one of the best ways to help yourself
qualify for more financial aid", says the editors of Rodale Press in the book Cut
Your Spending in Half.
It goes on to relate: "Let's say the car you want to buy costs $20,000. By paying
for it in cash from your savings accounts, you reduce your reported assets, making
you look $20,000 poorer. And that could qualify you for an additional $1,000 in
aid.
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"Of course, this doesn't mean you need to buy a new car in order to send your kid
to college. But any large purchase you make - and pay for with cash - helps reduce
your assets, making available family contribution appear smaller. Just be sure to
do it a year or two before you fill out the financial aid forms, since financial aid
officers examine your previous year's income. Besides, these "last-minute"
purchases may look suspicious to financial aid officers."
If the family doesn't have the cash for a new car they suggest borrowing against
the family home through a home equity loan. By doing this, families can reduce
the equity they have in their home, which also reduces the family's assets on the
financial aid applications. Not only this, but the interest on the home equity loan
tends to be lower than the interest on car loans, so the family will pay less for the
money they borrow.
Families could also reduce their assets and possibly receive more financial aid by
doing the complete opposite of the above. The family could build the equity in the
home by using savings to pay down their home mortgage.
Families can further reduce their assets by investing in their own retirement
accounts. When the family applies for financial aid, they will only have to disclose
their bank accounts, mutual funds, real estate, stock and bonds, as well as the
family's home equity and other assets. In contrast, seldom is the family expected
to reveal money saved in retirement accounts, such as a tax deferred annuity,
401(k)'s or IRAs.
Those with their assets invested in financial vehicles that may be considered
against obtaining grants or student loans, it may be wise to invest in a tax-deferred
annuity or retirement account. This largely untapped insurance market is typically
not considered by agents. Since agents are already selling life insurance and health
insurance products to their clients, it is an opportunity to recommend a retirement
investment strategy that benefits their clients in two ways:
1. The family receives the insurance or retirement plan they wanted, and
2. A strategy is developed for college funding for their children.
When recommending this avenue of financial planning it is important to realize
that there is no guarantee the family will receive extra financial aid for college. At
no time should an agent say doing so will qualify their children for any specific
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financial aid. It may be advisable to actually check with local universities and
colleges so there is advance knowledge regarding grants or student loans. Another
point to keep in mind is that putting funds into many types retirement accounts,
such as an annuity, puts the money out of reach, unless the family is willing to
accept the tax penalty.
Keep College Expenses Down
There are many opportunities for kids wanting to reduce their college bill. Again,
planning ahead in this area can help a college student get the most even out of high
school. One such avenue is taking college courses while still in high school if this
is available in the school district.
AP Courses & Exams in high School
Advanced Planning (AP) courses and exams are offered by many high
schools. AP courses are college level courses that can prepare the student for
college level work. After completing the AP courses, students can take the
exams. If the student scores a sufficient grade on an AP exam, they can often
receive college credit. The diligent student earning high enough scores on AP
exams are sometimes granted a full year of course credit at the college where they
enroll. This receipt of college credits translates into college savings - the cost of
tuition and fees for a whole year of college. These savings can be quite large and
enables a student to enter into college as a second-year student.
In all cases it is important that college credits earned in high school will be
applied appropriately for college. Not all colleges and universities may have the
same requirements so it is necessary to check in advance.
The Family Plan
It may be possible to save up to 50 percent on college tuition when the family has
two or more college-age children attending the same school. The discounts do vary
from college to college, but families can potentially slash up to 50 percent off
tuition costs for one or even both students on this family plan. Not all universities
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will be this generous, but a family can expect discounts in the range of 20 percent
off when the family sends a second child to the same school.
Alumni Discount
For parents who have attended a university or college, they may want to check the
alumnus opportunity. This is a variation of the family plan. The tuition breaks are
not always generous but any savings may be worthwhile. Generally 20 percent is
the largest discount, but as always, it is important to check. As with the multichild discounts, this program is rarely automatic. When applying for financial aid,
families may have to remind the school's financial aid officer and request a
discount if one if offered by the school.
Attending Community College
Attending a community college for the first two years is a great way to reduce
college costs and is probably the most common way of reducing costs. It is
important to make sure the college credits accumulated can be transferred to the
next school attended, however. By attending a community college families can
reduce their college expenses by as much as 40 percent in tuition alone. Not only
do families save on the tuition but also room and board. Commuting may be easier
as well, since junior will not have to go too far to school.
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Notes:
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Chapter 7 - Wills, Probate & Trusts
Wills, Probate & Trusts
Wills
Every adult needs a legally written will. Every stage of estate planning should be
done with the goal of minimizing inconveniences and legal problems, as well as
saving taxes (tax minimization is nearly always a goal). About two-thirds of all
Americans die without creating a will. The most critical time to have a will is when
children are young and therefore vulnerable. Dying intestate (without a will) could
be devastating to those left behind.
Too often individuals feel they have nothing of value so they assume a will is not
necessary, but that is a mistaken resumption. A will allows individuals a sense of
immortality since they can state their wishes even about small items that have more
sentimental value than monetary value. A will can direct the management and
distribution of their estate from beyond the grave.
Failing to create a legal will can affect many people. We know it affects finances
but it also affects guardianship of minor children as well. If both spouses die
without a will, the children become the responsibility of the probate court. A
probate judge will decide whom they will live with, whether their parents would
have approved or not. Ultimately, without a will, the children’s future will be in the
hands of a stranger. The judge will normally choose a relative, but not always.
Conceivably, the children could end up with a person they do not like. Perhaps
even someone the parents would have opposed.
It is important to speak with the chosen guardian prior to drawing up the will; it
must be determined if they would even want the responsibility. If so, make sure
they know the guardianship request is part of the will allowing them the opportunity
to speak up if the courts do otherwise. Secondly, financial arrangements must be
made for minor or disabled children. The parents may not be able to leave a large
amount of money, but whatever is available must be addressed. Many guardians
may not be financially situated to take on children without financial help through
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the will; guardians may need to move into a larger house or buy a larger vehicle to
accommodate their expanding family. Such costs should be considered.
We know a will is needed when children are involved, but even individuals that do
not have children need a will. They may mistakenly believe it is not necessary
since they can simply put property in both names allowing each spouse to inherit
from the other. Since it is possible, however, that both spouses may die
simultaneously or within a short time of each other, a will is still necessary. It
could come down to a simple question: who gets their property if death occurs
simultaneously or within a short time of each other? This would especially be the
question if there are children from previous marriages. Money intended for their
children could flow to the spouse if he or she died last, then to their children rather
than the individuals intended by the deceased.
A will is especially important for unmarried couples. Without a will, when an
unmarried person dies, the courts award their assets to parents, children or siblings.
A will, on the other hand, can include a lover, friend, roommate or charity if the
testator wishes to bequeath to them.
Execute only one will. To obtain additional copies, photocopy the original will.
Once a will is made, it should not be forgotten. If the guardian chosen suffers a
health crisis that would render him or her incapable of the responsibility, the will
should be changed or rewritten. All previous wills (including copies) should then
be destroyed. If the guardian moves, one should consider if he or she wants their
children to reside away from familiar surroundings, friends and family. All wills
need to be reviewed regularly to ensure that the most recent wishes are expressed.
If, after reviewing their will, the creator decides it needs updating or revising,
there are several ways to do this:
1. For minor changes in a will, codicils can be added to execute a formal
amendment to the existing will.
2. A new will may be executed, specifically revoking all previous wills and
codicils.
3. An old will may simply be shredded, with all copies also destroyed. When
choosing this approach, it is advisable to do this in front of witnesses. Of
course, another legally executed will should also be drafted.
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A Codicil, as previously stated, is a modification made in a will that involves
minor changes. A codicil must be signed according to the same requirements of the
original will.
Too many codicils can cause confusion in a will. One codicil may appear to
overshadow another. When this happens, a new will should simply be written.
Often redoing the entire will also avoids causing hurt feelings among the
beneficiaries, when property has been moved by codicils from one person to
another. In some states, when a codicil eliminates or reduces a legacy, the
disadvantaged person must be given an opportunity to protest in court. That means
the person must be located and served a notice, often called a Citation. Therefore,
a new will would perhaps be a better choice.
When a new will is written, it is important that all other wills be destroyed,
including all copies of outdated wills. If family members were not aware of a new
will, an outdated one (even if it was only a photocopy) may end up being followed
by the courts.
A will may be revoked in whole or part by operation of the law. Unfortunately,
this possibility may not be recognized by the creator when he or she is drafting the
document. Circumstances that may greatly affect the validity of a will include
marriage, divorce, the birth of a child, the death of a principal beneficiary, or any
other significant event that followed the effective date of the will. The rationale is
simple: if the creator did not recognize the major change, he or she would have
eventually; therefore, the will becomes invalid in part or whole.
Most states do not allow a legal spouse to be totally disinherited even if they are
legally separated. Some states actually mandate specific minimums. Children must
all be named in the will to prove they were not accidentally omitted. Disinheritance
must be conditioned upon an act repulsive to society. Most states will allow a
person to disinherit their children, but it is a good idea to at least mention them in
the will. The forgotten child could argue they were inadvertently overlooked,
perhaps simply due to clerical error.
When preparing a will, or for that matter any kind of estate planning document, it
should be a project of both husband and wife, with children brought in on some of
the discussions when appropriate for their age. Some parents never talk to their
children about their financial futures or any of the like matters. Children may not
even know a will exists, or even where to look for one.
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Every state requires certain steps be followed for a will to be valid. At the time of
execution, the testator must declare the document to be a will and must personally
request witnesses also sign the document. If an individual moves from one state to
another, a review of the will by an attorney should be considered. State laws differ
and some of those differences may affect the validity of the will.
If a person or couple dies without a will, the assets are divided up according to
present formulas that vary from state to state. This means that, in accordance with
state laws, not all property would go to the spouse. Grown children may receive
money that was meant for the spouse. Stepchildren may not get anything or, worse
yet, the family might battle with the courts. Without a legally binding will the
wishes of the deceased are not known and thus cannot be followed. Assets certainly
require a will for proper distribution and the more assets owned the greater the role
of the will. However, even small amounts of assets or merely prized personal
possessions should be covered by a will to ensure proper distribution according to
the owner’s desires.
An individual can make bequests in percentage form instead of specific dollar
amounts. This allows a person to make bequests without knowing how much the
estate is worth. The beneficiaries will also need to be reviewed regularly in case
they die before the testator. A contingency plan can be designed to overcome such
occurrences if this does happen.
Some items that cannot be included in a will may seem obvious. A person cannot
bequest something that is considered community property (which differs from state
to state). Insurance proceeds and pension benefits cannot be left to someone unless
specifically designated as such in the contract or document.
When a couple decides to draw up a will, it is important to seek out a lawyer who
specializes in estate planning. As with doctors, lawyers also specialize in different
facets of the law. There are several reasons for a couple to see a lawyer when
drawing up their will. Some of these reasons are obvious while others could be
overlooked. They are:
1. A qualified lawyer will understand state inheritance laws.
2. A qualified lawyer can advise the couple on how to hold their property
(jointly, individually or in a trust of some kind).
3. A qualified lawyer may be able to reduce federal death taxes.
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4. A qualified lawyer may pose questions that affect the estate.
5. Drawing up a will through a qualified lawyer makes it less challengeable.
6. If a person moves to a new state, a qualified lawyer will be best equipped to
inform them on the laws in the new domicile state.
To reduce lawyer fees preparation is the key. When preparing lists be sure to
include the following:
1. A complete list of assets and liabilities. Remember assets that will continue
to work and generate income after the person is deceased.
2. A detailed plan of who the beneficiaries are, and how to divide the estate
assets among them.
3. A complete list of those designated to receive monetary bequests, such as
charities, friends, or relatives. Names of charities and others should be exact
(no nick names, for example).
4. A complete list of any items or pets that will have specific provisions stated
within the will. For example, a vacation home might be specified for use in a
particular manner.
5. The complete names of executors and guardians for the children.
Once the will has been enacted changes in the will can be enacted without drawing
up an entirely new will. As previously discussed, these changes are called codicils,
which is a supplement adding to, deleting from, or modification of the terms within
the will.
A will only covers items that the individual owns, including his or her half of
community property and property held as tenants-in-common that do not have a
named beneficiary. This would also be true of personal property that is passed
down from generation to generation.
Some property still transfers, even without a valid will, to the rightful owner. For
instance, all joint property automatically goes to the other owner. Life insurance,
retirement plans, pensions, bonds, annuities and bank accounts go to the named
beneficiary even without a will (if the beneficiary designation is left blank,
however, then the property would revert to distribution under the will). Properties
put into a revocable or irrevocable living trust go to the beneficiaries of the trust.
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People may assume that since a majority of their properties are disposed of
through beneficiary designations the need for a will is eliminated. This is a wrong
assumption. Besides guardianships, there are many reasons to draft a will,
regardless of how property designation is set up. Property may be owned at death
that they did not expect to own. Property may be inadvertently not beneficiarydesignated or the designation stated within the asset may fail to meet legal
requirements.
Homemade Wills
It is possible to draft a will without an attorney. An individual may draft his or her
own will using a computer program designed for that purpose. An individual may
also simply hand-write their own will. A hand-written will is called a holographic
will and must be written entirely by the hand of the person who signs it. Even the
dates of the will must be completely written out. Partial dates or other inadequacies
may void the holographic will. Some states may not allow holographic wills. Even
if the domicile state allows a holographic will, if the will is not exact in who gets
what, it may result in a family feud.
For homemade wills to be valid, one should follow state guidelines so that the will
can be legally honored. The state may require witnesses to sign the will attesting
they either saw the testator sign it, or heard the testator acknowledge their signature
to them. The state may require one to three witnesses be present. For computer
generated wills, the testator(s) may only have to go and have the will notarized,
signing it in front of the notary. Whatever the state laws in the domicile state, the
witnesses may have restrictions laid upon them regarding what they can inherit, if
anything at all. Some states do not allow a witness to inherit anything.
Joint Wills
A joint will is a single will representing two people, normally a husband and wife.
In this instance, they might leave property to each other, and then equally to the
children when the last spouse dies. Once a joint will is drawn up, it can be hard to
change without the other's consent. After the death of the first spouse, the court
may decide that the will is a contract, thus making the property left to the remaining
spouse unable to count towards the marital deduction.
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Once a couple chooses their type of will, the next step is to name an executor. An
executor makes sure that the will is carried out. This step should not be taken
lightly. The role of the executor is a tiresome duty. All the property has to be
tracked down, creditors notified, heirs dealt with and arguments settled. This is the
worse case scenario, but the point is made. Even under the best of circumstances,
the executor still has to pay bills and taxes, the properties appraised and sold, life
insurance policies claimed and investments managed until turned over or cashed in
for the designated heirs.
The executor usually works with a lawyer, which means that the executor need not
be an expert in estate laws or high finance. A person can name a friend, family
member or even a professional executor, such as a bank or lawyer, and include a
family member as a co-executor. The difference between the two executors is that a
professional executor will charge the estate to do the job. A friend or family
member normally will not ask for compensation, although they may take
compensation for expenses or lost work time if they wish.
Living Wills
A living will gives a person the right to die without heroic means under specific
circumstances. Most states have been ratified by law to recognize such rights. But
even so, the wishes of the person may not be carried out. A child could refute the
living will and request a doctor to treat the parent anyway. To overcome this, a
person can name a surrogate or proxy in the living will. This surrogate or proxy
carries out the wishes of the person. A living will must be written and executed
while the person is competent and of sound mind.
For even stronger protection, where state law allows, a person should execute a
health-care durable power of attorney. Most professionals advise individuals to
have a lawyer draft such documents in order to conform to state laws and court
precedents. The lawyer would ask the person to name two stand-ins to act for the
person.
Living wills are often included in many wills and living trusts. Some states do not
fully recognize them, although most states now do. The reason not all states accept
a living will is the problem this causes doctors who are responsible for any liability
in such a situation, especially when family members disagree with the patient's
request. It is now common for hospitals and nursing homes to request copies of
living wills for even minor admissions.
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A person may want to set up a health-care proxy with their attorney in
conjunction with their living will. Many states even require health-care proxies.
This document designates a specific person to make health care decisions on the
person's behalf should the person become incapacitated. Normally, a living will
and health-care proxy each carries out a distinct function. The living will provides
guidance to health care personnel and family members as to the wishes regarding
life-sustaining treatment. The health-care proxy names the person who is
responsible for making health care decisions on behalf of the person in question.
The rule of revocation implied by law is based upon the theory that, because of
any significant change, new moral duties infer that the testator would have changed
the will had he or she thought of it. In some states, this common law rule is
preserved by statute.
A legally married spouse (at the time of death) cannot be disinherited. A surviving
husband or wife has the right to take one-third to one-half of the estate even if the
will states a lesser amount. The exact amount of mandated inheritance depends
upon the state involved. Generally, taking this "forced share" must be done within
six months of the spouse's death.
Anyone who is considered to be an interested party may contest a will. An
interested party is a person who would financially gain by overturning the will.
Contesting the will means having it set aside through legal channels. This can be
done if the will was improperly executed meaning a vital part is missing. An
incompetent testator, such as someone who is senile, will also invalidate a will. If
the testator were wrongly influenced, this would also be grounds to contest the will.
That would generally involve someone who had financially benefited directly or
indirectly by having the testator write the will in a certain way.
If fraud were involved in writing the will, it could be contested. This would
generally happen if another person misled the testator. Of course, any forgery of
signatures would certainly invalidate a will, or any legal document.
When a will is contested, it destroys the entire will. It is not possible to contest
only certain portions of it, since any reason that invalidates one section of the will
would apply equally to all sections.
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Some wills contain a Testamentary Trust. This is where the will creates a trust
as part of the probate estate. It becomes effective at the testator's death. It is also
irrevocable upon the testator's death.
There can be many reasons for incorporating a testamentary trust into a will. The
trust provides security for beneficiaries and can also be set up to mange the assets
for them. If a life income was set up, then the assets avoid taxation when the
income beneficiary dies.
A testamentary trust gives the testator much more control, even after his or her
death, of the assets he or she accumulated during their lifetime. It can save taxes
through income splitting and accumulated income, also.
A Pour-Over Trust transfers assets from one estate or trust into a pre-existing
estate or trust. Typically, a pour-over trust needs to be executed prior to the will. A
will that directs specifically named assets or all residuary property passes into an
already established trust, revocable or irrevocable, is called a pour-over will.
Probate
With probate costs soaring along with estate taxes, people are leaving their
probate estates almost depleted. This could be referred to as "the non-probate
estate." If most of the family's financial assets pass outside the will, the domicile
state may not require probate for the little personal property that remains. Some
states may even let cars or boats transfer title without going through probate.
There are three main ways of avoiding probate:
1. Owning property jointly,
2. Naming beneficiaries on life insurance policies, annuities, and the like, and
3. Putting property into trust.
Probate is generally an easy, though sometimes lengthy, process. As a result, few
people have the goal of avoiding probate as they used to. We seldom hear of
probate catastrophes, except in the extreme cases. Even so, it makes sense to list
beneficiaries anytime there is the ability to do so in an asset or financial contract.
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The word probate is Latin meaning "to prove." Therefore, probate means "to
prove" the will. This system is supposed to prove the will is valid and ensure the
property passes to the designated person. We've all heard the scandals and the
horror stories of the probate process; survivors waiting years to receive their money
while judges dithered and greedy lawyers bled the estates dry. Most states have
specific laws in place to protect the consumers so, except in rare (though highly
publicized) cases, probate proceedings are generally routine. The most likely cause
of delays is not the process itself, but rather assets that are difficult to appraise and
sell.
States have passed probate-simplifying laws. This is especially true for smaller
estates or estates where everything passes to the remaining spouse. States have also
passed these probate-simplifying laws for estates that are not contested or estates
where families can handle the paperwork themselves. In this instance, they just go
in to the probate court and let the clerk tell them what to do.
Living Trusts
The last few years have seen a flourish of those selling various forms of living
trusts. Anyone considering a trust should first seek out a qualified lawyer trained in
this area. A qualified lawyer will be able to advise couples on whether or not they
even need a trust, and secondly how to execute one effectively if the need does
exist. Few would recommend the use of an attorney or attorney’s associates that
use the door-to-door method of selling trusts. The pitfalls are too numerous. A
well-qualified trust attorney has no need to peddle trusts door-to-door.
People set up living trusts to avoid probate, or as an alternative to a durable power
of attorney. There are good uses for trusts, but that doesn’t mean one is always
necessary. If the majority of properties or assets are given to the correct people, a
trust may not be the wisest choice. People need to look at the uses of a trust and
explore their options. Sometimes a durable power of attorney may be the better
option.
When a trust is advisable, there are several types available:
1. A revocable living trust.
2. An irrevocable living trust.
3. A testamentary trust.
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There are several reasons that an individual might want a living trust. The most
commonly listed reasons include:
1. Perhaps the most popular reason for utilizing trusts is probate avoidance.
Trusts allow property to bypass probate and go directly to the beneficiaries
when the person dies or at whatever point dictated in the trust. Trusts allow a
fast and economical way to distribute an inheritance. Just as in a will, a
person can divide their estate any way they like.
2. Trusts allow someone to handle their money if they are incapacitated. With
diseases like Alzheimer's and Dementia, a person can become incapacitated
without even knowing it. If they did not make a provision for someone to
manage their money in such a situation, the family would have to ask the
court to name a guardian. This can be handled simply with a durable power
of attorney, which would name the person responsible for managing the
money if such an occurrence happened. It is best for the individual to choose
someone themselves without having to petition the court. Not only does it
save quite a few headaches, but also for families that do not get along, it can
avoid heated debates. When naming a person to succeed them as trustee,
specific instructions should be given as to when to take over their affairs.
3. A trust can be set up to have a professional money manager handle their
affairs. A person may not feel adequate to handle their money themselves, or
simply not have the time to do so. A professional money manager from
investment-management firms or bank trust departments can be paid for this
service. Bear in mind that professionals can also be paid to handle funds
outside a trust, however. A person can remain as his or her own trustee while
still having a financial manager. Or the person can also name the bank as
their trustee. One caution: make sure that the arrangement allows the person
to switch to a different trustee if they do not like the investment results.
4. A trust can disinherit relatives if the trust creator so desires. While it is not
impossible to refute a trust, since the trust document is not a public
document, revoking a trust is very difficult.
5. Trusts allow a person to keep their financial matter private. Wills are public
documents, as are court hearings to establish mental incompetence. Trust
documents are private.
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6. Some types of trusts may allow a person to avoid creditors. Revocable trusts
do not avoid creditors, although payments may be delayed. Funds in some
types of trusts that have not been pledged to secure a debt may not be
available to pay creditors following the testator’s death. Many states do not
allow this, however, since creditors have a right to be paid. For the best
protection against creditors, it is advised to use joint property.
7. A trust can hold money until a child grows up. This may be a good idea for
larger sums. The designated trustee manages the inheritance and pays it to
the child according to the instructions of the trust. The money can be set
aside for education, living expenses or a nice 25th birthday gift. For more
than one child, it is still advisable to use a single trust rather than individual
ones.
8. A trust can save estate taxes in specific situations. It is advisable to seek a
qualified taxation lawyer for possible tax savings.
9. A trust can manage money left to a spouse. In this scenario, a trustee
managers the money and the spouse receives the income. When the spouse
dies, the remaining assets go to the beneficiaries. Funds should not
necessarily be tied up in a trust, making access difficult or even impossible
regardless of the circumstances. The living spouse should also have the
ability to change trustees if the relationship is not working.
10.A trust can provide for handicapped children. This would be true for the
higher income parents. State and federal programs cover basic medical and
residential care, but only if the child has basically no money. To leave them
money in a will would mean their state and federal programs might stop. A
trust can be set up to supply extra maintenance and support.
11.A trust can assure that the children of a prior marriage will inherit. If a
person gives all their assets to their spouse, they can do anything with it,
including disinheriting stepchildren.
12.A trust may be preferred in states where the probate process is burdensome or
slow.
Homemade Trusts
One thing that experts all agree on: do not try to save money by setting up a trust
without a lawyer. It would be easy for the person to misunderstand the instructions.
Anyone who has put together a bicycle or other item understands how very
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ambiguous directions can be. A person may think they have moved their property
into a trust when they have not because they did not transfer the title properly. If
avoiding probate is so important, setting up a trust correctly is just as important.
Funded Trusts
A funded trust is used to hold property naming the testator as the principal
beneficiary. This should not be confused with a living will. Regardless of the
person's age or mental condition, the trustee is legally bound to act in the person's
best interests according to the trust's instructions.
The funded trust has been nicknamed "the poor man's living trust" because it
allows someone to take over the affairs of someone else without actually setting up
a trust. If a person becomes incapacitated, another way to handle their affairs is by
setting up a standby living trust. A variation of the funded trust, the standby living
trust is set up without putting money in it. This saves the occasional paperwork
problem of selling assets held in trust. Under a revocable agreement the standby
trust can allow assets to be transferred into it only if the person becomes unable to
manage their own finances. If the person ever becomes incapacitated, the person
holding the durable power of attorney could activate the trust, put their property
into it, and arrange for it to be properly managed. As long as the trust remains nonfunded, there may not be any administrative fees.
In the last few years there has been a movement for insurance agents to delve into
the trust market. Insurance agents who recommend a qualified lawyer may not
have a problem. Insurance agents have set up commission scales with lawyers so
they get a "cut" of the cost of setting up a living trust. If insurance agents
recommend to their clients to set up a living trust for their estate when their estate
does not warrant a living trust, how ethical is this? For many older people,
inheritance laws are confusing. Their goal is to leave their children their hard
earned money rather than pay taxes and probate fees. Since consumers often prefer
to believe myths rather than fact, unethical lawyers and agent have set up trusts that
are not warranted. Since consumers have the right to spend foolishly, this practice
is hard to regulate.
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In the past few years, it has become increasingly common to attempt to cure
everything connected with death through a revocable living trust. While a trust,
both revocable and irrevocable, does have their place in estate and retirement
planning, the trust is not a cure-all. Consumer Reports book titled How to Plan for
a Secure Retirement calls the trust "the most complicated way of assigning someone
the task of managing your money." Not everyone agrees with that statement and
there are some positive aspects to forming a living trust under the right
circumstances.
For many people, a simple will is all that is needed to dispose of their assets at
death. In fact, the will is the easiest and most suitable method in the majority of
cases (despite what you were told by the company who is touting living trusts). For
those estates where extenuating circumstances exist, however, a trust can be a
valuable estate-planning tool.
There are two major reasons for setting up a living trust:
1. To manage assets, and
2. To save or minimize taxation (irrevocable trusts only).
Trusts come in many forms and all of them are designed to accomplish one or the
other or both. Trusts have long been used to preserve family lands for future
generations. They are still used today to control family fortunes.
Trusts are often used to provide funds for children, grandchildren, and other
relatives. For some people, the trust becomes the central feature of their estate
plans. What many people fail to recognize when trusts are being sold to them is
that they nearly always involve some expense and inconvenience. Sometimes using
the cheaper and easier will just make more sense.
A trust is a legal arrangement under which one entity transfers ownership of
assets to another entity. The entity may be a person or a corporation. Once these
assets are transferred, a trustee then manages them for the benefit of yet a third
entity, usually a person, although it can be an organization also. The third entity is
the beneficiary. A trust created during the individual's lifetime (the individual
being the trust creator) is called an inter vivos or living trust. A trust that is
created under the will is called a testamentary trust. A few trusts have
characteristics of both and are called combination trusts. Combination trusts are
set up while the testator is alive, like inter vivos trusts, but they do not become
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effective, like testamentary trusts, until the testator has died. In fact, some types of
insurance trusts are combination trusts.
To Recap:
1. An inter vivos, or living trust, is created and used while the individual is
living.
2. A testamentary trust is created through the will and is used after the
individual has died.
3. A combination trust is created while the individual is alive, but it is not used
until he or she has died.
4. Trusts are either revocable or irrevocable. A trust that is revocable gives the
individual creating it (the testator) the ability to change or even terminate the
trust. If the trust is irrevocable, the testator may make no changes.
Revocable Living Trusts
Generally, individuals use revocable trusts because they want to manage their
assets in some way for some specific purpose. Perhaps the individual is fearful that,
at some point, they may be unable to manage their own assets. This might
especially be true if early signs of Alzheimer's disease have been diagnosed. The
testator can name themselves as one of the trustees along with some other person or
group of people. While the individual's health permits it, he or she can take an
active role in managing the assets, but when their health deteriorates, the co-trustees
can then take over. It is possible to write a revocable trust naming the individual
(the testator) as a trustee with the power to actually handle the investments assigned
to a bank, trust departments or to another person.
When a revocable living trust is enacted, the person gives some or all of the
property to themselves as a trustee. The individual no longer owns it; he is both the
trustee and the owner. Spouses can be co-trustees. As a trustee of the property, the
individual is still able to control the money, shift it around or change the terms of
the trust. An individual can even name someone else as a trustee, and fire them if
not satisfied with their management.
Revocable trusts have many uses when it comes to asset management. If a person
owns real estate or businesses located in several different states, a trust can make
not only management, but also estate disbursement much easier. On the
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management end, having a trustee who watches over the business in one state while
the individual is in another can be a great advantage.
Revocable trusts do not save taxes! All too often revocable trusts are thought to
prevent the IRS from taxing assets. This is simply not the case. The IRS has been
around for a long time. Congress would simply not allow individuals to bypass
taxation simply by using a revocable trust. Any time a person retains the right to
receive income, or decide how principal should be used, or even retain the right to
vote stock in a family business, taxes must be paid. The Internal Revenue Service
considers anyone who is able to change or terminate a trust to be the owner of the
assets located in it. This is true even if someone else actually receives the income
from the trust.
There are trusts that can save or at least reduce taxes. Some of these may be:
1. Bypass Trusts: This type of trust can be set up to hold that portion of the
estate that is exempt from taxes upon death of the first spouse by reason of
the unified credit. The trust is designed to exempt the assets placed in it from
estate taxation upon the death of the second spouse. This estate tax savings
ploy can be accomplished with a general power of appointment trust or a
qualified terminable interest property (QTIP) trust.
2. General Power of Appointment Trust: A distinctive characteristic of this
type of trust is that it gives the surviving spouse the power to name, normally
in a will, the ultimate beneficiary of the trust's assets. If the spouse fails to
name a beneficiary of the assets, they will go to the beneficiary named by the
spouse who died first. Two other essentials for setting up this type of trust is
that it must give the surviving spouse a lifetime right to the income earned on
the trust property, and it must find the trustee or surviving spouse the power
to withdraw and use the trust principal for certain purposes.
3. Qualified Terminable Interest Property (QTIP) Trust: This type of trust
allows the ultimate beneficiary to be named from the very start. The
surviving spouse could not name another person. The lifetime right for the
surviving spouse to receive income will qualify for the marital deduction, so
the ultimate estate tax-saving features remain. This feature is like that found
in the general power of appointment trust. So in essence a spouse can get
income from the trust over their lifetime, but upon death, the principal in the
trust passes on to whomever you choose, which is usually the children.
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4. Irrevocable Life Insurance Trust: To avoid incurring estate taxes on life
insurance proceeds, an individual can place the policies in an irrevocable life
insurance trust. Doing this will prevent the heirs from having to raise money
for taxes on life insurance income. The individual up all ownership rights
when they use this type of trust. This would include the ability to borrow
against the policies or change listed beneficiaries. If the policyowner dies
within three years of setting up the trust, the insurance could be included in
their taxable estate anyway.
5. Charitable Remainder Trust: This type of trust is for the people who are
charitably inclined. The Charitable remainder trust offers a variety of
advantages both during the person’s lifetime and when the estate is
eventually settled. When this type of trust is set up, the property that the
person wants to donate is put into an irrevocable trust. The income from this
trust is distributed to those chosen, normally themselves or their spouse, but
sometimes children are included. The trust's income is typically distributed
to the creators and listed beneficiaries for their lifetimes, depending on what
was initially set up. Once the last income recipient dies, the property in the
trust is given to the charity or charities chosen.
6. Charitable Lead Trust: In many aspects, this type of trust operates in the
opposite way from a charitable remainder trust. The income provided by
property that is placed into a charitable lead trust is given to a qualified
charity, rather than the donor. The charitable lead trust also includes the
provision that upon the death of the donor, the property is to be given to
specified non-charitable beneficiaries. Once the trust is enacted, the value of
the property in the trust is no longer included in the taxable estate, but there is
no immediate tax deduction granted upon opening the trust. Therefore, a
charitable lead trust can provide significant estate tax savings while keeping
the property in one's family. Remember though, that one gives up the income
generated by the property for the rest of their life.
Avoiding Probate
Many people utilize a trust simply to avoid probate proceedings. Since a
revocable living trust is a living entity, just because the creator dies does not mean
that the trust dies also. Because the trust lives on, it is able to disperse property
without any court proceedings even after the death of the testator or trust creator. In
many situations, this can be a major advantage for an individual. If the trust was
created for the benefit of others, it can continue to benefit them long after the
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creator has died. The trustee(s) simply continue to administer the trust assets for
them. If, on the other hand, the intent of the creator is to have the trust terminate at
his or her death that can happen also without court proceedings. The trustee will
simply follow whatever directions were made in the trust.
It is true that transferring an estate at death through a trust is generally cheaper and
faster than having an estate go through probate proceedings. Of course, the trust
was also more expensive to set up and probably had expenses of administration as
well. Even so, if a trust was set up, for example, to benefit the individual's children,
the trustee can begin paying them income almost immediately upon the testator's
death. However, if the individual's estate is part of a trust created by the will, the
distribution may be delayed for months or even years until the estate is settled.
Earlier we mentioned that a living trust might be used to benefit real estate or
businesses located in multiple states. When the owner of these assets dies, probate
could easily be required in multiple states if the assets were outside of a trust. By
putting these assets into a trust, this can be avoided. However, few professionals
recommend that a corporation be placed into a trust. Doing so creates multiple tax
liabilities.
Avoiding probate may save commissions paid to an estate executor under a will,
but the estate will not be without expenditures. The estate must still pay any
expenses due for legal and accounting fees. Additionally, the assets in the trust are
subject to federal estate and state death taxes. Assets transferred to a revocable trust
are not considered gifts under the federal gift-tax exclusion. They do qualify,
though, for the $600,000 unified tax credit and the unlimited marital deduction.
Revocable Living Trust Disadvantages
Despite what some trust salespeople would have you believe, trusts can have
disadvantages. To begin with, assets must be in a form suitable for trust
management. This is probably the most frequent mistake made by many people.
Some assets simply do not do any better in a trust, so the less expensive will is more
sensible.
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For example, Ezra and Hazel Dobson are husband and wife. All of their assets
(their home, automobiles, bank accounts and so forth) are held jointly. Their
pensions cannot be transferred to a revocable trust. In this situation, a revocable
trust simply is not appropriate. It is expected that the coming years will experience
multiple lawsuits regarding this point by state officials against those selling trusts.
If an individual decides that it does make sense to establish a revocable living
trust, it will probably be necessary to transfer a number of bank accounts or
securities and set up a system for record keeping. If a new asset is purchased, that
investment will have to be registered in the name of the trust as well. In some states
the testator cannot be the sole trustee. In those states that require a co-trustee, the
testator will have to tolerate another individual interfering in his or her financial
affairs.
Depending upon the situation, creating a revocable living trust can be expensive.
There should always be an attorney involved. If an individual does not work with
the attorney face-to-face it is not a desirable situation. Attorney fees can run from
only a few hundred to several thousand dollars, depending upon the individual's
personal situation. There may be additional costs to transfer asset titles to the trust.
There will probably be real estate recording fees, for example. Depending upon
who is chosen, there may be fees for trustees. Some organizations provide trustees
for a fee. This would include banks and trust organizations. A family member may
not charge a fee, but he or she would certainly have the right to do so. If the trust
must file income taxes, there will also be fees to accountants or tax preparers. The
will should be coordinated with the trust to avoid tax problems.
Some of the advantages of the revocable living trust can be accomplished without
actually creating a trust. For example, an individual can give another person a
durable power of attorney.
Power of Attorney
A power of attorney is a legal tool used to give another person the power to act in
another's behalf. The person given this power is called an agent or an attorney-infact. That person does not, despite this name, have to be an actual attorney; it can
be any person of legal age.
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A power of attorney is initiated simply by signing a prepared form obtained from a
bank, brokerage house, attorney or legal supply store. Often even stationary stores
carry these forms. The powers that are given to the agent or attorney-in-fact are
listed specifically. A power of attorney may be extensive or quite limited,
depending upon the desires of the individual. A person may only allow the agent to
sign on real estate contracts, or he or she may be allowed to sign virtually any legal
form. Again, it simply depends upon the desires of the individual. Although forms
can be purchased, if there are going to be specific requirements and limitations, it
may be a good idea to have a specially written form drawn up by an attorney.
A simple power of attorney cannot be used after the death of the grantor.
Additionally, they cannot be used if the grantor becomes disabled, unless the form
specifically gives this authority. When a power of attorney gives the agent the
power to act on an individual's behalf when they are incapacitated, that form is then
called a durable power of attorney.
Powers of attorney are simple to establish and should be part of every will. They
are especially suitable if the grantor has only a few assets, such as Certificates of
Deposit at the local bank or just a mutual fund or two. Powers of attorney are often
short-lived documents. A power of attorney can be terminated by simply tearing up
the legal document.
Any person giving another a power of attorney in their behalf does want to be
aware of some possible disadvantages. The agent can act while the grantor is still
alive and make decisions that he or she may not approve of. Even though the agent
is required to make all decisions for the benefit of the grantor, there are few
safeguards to prevent the misuse of funds. Should that happen, the only option
might be a lawsuit and if there is nothing monetarily to recover there is little point
in suing. Some organizations and large institutions will not accept standard-form
power of attorneys. If this is the case, these organizations and institutions usually
have a form on the premises that the grantor can use. A few may require that an
attorney draw it up.
Furthermore, it is very important that more than one person be aware of a power of
attorney that is in existence. If the grantor has a trusted attorney, he or she may
even want a copy filed at his or her office.
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If a power of attorney does not suit the situation, an individual may also allow the
court to appoint a guardian, conservator or committee to manage his or her affairs.
Guardians, Conservators & Committees
Sometimes guardians, conservators and committees are appointed by the court
simply because the individual did not make any other arrangements. Sometimes it
is done because the individual or a member of the family or some other interested
party requested it.
If guardians are necessary family members, or other individuals acting on behalf
of another, files papers with the court requesting a hearing. The papers generally
specify the relevant facts about the mental and physical conditions of the person
being represented. The papers would also address the individual's financial assets
and liabilities. An application of guardianship may also set out a plan for managing
the money and caring for the individual. It is common for the doctor to be called to
the court to testify about the person's mental and physical condition. This would
help to provide evidence that the individual is unable to care for himself or herself
and his or her finances. In some states, this amounts to a legal declaration of
insanity, but that is not true in all states. In some states the individual has little or
no say in the hearing, even though it concerns him or her and his or her finances. In
other states, such as California, the person must give their permission for a guardian
to be appointed. In every state, the individual has the right to be represented by an
attorney. If the individual does not have an attorney, the court will appoint one.
The attorney is called the guardian ad litem or a special guardian.
It is often assumed that only certain people are qualified to be a court appointed
guardian, but this is not the case. Anyone can be a guardian. We often see cases on
television and in the newspapers of multiple parties applying for guardianship when
lots of money or other assets are involved. If the person is of legal age, most states
allow the individual to choose or at least recommend their own guardian. It is
actually advisable to list desired guardians in one's will while they are mentally
competent. Often the individual knows better than the courts that would fairly
represent them.
Where the individual has not recommended a desired guardian, most state laws
leave the decision up to the judge. Normally he or she will appoint a close family
member, such as the spouse, adult child, or other blood relative. They are most
likely to appoint a person the individual has already been living with, such as the
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spouse. Some states require that the guardian reside in the same state as the
individual being represented.
Appointing a guardian is not an easy task. It can be complicated and costly. Most
professionals feel that this situation is not desirable and recommend the
establishment of joint accounts, established power of attorney or a living trust
instead. Still, it is an option.
When an individual believes that relatives may try to have a court declare them
incompetent for financial reasons, attorneys often recommend that a revocable
living trust be set up immediately naming the individual and a co-trustee of their
choice. That allows them to retain their income for life without allowing the
suspected relative or relatives the satisfaction of gaining control. Trusts, like wills,
can be challenged in court, but a trust is very difficult to successfully challenge
since it is a private document. If the individual cannot see what the trust states, it is
very difficult to challenge.
Irrevocable Living Trusts
There is another type of trust that is created during one's lifetime. It is called an
irrevocable living trust. Any agent selling trusts absolutely must understand the
differences between a revocable and irrevocable living trust. An irrevocable living
trust will shift the individual's assets for use by a beneficiary and remove the assets
from the estate. When an individual cannot change the terms of the trust and retains
virtually no power over the assets, the trust is irrevocable.
Revocable living trusts are used primarily for asset management. An irrevocable
trust, on the other hand, has several other uses. An irrevocable trust can be used for
asset management, but it is usually done for someone other than the trust creator,
whereas a revocable trust usually manages the assets for the trust creator. Other
uses include the removal of property from the taxable estate, which saves estate
taxation, and also saves income tax while the creator is living.
The revocable trust is most often used for asset management and the irrevocable
trust is used primarily for tax minimization. When a trust is used for tax
minimization, it is always necessary to shift control of the asset or assets to
someone else and the grantor and his or her spouse must give up the right to income
from the trust. Many people do not want to do this for many reasons. We do not
always know what the future will bring. To completely give away assets is not
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always something that a person feels comfortable with. For this reason, irrevocable
trusts are often used for other reasons and not tax minimization, even though that is
a possible use.
It is more common to see an irrevocable trust used to benefit specific people. A
trust allows an individual to give to beneficiaries, during one's lifetime, money that
would otherwise have not been transferred until death. The trust can continue to
shelter the money for the beneficiary protecting them from outside influences. For
example, Lucy has a grandchild she feels very close to. Even though she loves this
grandchild, Lucy has seen evidence that her grandchild is not responsible with
money. Lucy feels that the grandchild would quickly spend all the inheritance that
she plans to give her. Therefore, Lucy sets up an irrevocable trust to manage the
money and give it to her grandchild gradually in a responsible manner. It is Lucy's
hope that over time her grandchild will learn to be more financially responsible, but
in the meantime Lucy wants the money partially available. A trustee will follow
Lucy's instructions and give the grandchild a monthly allotment. Neither the
grandchild nor any creditors can touch the money in the trust.
A primary reason irrevocable trusts are used is for Medicaid protection. Currently,
Medicaid cannot touch funds placed inside an irrevocable living trust, but Medicaid
can tap funds placed in a revocable trust. A revocable trust can be tapped by
creditors, but an irrevocable trust cannot.
Despite the advantages of an irrevocable trust, there are certainly some
disadvantages also. Creating an irrevocable trust is a serious step to take. Once it is
set up, it is very hard or even impossible to undo. Sometimes only court
proceedings can reverse an irrevocable trust. The court proceedings are time
consuming and costly.
Sometimes an irrevocable trust can be terminated if all the beneficiaries give their
consent to do so. However, if one of the beneficiaries happens to be a minor child,
including unborn children, this may not be possible.
It is very important to consider all areas before enacting an irrevocable living trust.
If the desire is simply to save or minimize taxes, the individual wants to be sure that
he will not need the assets in the future. There is no way to know what will happen
years down the road.
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It is also very important to completely understand all the powers retained and
given up. For example, if an individual creates a trust with the intention of
primarily benefiting the children, but still maintains control of the income and
disposition of the principal, he or she may be in for a nasty surprise. He or she will
have relinquished control over the assets, but will still be responsible for paying the
income taxes. A person who is a trustee of a trust they have created may also still
have to pay income taxes. This is true even if that person is not receiving any of the
income being generated. In addition, if the trust creator holds on to the purse
strings of the assets in the trust, he or she may also be subject to estate taxes;
something that the creator probably thought they were avoiding.
Another consideration must be looked at if the trust creator is married. If a
husband and wife own property jointly, both of them must create the trust.
Depending on how the trust is drawn up, this could mean that the assets in the trust
wind up in the estate of the spouse who dies last where they would be subject to
estate taxes. This is usually an unintended consequence of a joint trust.
Some real estate groups do not allow property to be held by a trust. This is often
seen in cooperatives and condominium apartments. In addition, if property is
mortgaged, before it can be transferred to a trust, it may be necessary to get the
permission of the bank or mortgage company. If property is put into the trust
successfully, refinance loans are often hard to obtain.
Types of Irrevocable Living Trusts
There are several types or intentions of irrevocable living trusts. They include:
1. Medicaid qualifying trusts,
2. Trusts for children and grandchildren, and
3. Grantor-retained interest trust
Unfortunately, some feel it is better to have the government pay for their longterm care needs than to personally fund it. Some people try to avoid having to
"spend-down" to required Medicaid levels by simply hiding their assets in a living
trust. A revocable living trust will not hide assets. Even attempting to use an
irrevocable trust for this purpose is tricky. All rules and regulations must be
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conformed to and these can vary from one state to another. States have been
closing loopholes that have allowed individuals to hide personal assets and tap into
tax dollars through Medicaid. Today, even having substantial home equity can
prevent Medicaid qualification.
To qualify as a Medicaid resistant trust, neither the creator nor the trustee can have
any control over the assets in the trust or over the income they generate. If either
the creator or the trustee does have control, then Medicaid counts both the income
and assets in determining the individual's eligibility for benefits. Giving up all
control preserves the savings and assets for the individual's heirs. Having done this,
however, the individual cannot tap the funds, neither the principal nor the interest,
for any personal reason.
There are often other qualifications for Medicaid as well. Assets must be
transferred long before applying for Medicaid (several years prior). The assets must
also be transferred for their fair market value. While this does not usually apply
when transferring to a trust, it would apply if the assets were being transferred to an
individual, such as a child or other relative. There may be cases where asset
transfer time requirements might not apply. If an individual has been receiving care
in a Medicaid-approved facility, such as adult day care center, it may be possible,
depending upon the state of residence, to transfer assets one day and begin
receiving Medicaid the next. Since such circumstances are impossible to predict, it
is better to be preparing in one way or another.
Irrevocable trusts are commonly set up for the benefit of children or grandchildren.
Often these are intended to pay for college. The gift-tax exclusion allows an
individual and his or her spouse to give a specified amount each year to the trust
and escape gift taxes.
By shifting some assets the couple may also avoid taxes on the income these assets
generate. Again, however, the husband and wife must give up all control over these
assets. That includes both the asset and any income it generates. The children,
grandchildren or the trust itself will be responsible for any income taxes that come
due. Often the children and grandchildren, or even the trust, are in a lower income
tax bracket, so this is actually an additional advantage in many cases.
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If the child or grandchild is over the age of 14 and the trust is used for such
necessities as food and clothing, the IRS usually considers it to be the child's and
also taxes it.
As we stated, many of these trusts are established for college funds. Often those
creating these trusts do not realize that the Internal Revenue Service has ruled that
income used to pay for a grandchild's college fees will be taxed to that child's
parent, even if the grandparent paid the cost.
The third reason irrevocable trusts are often established is for grantor-retained
interest trusts. This type of trust is usually referred to by the acronym GRIT.
This is an irrevocable trust created solely to save taxes. The grantor retains the
right to receive an annuity or percentage payment from the trust for specific time
period (generally no more than 10 years). If the individual lives for the entire tenyear period (or whatever period was stated), he or she has no further interest in the
trust. At the end of the stated time period, the assets in the trust pass on to the
named beneficiaries. If the individual dies during the stated time period, the assets
go to his or her estate. If an early death occurs, there may not be savings on estate
taxes.
Wealthy people use GRITs to save estate taxes, so their assumption is that they
will live to collect the payments during the time period stated. People who are not
wealthy do, however, also use GRITs. Tax savings come about because the
individual (the grantor) is making a gift of the discounted future value of the
property put into the trust. At the stated time period when the trust ends, the
individual has removed assets from his or her estate (having put them into the
irrevocable trust). Any increase in value was also in the trust, which benefited the
estate. Many people put their home into a GRIT, but this should not be done
without receiving expert tax advice in advance. Be sure the person giving the
advice is well qualified because putting real property into a trust can be tricky and,
of course, rules do change as well.
It should be noted that GRITs are generally only used by individuals whose estate
will be financially large. If the estate is too small, the charges associated with
establishing and maintaining the trust will eat up any tax savings.
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Uniform Gifts to Minors
Sometimes it is not necessary to utilize a trust to accomplish a particular goal.
Rather than using a trust document, a gift may be made by utilizing the Uniform
Gifts to Minors Act. This works especially well if the grantor has little money to
spare, but would still like to give something to a grandchild.
A Uniform Gifts to Minors account may be set up at a local bank or brokerage
firm with any amount of money or securities. Depending upon the date of
residence, the grantor may be able to transfer insurance policies, real estate or even
limited partnership interests to a Uniform Gifts to Minors account. There is no limit
as to how much can be contributed.
If desired, the grantor could give the money or assets to a "custodian" who would
then be required to use it in the child's behalf for health, welfare and education. In
fact, the grantor can be the custodian himself or herself. Most experts do not
recommend that, however.
When the child attains legal age in their state of residence, the money remaining in
the account automatically belongs to that child. Many people feel this is a
disadvantage of Uniform Gifts to Minors accounts. A child who has just turned 18
(or 21 in some states) may not be able to handle large sums of money with wisdom.
As a result, depending upon the child, a trust may be the better choice.
Testamentary Trusts
A testamentary trust created under an individual's will is always irrevocable, but it
can be changed by changing the will while the creator or grantor is living. After the
death of the creator, however, no one can change the provisions. Testamentary
trusts, since they are irrevocable, can save estate taxes and preserve assets.
There are different types of testamentary trusts. One type is a Credit Shelter or
Bypass Trust. These trusts are designed to take advantage of the federal unified
estate and gift-tax credit. They allow over a million dollars in assets left in trust by
one spouse for the other to escape estate taxes in the survivor's estate.
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Another type of testamentary trust is the Qualified Terminable Interest
Property Trust (called a Q-TIP trust). The Q-TIP trust is commonly used and
most likely to be recognized by name.
In the Q-TIP trust, all the income from it must be paid to a spouse and the executor
of the estate is responsible for making sure that the trust is eligible for the marital
deduction, thus exempting it from the gift or estate taxes. The assets in the Q-TIP
trust are taxed in the spouse's estate.
As an example: Mildred and Bob have been married since they were childhood
sweethearts. Bob has always handled the finances and done very well financially.
Bob is concerned that Mildred, while a very smart woman, does not have the
experience to manage the finances. This may especially be true because her health
is not good. Bob decides to create two trusts under his will: a Q-TIP and a bypass
trust. Bob names Mildred and a trust management firm as co-trustees. Mildred will
receive all the income from both trusts and the trust management firm can tap the
principal, if necessary, for Mildred. The assets in both the trusts will escape federal
estate taxes, due to the marital deduction. When Mildred dies the assets in the
bypass trust will also escape taxation, but those in the Q-TIP trust will not. The
assets in both the trusts will go to her sons when Mildred dies.
Another type of testamentary trust is the Q-DOT or Qualifying Domestic Trust.
This type of trust is not often necessary, but if an individual's spouse is not a United
States citizen, it may be the best choice. The Q-DOT preserves the marital
deduction for spouse's that are not citizens of the U.S. As you may know, the
marital deduction is not available under normal circumstances to spouses who are
not citizens. Without a Q-DOT the portion of the individual's estate that exceeds
the unified credit would be subject to federal estate taxes.
The Q-DOT is similar to the Q-TIP in that the surviving spouse must receive all
the income during his or her lifetime and the executor of the estate must choose to
qualify the trust for the marital deduction. It is very important to seek qualified
legal and tax advice before establishing a Q-DOT since rules do change.
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Combination Trusts
As we mentioned, combination trusts combine qualities of both the living trust and
the testamentary trust. An individual sets them up while he or she is still alive, but
they do not become effective until after the creator's death.
Insurance trusts are often combination trusts. When setting up an insurance trust,
there are three choices:
1. An individual can establish a revocable trust that does not actually own the
insurance policy. The trust is named the beneficiary of the policy, so when
the individual dies, the trust collects the proceeds. This type of trust is
inactive, or non-funded, during the creator's lifetime. When death occurs and
funds are deposited into the trust, it then becomes a funded trust. This trust
could also receive other assets and help eliminate some of the delay and
expense of probate, if that was desired. A non-funded trust may also be
called an empty trust.
2. An individual could set up a revocable insurance trust that does actually own
the insurance policy. If this is the case, ownership of the policy must actually
be transferred to the trust. The individual must give up any rights associated
with ownership of the policy, such as the ability to change beneficiary
designations. The trust can buy the policy, but the individual will have to pay
the premiums.
3. An individual could set up an irrevocable living insurance trust. The primary
purpose of such a trust would be to save estate taxes. The trust owns the
policy, which means that the individual has given up all rights of ownership,
such as the ability to change beneficiary designations. In addition, the
individual must give up control over the trust and could not, for example, be
a sole trustee. The insurance policy is removed from the taxable estate and
also from the estate of the spouse and beneficiaries. It belongs solely to the
trust. As always, an attorney should draw up this trust.
Any time assets are removed from an estate there may be gift-tax implications.
Therefore, if an individual is considering an insurance trust it is probably best to
have the trust buy a new policy rather than attempting to transfer an existing policy.
If the individual seems set on using an existing policy, borrow the cash value before
putting the policy into the trust. This will eliminate the potential for gift taxes. It
should not be forgotten, however, that any outstanding policy loans would reduce
the amount of death benefit. Other assets that were also put into the trust can pay
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the insurance premiums. If the grantor of the trust pays the premiums, they may be
considered gifts to the trust and may, therefore, be subject to gift taxes. In larger
estates, premiums may also be subject to generation-skipping taxes.
Whatever type of trust is utilized, it is vitally important that it be properly drawn
up. Far too many trusts are improperly written by people who proclaim him or
herself an "expert." Many law and tax professionals expect the future to bring
multiple lawsuits from beneficiaries who feel the sting of improperly written trust
documents.
There are many uses for insurance trusts. Perhaps one of the most widely stated
reasons for an insurance trust has to do with second and third marriages. It is now
common for an individual to have children from a previous marriage. While he or
she may want to leave the estate to their spouse, they can still remember their
children from former marriages by creating an insurance trust. The insurance
proceeds will go to the children, while the estate assets will go to the current
spouse.
Trust Record Keeping
Revocable trusts gained great popularity in the 90’s. Virtually everyone was
selling them from insurance agents to accountants. Even software programs were
being marketed to the consumer so that they could “write” their own revocable
trust. For the most part, little information was gained by the consumer who often
ended up with a worthless, non-funded trust. Even when some assets were
transferred to the trust, there was often little understanding as to why it was done.
Whether the trust is revocable or irrevocable, good record keeping is necessary. In
fact, many of the trust advantages will be lost if records are not kept properly.
Commingling trust assets with non-trust assets could even render the trust
ineffective.
Trustees
In many states, the creator of the trust may act as the sole trustee and this is often
done. In fact, the creator may be one of the trustees in either a revocable or
irrevocable trust even if he or she retains no interest or control. Even if the
individual's particular state does not allow them to be the sole trustee, he or she may
still share the responsibilities with another party, such as a bank or other individual.
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If the trust creator cannot be the sole trustee, or does not desire to be, there are
many good alternatives:
1. An adult child or close relative is a common choice. If this is done, do try to
avoid conflicts of interest. A beneficiary should never be named as trustee.
Anyone who would benefit from the estate should be avoided as trustee
because their goals could certainly be different than those of the trust creator.
2. A professional person, such as an attorney, accountant or professional in the
same field as the trust creator. It is not recommended that one of these
professionals be the only trustee, since professional fees could be unfairly
charged.
3. A bank or trust company is often a good choice for a co-trustee. They tend to
know the duties well and are prepared to perform them. It should be noted,
however, that banks and trust companies do charge for this service. If a bank
is chosen, be sure to check their investment history. Not all banks are
experienced enough to handle a large trust so this should also be considered.
Trusts definitely have a place in estate planning. However, a simple will is often
adequate and will save the expense and administration of a trust. The most
effective estate-planning specialist will understand which tool is most appropriate in
individual circumstances. Any professional that believes the same tool is correct
for each individual is not really an estate planner. Rather, he or she is a salesperson.
Planning on Death
Everyone knows they will die one day, but far too many people never plan for the
event. Estate planning and retirement planning go hand-in-hand. Estate planning
refers to death planning whereas retirement planning refers to life planning.
Estate planning includes many things, among them a will, gifting, trusts and tax
minimization. Most estates do not end up paying federal estate taxes, but there may
be state death taxes and both state and federal income taxes.
When planning ahead for one's death, it is often difficult to be objective.
Therefore, experts generally recommend that one use the services of various
specialists. These normally include an insurance agent, an attorney, and a CPA or
general accountant. The attorney is almost always necessary since even simple
estates need to follow the letter of the law. It is possible in many states to write
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one's own will. However, if an individual's financial circumstances include more
than one marriage, children from any marriage, interest in a closely held
corporation or partnership, investment real estate or significant assets in more than
one state then an attorney is absolutely essential. In addition, if the individual
expects the value of their qualified pension or profit-sharing plan to exceed
$100,000, it is necessary to have an experienced accountant or tax advisor involved.
There are several things to focus on when estate planning:
1. Recognizing the appropriate beneficiaries;
2. Selecting the correct estate planning tools, such as wills or trusts;
3. Obtaining competent managers for trusts and so forth;
4. Providing sufficient liquidity of assets to meet death obligations; and
5. Recognizing and planning for special situations or responsibilities, such as a
handicapped child.
Occasionally, a person may resist estate planning because he or she feels it will be
costly. Actually, NOT doing any estate planning will cost much more than the fees
involved in a proper plan.
The actual monetary cost will vary depending upon many factors, such as the
complexity of the estate, where the individual lives and variations in fees from one
area to another. Some attorneys charge relatively small fees for drawing up a will
because they feel it will lead to other business. On the other hand, if the attorney
insists upon being named the executor of the estate, a cheap will could end up being
very costly in the end. Some lawyers charge a flat fee for a will; others charge by
the time involved. Revocable and irrevocable trusts will be more expensive than a
will.
A will or trust can be a powerful, useful tool in estate planning. For years
following their death, a person may direct the management of their money and other
assets.
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The ultimate test of a will is: Does it seem basically right and fair? It cannot be
denied that it is the right of each person to do as they wish with their possessions.
When it comes to wills, however, there are laws that apply. A legally married
spouse cannot be cut out of a will entirely, for example. Generally, at least one
third must go to the spouse. Some states require half of the estate go to the legally
married spouse. Most statutes also state that all children must be given an allotted
portion.
As soon as reasonable, it is wise to share a will's contents with the adult children.
Many people still keep their wills a deep, dark secret. This is not only foolish in
most situations, but also groundless when considering the laws that exist to protect
all parties.
Wills first came into being as a way of giving peace of mind to those writing the
wills. The primary concern should always be in accomplishing what is considered
best for all parties concerned.
Some of an individual's property will automatically pass to others whether or not a
will exists. For example, joint accounts with right of survivorship pass to the
surviving joint owner.
Joint Accounts
Establishing a joint account at a bank or a brokerage is one way of managing one's
money. Deciding who will manage our money when we die is part of estate
planning. When a joint account is set up, the individual signs an authorization card
giving one or more joint owners the right to withdraw or deposit funds in the
account. If the account has two owners, either one can withdraw all of the assets in
the account for any reason. In most cases, however, an owner who did not
contribute any funds to the account cannot keep more than half it's value. In any
case, when one of the owners dies, the remainder of the account value immediately
belongs to the other. In some states, the new owner may need tax waivers to use the
money if the account is large. There may be estate taxes, which the new owner
would be liable for, depending on who contributed to the account.
Joint accounts are commonly used between husband and wife. As parents age, it
is also common for a child to have a joint account with his or her parent. This
enables the child to make deposits and write checks as necessary when the parent is
no longer able to do so.
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Even though there are many valid reasons to have a joint account with another
person, there can also be some drawbacks. We all want to believe that we can trust
our children, but that may not always be true. An individual who has a joint
account needs to realize that the person chosen as the joint owner has the ability to
raid the account at any time and to take all of the money in it. Therefore, joint
account owners may want to also keep a separate account for the bulk of their
money.
Sometimes a joint account can mistakenly circumvent the will. For instance,
suppose Jane Jones states in her will that her children are to share equally at her
death. The son that lives closest to her, however, is a joint owner in her checking
and savings account. Since the will governs only property that goes into probate,
the money in the joint account will not be covered by it. Therefore, Jane's son will
get his share of the rest of her estate plus the amount in the joint checking and
saving account. Such cases cause family fights in probate court every day.
Some elderly citizens mistakenly believe that a joint account will help them
qualify for Medicaid and protect their money at the same time. Fifty percent of the
money in the joint account belongs to each individual and Medicaid can use that
money if it would legally apply. This is true even if the individual on Medicaid did
not contribute to the joint account.
Do not confuse a joint account with rights of survivorship with tenancy in
common (another device for transferring assets). A tenancy in common states that
each person owns half of the assets, but at the death of either owner, the survivor
will only receive the half he or she already owned. The other half of the money
goes into the estate of the deceased.
Neither are joint accounts the same as accounts that are being held in trust for
another. With trust accounts, an individual may have control over the money, but it
is not theirs to use.
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Choosing an Attorney
Choosing an attorney can and should be a major decision. If a person suffered a
stroke, that person would seek out a cardiologist--not a podiatrist. Both are doctors,
but only one specializes in hearts. The same concept applies to attorneys. Seek out
the attorney who specializes in your needs and the needs of your client.
An attorney has a high fiduciary duty in every client relationship. The attorney
often speaks for his or her client. The attorney is, in fact, the very first fiduciary in
the sequence of a will or trust, death, administration and distribution of an estate.
Until recently, it was difficult to find a "specialist" when choosing a lawyer.
Every lawyer professed to be a specialist at all things. Many still try to do whatever
comes their way. An attorney or law firm that specializes in estate planning is a
must.
Any attorney can write the standard estate planning documents, such as a will or
simple trust, but few are qualified to actually design an estate plan. There are
thousands and thousands of income tax, estate tax, and gift tax rulings every year.
Realistically, an attorney that does not specialize in this field cannot be expected to
keep up with all of these rulings. Of course, we would expect a specialist to keep
abreast of all changes. For most lawyers, estate planning is only a small percentage
of his or her overall business.
Because so many consumers believe that estate planning is costly, few actually
take the time to seek out a specialist. An estate-planning specialist can almost
invariably save your clients in taxes many times the cost of developing a program
for his or her estate.
If a person is not familiar with a good estate-planning attorney, start to look for
one by asking around. Ask your bank; ask a businessman; ask your friends. Get
several names. Then get on the telephone and call the names you have. Ask
Questions. Do not hesitate to ask about schooling specifically in tax planning and
trusts. Never go with any attorney who does not have your fullest confidence.
Even if it is only a "feeling" of distrust, go to another attorney.
The task of finding the type of specialist desired can be a most difficult one. The
Bar Register, published annually, includes only those attorneys who possess a
professional reputation. That does not necessary measure their actual competence
in estate planning. Even so, it is certainly a good starting point.
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The Martindale-Hubbell Law Directory lists every attorney in the United States
and rates his or her legal ability with the statement: "No arbitrary rule for
determining legal ability has been formulated, but ten years' admission is the
minimum required for the legal ability rating of 'a' (very high), five years for the 'b'
(high) rating and three years for the 'c' (fair). Obviously, this is more a listing of
time served than legal ability. Also listed will be a biographical section that lists
legal education, public offices held and association memberships.
Special Provisions
A tightly drawn legal will contains a residuary clause. This pertains to what
remains after the rest of the estate has been distributed or paid out. Generally, a
paragraph is included to direct the state in the rare event that all of the family is
wiped out together. In this event, a charity is often named.
Since a will is a personal document, there is often a need for special provisions.
Generally, exceptional or special provisions fall into four groups:
1. Personal;
2. Beneficiary arrangements;
3. Property distribution; and
4. Family and public relationships.
Under the personal category, it is easy to understand why personal situations might
affect the testator. A nurse or housekeeper who has stayed with the family through
all situations may certainly deserve to be recognized in the will. Often it also serves
to keep a person's loyalty when they know that loyalty will be financially
recognized.
Still under the personal heading, many people also like to include their funeral
arrangements in their will. Sometimes, they simply state their funeral wishes with
no actual arrangements having been made. Frequently, however, the will is not
read until days after the grave is closed. Therefore, the testator needs to make their
wishes known to family and friends. It would also be wise to record their wishes
elsewhere.
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It is also, as a personal choice, becoming increasingly popular to donate, in part or
whole, one's body to medical science or to others. With so much in the news about
people who can live only with organ transplants, it can be expected that more and
more testators will make provisions for this in their wills. As with funeral wishes,
these types of gifts need to be common knowledge among friends and family,
especially with organ gifts where timing is so often critical. Many states now list
organ donors on their driver licenses.
The second group, beneficiary arrangements, often ties into the first group of
personal wishes. If the testator wants to make a lump-sum bequest to another
person who has a shorter life expectancy, some special considerations may need to
be considered. This might be an older sister or brother, or someone with severe
health conditions. Then the question becomes one of good sense. Why leave a
person something he or she probably will not live to enjoy?
Sometimes, a better choice is to put the money into a financial vehicle that can be
used prior to the testator's death. An annuity is often used for this purpose since the
money can revert back to the testator upon the annuitant's death.
Another problem that can come up when designating beneficiaries arises when the
beneficiary is a mentally or physically handicapped child. Sometimes it is not
merely a matter of willing financial assets, but willing them in a way that will best
protect that child. This is one situation where a living trust may be called for, even
if the estate is relatively small.
Providing funding is often not the main concern for the parents of a handicapped
or mentally challenged child. Their main concern may be who will care for that
child. Sometimes an estate is set up to tie a caregiver into it. For instance, it may
financially aid a sibling who provides that care for their disabled sister or brother.
When the estate is small, it can be extremely difficult to provide for a disabled
child. There simply may not be enough resources to do any long range planning.
In this situation, it is wise to investigate state and federal programs that may be able
to help the disabled child.
Some examples of providers of these programs are:
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1. Medicaid (medical care for all ages). In California, it is referred to as MediCal.
2. The Department of Health, Education and Welfare.
3. The Old Age and Survivors Disability Insurance Program under which a
disabled child may be entitled to benefits.
4. A federal-state program of assistance known as Aid to the Permanently and
Totally Disabled.
5. Benefits under GI insurance policies and other veteran's benefit programs,
such as Orphans Educational Assistance.
6. If either parent worked for the railroad, The Railroad Retirement Act.
These programs listed are only some that might be available. The various
programs available are in a constant flux. Inquiries into the programs available
could result in provisions in the will that might otherwise have been overlooked.
Still under beneficiary arrangements comes the Spendthrift Clause. This clause
is designed to prevent claims by third parties from touching trust assets. It does not
necessarily mean that the beneficiary is not financially dependable. It is simply a
protection against those who may want to tap into the funds, such as salespeople or
creditors, while still allowing the trustee to provide for necessary living expenses.
If a spendthrift clause is used, it should be expressly inapplicable to those portions
of the document establishing or relating to a Marital Trust. Otherwise, tax benefits
may easily be lost.
Sometimes, a testator may include a provision in his or her will regarding the
possibility of one of the beneficiaries becoming disabled after the will was written.
Generally, they direct a trustee to make payments directly to those supplying that
beneficiary with goods or services. The trustee is then entitled to protection against
the claims of other disgruntled beneficiaries who feel that the trustee was too
generous in caring for the needs of the one beneficiary who became disabled. The
trustee must still, of course, act in good faith.
Under the third group, property distribution, some types of property need special
attention.
This is true of both published and unpublished manuscripts,
compositions, and artwork of writers and artists. A special literary executor with
authority to handle all matters affecting artistic property needs to be named.
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Many people own art objects. This may also include special pieces of furniture,
silver, or other items, which should not be sold as simple possessions. The high
cost of storage can be saved and the lives of the beneficiaries can be brightened if
such items are specifically mentioned in the will. Generally, wills make these items
available for use and enjoyment directly by the beneficiaries.
Every person has personal items that they hold dear. These items may or may not
be valuable. Often a person's favorite things should not be wholesaled into the
residue of the estate. Say, for example, that the wife dies and the husband
remarries. There will undoubtedly be items she would not have wanted another
wife to use. Had she specified in her will specific people these items should have
gone to the matter would be much simpler for the husband to handle. The wife
should not only make mention of special items in her will, but also make it known
to family members. Not only is this wise legally, but it will also go a long way in
keeping family peace in the event of her death.
A dear possession for many people is their pets. All too often, these important
family members are forgotten in the will. This is certainly understandable since
wills are so often written prior to obtaining the pets. If other family members are
equally attached to the pets in question, there may not be any problem of continued
care. Unfortunately, this is not always the case.
Care for pets must cover three time periods:
1. Prior to the death of the testator, when critical illness may prevent proper care
of the pets;
2. During the interim months of postmortem management; and
3. For the rest of the pet's life once the will and distribution of property is
completed.
Sometimes, one simple arrangement covers all three periods; sometimes, it takes
two or even three separate arrangements. If a trust is established, the trustee will
need to have specific instructions as to the financial arrangements to assure proper
care of the pets.
Of course, the difficulty of the situation is obvious. No matter how well a person
attempts to protect and provide for the pet, that pet cannot speak up for itself. If the
pet's rights are violated, the pet has no legal recourse. The plan is really an act of
faith, in many ways. The ability to actually offer legal protection is limited since it
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is not likely that any person will care about that particular pet as much as it's
original owner. The best protection for pets is friends or family who act, not on
legal grounds, but out of love for the pet and the pet's previous owner (the testator).
Sill under the third division of property, there sometimes occurs what is called
ademption. This means that a specific bequest of a will is no longer possible. The
reason varies: the property may no longer exist; it may have been previously given
away or sold; or the value may no longer exist in the case of some types of assets.
Therefore, the will needs to include instructions in the event that the property, for
whatever reason, cannot be transferred to the beneficiary as the will directed. Some
wills direct a cash value if the item is no longer available.
Any debts against the property must also be addressed in the will, as might be the
case with real estate or an automobile. The will must specify whether or not the
estate is to pay off the debt prior to transferring the title to the beneficiary. When
making any specific bequest, all factors need to be stated clearly. This is why the
"do-it-yourself" wills and living trusts often cause more problems than they ever
solve.
It is not unusual for a testator to want to "forgive" an existing debt when
distributing property through a will or trust. If the testator does wish to do so, it is
necessary to be very clear in the will as to how it should be accomplished. There
can be so many small technical issues that it may have been wise to forgive the debt
before death. Anytime this is considered, a tax specialist should probably be
consulted for the best tax results.
The fourth group, family and public relationships, was originally rooted in the
belief that estates pass primarily to the eldest son. Seldom was it passed on to a
daughter, eldest or not. This was done to ensure that the family, its name, and
status continued through the generations. Now, estates tend to be more of an
equality issue. Still, many family-owned businesses continue to be given cash
equivalents.
Unfortunately, some testators still want to make their will an occasion to denounce
certain family members. This is an outdated way to write a will and is often
considered more of a statement about the testator's personal shortcomings than a
flaw on the beneficiary. If a testator truly wishes to exclude family members it
needs to be well thought out and reviewed often. Anger present today may not exist
at the time of death. Often anger ends just prior to death; changes in the will are not
possible at this point, or at best difficult to achieve.
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In some jurisdictions, children as well as the spouse, receive a statutory minimum
even if the testator tried to prevent them from receiving anything. It is true,
however, that a testator has the right to NOT bequeath. Except for spouses and, in
some states, children, the testator can simply not give anything to a family member.
If this is the desire of the testator (and he or she wishes it to hold up if contested), it
must be legally written. If all sisters and brothers are mentioned except one, for
example, an attorney could successfully argue that it was merely an oversight or a
clerical error. Therefore, as a legal precaution, that one excluded sibling needs to
be specifically mentioned as disinherited as a matter of record.
Some wills include a clause or two stating that anyone who contests the will
receives nothing or a trivial amount. Due to state laws governing wills, such a nocontest clause must be very carefully thought out. Often a kind, well thought-out
will can prevent someone from contesting the will in the first place. If the testator
avoids excessive eccentricity in his or her will, it will also make a will more
difficult to contest. A testator who makes extremely unusual bequests may make
himself or herself look senile and invite a will to be contested.
The types of property owned will play a key role in the will or trust. Property is
anything capable of being owned. This may include material objects held in
outright ownership or the right to possess, enjoy, use or transfer something.
There are two classes of property:
1. Real Property, and
2. Personal Property.
Real property is land and all things that are permanently attached to that property,
such as a home, garage, trees, shrubs, growing crops, and so forth. It does not
include a mobile home, unless it has been put on a permanent foundation.
Personal property may be either tangible or intangible. Both types include any
property that is not "real" property. Tangible property can be touched, felt, and
seen. This would include motor vehicles, furniture, clothing, etc. Intangible
property has no intrinsic value. This would include bonds, mortgages, and stocks.
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In most states, there are assets that speak for themselves regarding who are to be
their new owners. These items pass outside of a will or trust because they have a
named beneficiary. Only if the beneficiary stated is the "estate" will they pass
through the probate procedure. Insurance policies come under this situation. Also
included, as previously stated, are joint bank or brokerage accounts with the rightof-survivorship.
Estates generally involve ownership interests in real property. Items that list
beneficiaries pass outside of living trusts and wills. This would include insurance
contracts where beneficiaries are stated.
There are three main types of estates:
1. Fee Simple Estates,
2. Life Estates, and
3. Estates for a Term of Specific Years.
Fee-Simple Estates mean that there is an interest in the property (real property)
that belongs to an individual, then to the heirs forever. For example, Sam Jones
dies. In his will he leaves his home to his son, Howard Jones. When Howard dies,
his will leaves the house to his daughter, Jane Jones. This might continue through
generations.
In a Life Estate, an individual has absolute right to possession, enjoyment, and
profit from the property for the duration of his or her life. The person's legal
interest in the property ends at their death. For example, when estate owner Sam
Jones dies, his will states that his home goes to his son, Howard Jones. When
Howard dies, however, ownership goes to a person specified in Sam's will, not to a
person named in Howard's will. Howard never had a legal right to pass on the
home according to the terms of Sam's will (the original owner). The owner of a
Life Estate for his own life has no interest in the transfer at their death. A life estate
can be measured by the tenant's life or by the life of another person, as designated
by the will.
An estate for a term of specific years sets the interest in the property for a set
amount of time. If a tenant dies before the end of the specified period of time, the
right to possess the property for the rest of the term will be determined by the will.
Of course, the tenant has no right to transfer the property either during his or her
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term or at the close of the term. The will states what is to become of the property at
the end of the term.
For example: estate owner, Sam Jones, specifies in his will that his son, Howard
Jones, may have possession of the home for five years. At the end of those five
years, Sam specifies that the home revert to Sam's grandson who turns 21 years old
at that point in time.
Sam's grandson would be called a Remainderman. He received ownership of the
home only when the five years were up. Sam's grandson had a vested interest
because his right to receive property at a specified time was fixed and absolute.
Some wills may put a condition upon receiving property at a specified time. This
is called a Contingent Interest. For Example: suppose Sam Jones said his
grandson could have the house in five years only if he were married. Remember
that a contingent interest may or may not materialize. If Sam's grandson had not
married by that specified period, most wills would then state another person to
receive the property or it would remain with Howard himself.
If the grandson must be married at a specific time to inherit the house that would
make him a contingent remainderman.
Some wills may have Reversionary Interests. This means the property owner
transfers the property while still living, but reserves the right to have all or part of
the property returned. Reversionary Interests may be either vested or contingent.
One point to keep in mind regarding remainder and reversionary interests - they
must be carefully structured to avoid the tax liability of incomplete transfers. The
property may be taxed to the original grantor as if the grantor were still in
possession of the property.
Special Agreements
Agreements often control how a will is written. There may be an agreement, for
example, to supply college funding for a grandchild in return for care during the
individual’s last years. Also, several types of ownership are so well aimed at estate
planning that they require special attention in a will. A legally binding agreement
regarding mandatory provisions of a will is useful to both parties involved. The
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disadvantage is that the will takes on an undesirable finality. To make any changes
requires a mutual consent.
A type of agreement used more and more is Antenuptial Agreements. Many
older people are now involved in second and third marriages where both husband
and wife have grown children. It often prevents problems and misunderstandings
when Antenuptial Agreements keep the husband's and wife's property separate. If
either party dies, their property reverts to their own children rather than to their
spouse. Of course, an Antenuptial Agreement can bequeath property to anyone, but
typically, it goes to the person's direct family as in this example. These types of
agreements can be especially important in community property states.
There can be two types of property owners. The Legal Owner is the most
common type. As implied, the legal owner has legal title to the property. This
individual has absolute ownership with all the related responsibilities of ownership.
An Equitable or Beneficial Owner is a person entitled to all the benefits of the
property. This might be through a trust where the trustee is vested with legal title,
but the income from the trust goes to someone who has Equitable Title.
Domiciles and Property Ownership
There are several factors that affect ownership of property. One is the location of
the property, or where the property is kept. All personal property (real and
tangible) is subject to the tax laws of the state or jurisdiction in which the property
is located. The place where the property is located is called the situs.
The permanent residence of the person who dies is called the domicile. Since a
person may have several residences, it is possible to have what appears to be more
than one domicile. A domicile is established by several factors:
1. Bank accounts and safe deposit boxes
2. Living in a residence for more than six months out of a year
3. The automobile registration
4. Their voter registration
5. Memberships established in social clubs or religious groups
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6. The location of the property that is considered to be the principle residence.
Taxation of property can also take several avenues. Real estate is taxed by the
state in which it is located. This is true regardless of the deceased person's stated
domicile.
Tangible personal property is taxed according to where the property is kept. In
some cases, it may also be taxed by the domicile state.
Intangible personal property is taxed by the state where permanent residence is
kept regardless of where the property is located. For instance, a bond may be kept
in a safe deposit box in another state. However, the state of residence would collect
any tax owing on it.
Taxation in multiple states can sometimes occur. Say, for example, that a person's
permanent residence is in Oregon, but they own real property in California, as well.
In addition, tangible personal property is located in Nevada and intangible personal
property is in Montana. At death, Oregon could tax all property, except real estate
in California. Real estate is always taxed by the state in which it is located.
Montana may also tax the tangible personal property unless Montana exempts
personal property of a non-resident. With such scattered assets, it would be wise to
investigate the use of a living trust.
What happens when the person who dies is a co-owner of property? This is also
called Concurrent Ownership. There are four types of co-ownership of property.
Tenancy-In-common means co-ownership between two or more people who are
not necessarily related to each other. Each person's share is an Undivided Interest
in the property. The people involved may have unequal or equal shares. Each
person may do with their share as they choose. They may sell it, gift it or direct it
to their heirs. It does not require the consent or knowledge of the other tenants. For
tax purposes, a co-tenant is treated as a separate owner. Of course, any income
generated is divided among the co-owners according to their share of property.
Each co-owner would also pay their share of the maintenance and operation
expenses. When a co-tenant sells or gifts their interests, the gain or loss may be
realized on the transaction. The new owner becomes a co-owner with the other
tenants.
As previously stated, the most common form of co-ownership is Joint Tenancy
with Right of Survivorship (JTWRS). This means that the tenant's share cannot
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be transferred by will. When a joint tenant dies, that tenant's share goes to the
surviving tenants.
When a joint tenancy is created, the person giving the most money to buy the
property has made a gift to the other joint tenants. Should a co-tenant wish to sell
his or her interest and the property cannot be divided, the entire property must be
sold and the sale proceeds then distributed among the co-tenants. This is called a
partition sale.
Each tenant may sell their interest in their property only during their lifetime,
without consent of any of the other tenants. The new owner would become a
tenant-in-common with the other tenants. As each tenant dies, the last surviving
tenant becomes the sole owner. He or she may then dispose of the property as they
wish.
There is a legal relationship between the joint tenants. Interest on bank accounts is
reported in a proportionate amount to the amount of money they put into the
account. If immediate vesting is given to the co-owners, then each tenant is also
entitled to an equal share of any interest earned. They would, of course, also be
taxed on those interest earnings, in most cases.
Tenancy by the entirety is similar to a JTWRS, but it is limited to the coownership of property by a husband and wife only. The tenancy would
automatically terminate should a divorce occur. The death of either spouse would
put sole ownership with the remaining spouse. Neither the husband nor the wife
could sell their share without the consent of the other.
There are some distinct advantages of Joint Tenancy with the Right of
Survivorship and also of tenancy by the entirety. One of these advantages is that
it puts the property outside the reach of a tenant's creditors. Another definite
advantage is the fact that there are no probate delays at death. Depending upon the
state laws where the property is held, it may be exempt from state death taxes.
During the death of a tenant, the passing of ownership is also private. All of this
gives the tenants great security.
As with all things, there are also some disadvantages. One may be the possibility
of gift taxes. There is also the possibility of double federal estate taxation. If the
property gets down to a lone surviving tenant, then his or her creditors can attach
the property.
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Some states are community property states. This means that all property
acquired during the marriage is owned equally by both husband and wife. At death,
neither one can will more than half of the joint property to another person.
Property acquired prior to marriage is generally considered to be separate
property. Gifts, inheritances and property bought with individual funds are also
generally considered separate property.
If a couple moves out of a community property state to a common-law state, those
properties acquired in the community property state will still be considered
community property. Therefore, the reverse is also true. If a couple moves from a
common-law state to a community property state, the property comes under the
laws of the original state where purchased.
A Joint Will is one where the same document is made the will of two or more
people and is jointly signed by them. Typically, joint wills are used where jointly
owned property needs to be willed.
When two or more people make separate wills containing mutual provisions in
favor of each other, it is called a Mutual Will. A will may contain provisions,
which make a single will both joint and mutual.
Gifting & Other Property Disbursement
Although gift giving is generally an effective tool for estate planning, gifts can
also sometimes be taxable. Naturally, no one should give away property that they
may need to live on in the future. Since future events may be uncertain at best,
extensive gifts should be limited.
A book put out by U.S. News & World Report titled Money Management states
very specifically that one must think before giving away large gifts. It is true that
an individual can save money by giving it away, although gifts in excess of the
allowable exemptions are taxable. If an individual gives away income-producing
property, he or she will reduce his or her own income tax liability. But again, it is
necessary to first think about what is being given away. The tax consequences are
not the most important factor to consider.
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No gifts should be made that will reduce the size of the estate below the amount
that will be needed for the individual's future standard of living. Each person must
consider how much is necessary to have to maintain the current level of comfort.
Do not forget about the effects inflation will have on the standard of living. It
should also be remembered that things can quickly change. There is no way of
knowing how future needs may change, whether by illness or other circumstances.
In addition, unless the estate is very large, gifts seldom make a substantial taxable
difference.
A gift is generally considered to be any gratuitous transfer of property. The donor
is the person who gives the gift. The donee is the one who receives the gift.
Taxation occurs when the value of the gift is over a certain dollar figure.
There are three conditions that must be met to qualify a transfer of property as a
gift:
1. The transfer of property must be for less-than-adequate consideration. This
means that the gift given was not compensated for by the donee in any
adequate fashion. Say, for example, that Mr. Jones gives his son, Howard, a
parcel of property. In return Howard thanks his father and promises to be a
good son. Howard's verbal thanks are not adequate monetary compensation.
Therefore, the land is a gift.
2. The donor must actually deliver the gift to the donee. In other words, if Mr.
Jones merely promised Howard the land, but never actually transferred the
title, no gift was legally given.
3. Lastly, the donee must accept the gift. If Howard refused to accept his
father's gift of the land, the transaction cannot be completed. Say, for
instance, that the land Mr. Jones wishes to give to his son was barren and of
little value for any practical use. Once transferred, Howard would be
responsible for the property taxes on that parcel of land. If Howard did not
want to pay property taxes on property he had no use for, he might decide to
refuse the gift.
Sometimes a gift transfer is not completed for technical reasons. A sick person
may gift property to transfer at his or her death. If that person then recovers from
their illness, the gift transfer may not complete itself for a long period of time, or
perhaps, due to changes, never occur at all.
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A gift of cash issued by check is not complete until that check is actually cashed.
If the check becomes lost in the mail the gift transaction cannot be completed until a
new check is issued and cashed.
Transfer of U.S. government bonds occurs under federal law rather than state law.
Under federal regulations, the gift transfer is not complete until the registration has
been changed to the donee.
Gifts given through a revocable living trust are incomplete gifts in trust. The
donor has the right to change his or her trust at any time. Only death actually
completes the gift transfer assuming the donor did not revoke the gift during their
lifetime. An irrevocable living trust would complete the gift transaction before
death. In an irrevocable trust, the donor gives up all further control of the property.
This should not be confused with a revocable trust where the donor retains control.
There are several types of gifts. Direct gifts are probably the most common. As
the name implies, property is simply transferred to another. This often happens
when a money transaction begins as a loan. For example, Sam Jones loans Howard,
his son, $40,000 for a down payment on a new home. Howard signs a note
agreeing to pay his father back. After consideration, Sam decides not to require
Howard to pay him back, so he cancels out the note Howard signed. The $40,000
now becomes a gift.
Third party transfers involve three people or three groups of people. Typically,
the first party provides a gift to the second party who agrees to provide a service to
a third party. The third party is the donee. The first party is the donor. This
concept may sound confusing, but it does have its uses. For example, Sam would
like Howard's wife to take care of Sam's mother. However, Sam's wife, Helen,
feels that she needs to bring in an income to help the family. Therefore, Sam agrees
to give Helen something of value in return for caring for his mother.
The first party is Sam. He is the donor who gives the gift.
The second party is Helen. She agrees to provide a service to the third party
(Sam's mother) for the gift.
The third party is Sam's mother. She is also the donee who receives the
service.
Indirect gifts are more common than we might realize. For instance, Howard is
fired from his job, so his father, Sam, pays Howard's life insurance premiums for
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him and does not expect to be repaid. That is an indirect gift. An indirect gift also
occurs when property rights are shifted.
Life insurance is often an indirect gift. This happens when the insured buys a life
policy on his or her own life and:
1. Retains no reversionary interest.
2. Makes the beneficiary irrevocable.
3. Names a beneficiary other than his own estate.
To illustrate this, let's say that Helen Jones owns a policy on her husband, Sam
Jones. Helen makes the beneficiaries her grandchildren. When Sam dies, the IRS
could argue that the death benefit was a gift. In other words, Helen gave that
money to her grandchildren. As a result, it may possibly be taxed as a gift.
There are gratuitous transfers that are not considered by the IRS to be gifts. Since
services given are not considered to be property, one could give their time or
services without fear of a gift tax. Transfers in the regular transaction of business
are also not considered to be gifts.
A sham gift is also not considered to be a gift. This means that the transfer of
property was done solely to shift the income tax burden from a person in a high tax
bracket to a person in a lower paying tax bracket. The donor would still be liable
for any tax due, if the gift was determined to be a sham gift.
There are also some gifts that are exempt from gift taxes. The first one listed here
is no surprise: political donations to organizations (not individuals) for use by that
organization. Another exemption is money or other property given in payment of
someone's medical care. Also tuition paid to an educational institution is exempt.
Properties transferred between husband and wife during a divorce settlement is
never considered to be a gift.
When a value needs to be placed on a transferred property for gift tax reasons, the
value is determined by the date of the transfer. If a parcel of property purchased ten
years ago were gifted today, then today's market values would be used. If the donee
must pay property tax, then the gift value is reduced by the amount of the tax.
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If the donor is personally liable for a mortgage on the parcel of property, the value
is still for the entire amount of the land. The balance owing on the property does
not reduce its gift liability. If the donee pays off the mortgage and will have no
ability or right to recover the amount of the outstanding mortgage, then the value
will be based on the donor's equity only. Only if the donor pays for the mortgage
will the full amount be considered its gift value.
In other words, Sam Jones gifts a parcel of land to his son, Howard Jones. There
is a mortgage owing on the property of $25,000. The entire value is considered to
be $40,000. If Sam pays off the mortgage, Howard was gifted the entire amount of
$40,000. However, if the son (Howard) pays off the mortgage, then the gift amount
is the equity value of $15,000.
When life insurance and annuities are transferred within the first year of the
policy, the gift amount is the entire amount of the premium paid during that policy's
existence. A single premium or paid-up policy is valued at its replacement value.
The replacement value is based on the insured's age at the time of the transfer. If
the policy is in the premium paying state, it is valued roughly at the policy's cash
value and the unearned premium on the date of transfer.
One of the primary elements of any will is the designation of beneficiaries. There
are four types or groups of beneficiaries:
1. Preferential
2. Primary
3. Secondary
4. Tertiary
The basic purpose of wills is generally to provide property for the benefit of
people and charities. We are using "charities" in a broad sense. It may refer to
churches, hospitals, schools, etc. Other than providing people and charities with a
testator's property, a will is merely a format to disperse personal assets.
Preferential beneficiaries are those people who, in the eyes of the law, have legal
rights to designated portions of an estate, or at the least, to be mentioned in the will
as proof that they have not been forgotten.
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In common law states, the wife's portion, as required by law, was traditionally
called dower. Upon her husband's death, she becomes a dowager. The husband's
reciprocal interest in his wife's estate is called courtesy. These portions, protected
by law, are between one-third and one-half of the total estate. Both terms have
generally been replaced by what may be called statutory share of the surviving
spouse.
A husband or wife who was willed less than required by their particular state's law
may elect to take their statutory share despite the will's division. Therefore, a
spouse who decides to cut out their legally married partner will find himself or
herself unable to do so.
Many states also demand that other beneficiaries (children) be remembered,
although not necessarily left anything substantial or equal. Many testators simply
leave as little as one dollar to a particular child.
A primary beneficiary is self-explanatory. They are members of the immediate
family. Primary beneficiaries may include parents and siblings, though not
necessarily. The first and foremost primary beneficiary is the spouse of the
deceased. Second only to the spouse are the children. It is generally felt that all
children should be treated equally. That is not to say that a testator may not divide
his or her property as he or she sees fit. However, a teenager that is a problem
today may be a model adult five years later. A will written to exclude that child
today may be regretted five years later. Therefore, it is normally recommended that
all children be treated equally in a will or trust. The question then becomes hinged
on the word "equally." What is equal treatment?
Equal does not necessarily mean equal divisions of an estate. Say, for example,
that one child marries at 18 years of age and becomes self-supporting while another
child attends college for four to eight years. That college education might be
considered to be part of their inheritance. That may be especially applicable in
smaller estates, where there is less to go around.
Equal treatment can often be measured in terms other than dollars. A child who is
disabled physically, mentally or emotionally would need to be treated differently
than a sibling who was employed with a bright future ahead of him. Even though
the disabled child would receive the bulk of the estate, it is still fair and equal
treatment since the estate is balancing out the children's future.
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Often an estate that seems partial to one child might actually be an exchange for
past services. Say, for instance, that one unmarried (or even married) child took
care of the parents during their last years of life. Leaving that child the bulk of the
estate is fair and equal because it is repaying her for past years of service.
When estates attempt bequests to grandchildren, it is often difficult to keep it equal
and fair. If the estate goes to the grandchildren per stirpes, it is impossible to keep
it equal. Per stirpes means the grandchildren will get their parent's share if the
parent becomes deceased. One child of the deceased may have only one offspring
of their own, while another child of the deceased may have several. Therefore,
equality is not possible. Even with this inborn inequality, per stirpes is still the
general method used in wills and tends to work well.
Another method is by specific bequests. This means that the will specifically
states what each grandchild will receive. This is often seen when grandparents have
favorites among their grandchildren and wish to recognize those favorites.
In a per capita distribution, each grandchild would share equally. Large gaps in
the grandchildren's ages can cause some problems in this type of distribution
method. The testator's youngest child may not be much older than the oldest
grandchild, in some cases. Therefore, as the testator's children die, the
grandchildren would inherit in a trickle effect.
A common part of families today are stepchildren. With second and third
marriages on the rise, many families now have "mine, yours and ours." This can
also apply to finances. This can especially be true if deceased parents or
grandparents have established trusts. Adopting each other’s children sometimes
proves the most desirable step to take, although that may not always be a possibility
if divorce, rather than death, was the factor that split the family. Adoption may still
not equal out a trust, however, where the terms are typically quite specific.
When a trust is in effect which expressly benefits some of the children, but not
others, in a family made up of "yours, mine and ours," children will likely sense at
an early age that some of them "have", while others "have not." This does
sometimes strain the relationships, but need not do so if openly discussed. In such
situations, it is extremely difficult to draft a will that is fair and equal to all, since
finances may already be unequal. Second and third marriages also bring up another
fear when drafting a will: divorce. Many times parents do not feel comfortable
being "fair and equal" in their will in regard to stepchildren. There is no easy
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answer to this problem, but it is often solved by separate wills with each spouse
being private in their decisions, which is, after all, their right.
Secondary beneficiaries include brothers, sisters, aunts, uncles, and cousins and
may also include special friends. When dealing with secondary beneficiaries, there
is no attempt (nor should there be) to be fair or equal. Generally speaking, when
portions of an estate are given to secondary beneficiaries, there are good reasons
why sharp distinctions are made. It may be due to special affections or to services
given. It may even be due to specific financial needs of certain individuals, which
the testator wishes to address in some way.
Tertiary beneficiaries are the third class of beneficiaries and it includes charities,
projects, organizations, and people where there is no push of duty. It is common for
the bequest to be a small token amount with the intent to be more of a formal
mention in the will, rather than a substantial property transfer. Only a minority of
wills contains fairly large bequests given to Tertiary Beneficiaries. It may seem to
happen more often than it actually does because these are often bequests that end up
in the local newspaper.
There is a good reason why tertiary beneficiaries do not generally get large estates
willed to them. A person who has a fair sized estate is likely to give to charities
while they are alive; not after they are dead. Giving to charities allows a tax credit,
which is why it makes more sense to give to charities while one is still living. Such
advice is likely given to the testator by both their attorney and accountant.
When giving assets to charities through a will, it is wise to put as few restrictions
as possible on it. Too often restrictions placed on a will today poorly apply 20
years later when the testator dies. In the past years, it was popular, for instance, to
stipulate that funds go to research for a specific disease, such as small pox or polio.
By the time the testator actually dies, the money may have been much more
beneficial for more people had it merely been restricted in the will or trust to
medical research in general.
Sometimes a charity may even go out of business. In many towns, there are
organizations (the Cleveland Foundation was the first) established to administer and
disburse funds, as donors have directed, to worthy charities and groups. A general
directive is all that is needed. For example, a testator might simply say that he or
she wants their money to benefit wayward boys or girls. That organization will
then apply the money to a group working with boys and girls at the time of the
testator's death. Usually, a bank is the trustee when these organizations are utilized.
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There should be no vagueness when it comes to beneficiaries. Even when it
comes to a husband, wife or children, full names need to be used and the
relationship to the testator stated. For example: Mary Beth Jones, wife. This is
especially true when it comes to beneficiaries outside of the immediate family.
There may be two aunts with similar names. To simply say "My aunt, Bess" could
cause much confusion. Does the testator mean their Aunt Betsy (often called Bess)
or her Aunt Elizabeth, also often called Bess. Even if immediate family members
are quite sure the testator meant Aunt Betsy, the courts may decide otherwise.
When giving to charities, names must certainly be clear. This is especially true
now, with so many charities appearing to copy the names of well-known
organizations. If giving to a broad charity, the exact division of that charity should
also be stated for clarity. There have been court battles over large estates when the
charity named was vague. These court battles can go on for years and cost
thousands of dollars in attorney and court fees.
Following Legal Procedures
Laws governing wills vary from state to state. In every state, however, the laws
concerning wills are strict, since the person who signed the will is dead and cannot
say what he or she intended. That person cannot redefine what they wanted done
with their property. It must be clearly understood by those reading the documents.
It must also be clear that the decedent KNEW what he or she was signing.
Therefore, witnesses are required for legal documents. At the time of the execution,
the testator must declare the document to be a will and request the witnesses
personally attest to the signature of the testator. Once a will is executed according
to the laws of the particular state where it was signed, that will is then valid
anywhere.
Many states now allow for Self-Proving Wills. Such a will has an affidavit
attached to it that contains a sworn statement by each of the witnesses. The
affidavit is completed at the time the will is signed. The witnesses swear under oath
that the testator signed the will in their presence and was competent and not under
any duress. When a self-proving will is used, it is not necessary to locate the
witnesses at the time of death to obtain their testimony. Obviously, this saves time
and money after a death.
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When a person has a living trust drawn up, or some other estate planning vehicle
that requires a trustee (or fiduciary), there are responsibilities which the trustee or
fiduciary must accept. The trustee will be acting for another's benefit. It is
important to understand that the trustee does not have to accept the position or
appointment. If they do accept it, however, the trustee is then under legal obligation
to fulfill all responsibilities connected with the position until relieved of the duties.
The duration of the appointment may be up to one year or even for the trustee's
lifetime.
The trustee or fiduciary must meet many responsibilities. He or she is acting for
the benefit of another person. With that in mind, he or she cannot delegate power,
nor can he or she profit at the expense of the beneficiary. Full disclosure is required
and the trustee must be impartial when there are two or more beneficiaries involved.
A layperson is expected to handle the responsibilities according to the PrudentMan Rule. This means that the trustee must act in a manner that can be reasonably
expected of a prudent man. A professional, such as an attorney or an insurance
agent, would be held to a higher standard.
A fiduciary can be a guardian, an administrator, an executor, or a trustee.
Whichever the title, the fiduciary is expected to refrain from several specific types
of action. They may not compete for investments or business opportunities that
would involve the assets they are responsible for. Personal profits from the
properties are not allowed.
The trustee may not invest trust funds in any stock of the fiduciary. In some
states, if the trustee is a bank, then the trustee cannot even deposit the funds in their
own bank. The trustee cannot purchase property from any party in which the
trustee has an interest. If a trustee has several trust accounts, they must all be
treated equally. Obviously, a fiduciary cannot use any of the trust properties for
personal reasons or personal gain.
When a person is setting up a trust for himself or herself, choosing a trustee should
be done with much thought. Many people act as their own trustee initially, but even
if this is done, a trustee still must be chosen to follow in the event of their death or
to take over if the testator (acting as trustee) becomes ill. Complications often
occur when the trustee is also one of the beneficiaries. Family members are often in
uncomfortable and difficult situations when they are the trustees. That is because
the trustee cannot participate in some of the decisions. Age must be considered also
since an elderly person may not be able to handle the position for very long. Also
of great importance is the person's background and capabilities when it comes to
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managing a trust. In some cases, cost is also a consideration. Banks, for example,
charge a fee to act as a trustee. Attorneys may also charge a fee. Many experts
recommend that the attorney who draws up the trust never be the trustee also since
there can be definite conflict of interests. If an attorney is desired to serve as the
trustee, have a different attorney than the one who drew up the trust. This protects
not only the trust property itself, but also the attorney serving as the trustee. Most
professionals take it one step farther; they use attorneys in two different offices
rather than two attorneys who perhaps work closely together.
A trustee can commit what is called breach of duty. This means the trustee fails
to act appropriately. It can occur if the trustee takes funds from the trust for an
unauthorized reason. This is a civil and a criminal breach of duty.
A trustee does have considerable power. Although the trustee must act prudently,
the trustee has the power to compromise claims; distribute property in cash or kind
or both. The trustee may sell property and investments and borrow money, if the
trust document so allows. A corporate trustee may invest and reinvest in common
trust funds. This occurs when banks and trust companies combine investment
funds from many trusts to get better returns. A trustee may employ attorneys,
advisers and accountants. Again, the amount of power given is good reason to
choose a trustee with long consideration.
An executor or administrator acts for the person at the time of the person's death.
All powers come from statutes and last for the term of the estate. When choosing
an executor, consider their skills of managing assets, their personal knowledge and
their ability to give their time. Do avoid selecting someone who will have a conflict
of interest.
A guardian is given the responsibility of caring for another person and their
property. There may be two types of guardians in an estate: one for property and
another for a person or persons. A ward is the person the guardian cares for.
Generally, a guardian is needed because the ward is under the legal age or is unable
to protect themselves due to physical, mental or emotional disabilities. A guardian
does not receive any ownership of the ward's properties. Usually a guardian is in
charge of either a person or of property, or even both. A guardian's duties last until
the ward reaches legal age, or until the estate is settled and disposed of. A guardian
is held to the same legal standards as trustees.
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A witness to a will normally does not read the will. It simply is not necessary to
do so. The witness is merely witnessing another person's signature, not the contents
of the document. It is best if the witness knows the testator and is younger than the
testator. Even then, the witness may happen to die first and be unavailable when
the time comes to testify (if that should be necessary). It is most convenient if the
signature is one that can be easily verified, such as an attorney whose signature
appears on multiple court documents, or a doctor whose signature can be confirmed
by many pharmacists, or any person whose signature is easily proven.
If a person has a personal interest in the estate, either directly or indirectly, they
should not be used as a witness. The parent of a beneficiary, for instance, should
not be a witness to the will or trust. Those who should not be witnesses would
include (but may not be limited to) beneficiaries, or heirs, executors, trustees and
their spouses or any relative of a beneficiary. An officer or the principal
stockholders of a corporate beneficiary might also be challenged. Also, anyone
who would not likely be available at the testator's death is not a wise choice for a
will's witness. In this situation, proving a testator's signature can be difficult and
expensive when the witnesses cannot be located and there was no self-proving will
(an affidavit of signature with the will).
If there will be the slightest chance that a testator's mental state of mind will be
questioned, the witnesses should be people who, by training or knowledge, can
attest to the fact that the testator was of sound mind. This would include nurses,
doctors and other people who would be in a position to back up the authority of the
will. In many states, it is not valid for another person to guide the hand of the
testator when signing the will, even if the person is simply too weak to sign for
themselves.
In 1970, the Supreme Court of Wisconsin ruled that a guided hand was not
acceptable as a valid signature. The judges thus overruled a 1943 Wisconsin
decision involving the will of Walter Wilcox, which previously held that physical
touching of the pen by the testator was all that was required.
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Property Transfers
Property can be transferred at death several different ways. Insurance policies
transfer through contract designation. In other words, policies transfer through a
listed beneficiary. In fact, anything listing a beneficiary will usually operate
independently of a will or a living trust. State laws will distribute property when no
will was left or discovered.
In some states, spouses can use a community property agreement to leave all
property to each other. Often, this is the only document needed when all property
will be given between a husband and a wife.
There are several types of property that will pass directly from the decedent to
another person by contract. As mentioned, insurance policies are included in this
category. Of course, if no beneficiary designation were listed in the contract, the
asset would still follow probate proceedings. Property owned jointly with right-ofsurvivorship passes also by contract.
Investments involving survivor benefits of joint-and-survivorship annuity or
survivor benefits of a life annuity pass by contract designation. Qualified employee
retirement plans typically also list a beneficiary in their death benefits. Benefits
under Antinuptial/Postnupital agreements list beneficiaries and lastly nonqualified
employee benefit plans with a designated beneficiary. In short, any vehicle that
lists a beneficiary will generally pass outside of the probate proceedings through a
contract designation. That is the best reason to always try to list someone's name
rather than simply stating "estate" under a beneficiary listing.
Property that bypasses probate is simply called non-probate property. It is no
surprise that property going through probate is called probate property. The gross
estate includes all rights to all property, both probate and non-probate. The
probate estate is all property that will go through the probate process.
To Recap: The gross estate includes all property in the estate, even if it does NOT
go through the probate proceedings. The probate estate includes only that which
will go through the probate proceedings.
Probating a will proves that the will is valid. It will include only the property
covered by that will. Each state governs the laws concerning probate.
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Probate laws do vary from state to state and will occasionally change in any given
state. What is true for California may not necessarily be true in Oregon or
Wyoming. Therefore, it is best to try to use attorneys in the state where probate
will occur for the best results.
Selecting Trustees & Other Representatives
Selecting a trustee is a major decision for those who choose an estate vehicle such
as a living trust. Choosing a trustee will affect the entire family since how that
trustee handles the trust directly affects beneficiaries. Do not choose any person
who pushes him or herself forward (volunteers, as it were) to be a trustee. This
includes the individual’s attorney. Suggesting he or she be a trustee is a clear
indication that a different attorney should be selected to write the document and
perform other duties. If the attorney volunteers and the testator believes he is,
indeed, a good choice, then assign a co-trustee (perhaps a bank representative or
relative) to balance any decisions made. An attorney who draws up the document
should never be the trustee of it. The temptation to draw up the document in their
favor is simply too great. At the very least, if the attorney acts as trustee, have his
fees for this service in writing and made part of the living trust document.
Banks generally have trust departments. It may sometimes be argued that a bank's
fees are high (and they may be), yet they are sometimes the most effective trustees
available. A bank is immortal (goes on indefinitely) and, generally speaking,
interested in doing the best job possible. Their trust officers generally have
specialized training that a friend or relative would not have. Bank procedures are
audited by accountants, then by state and federal bank examiners. Do not select a
bank solely on one or two people who work there. There is no guarantee that those
trusted bank employees would stay with that particular bank.
If a bank is desired to act as a trustee or co-trustee, select one that meets the
following tests:
1. Is the bank financially sound?
2. Is there a trust department within the bank that has a sound reputation?
3. Does the bank trust department have experience in the type of assets your
estate will contain?
4. Do you feel comfortable with the bank personally?
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Anytime a trustee is chosen, be careful not to select one that stands in a position to
gain personally. Regardless of how good the person is and how much they care
about the testator, it would invite too much temptation to do something that should
not be done. Again, if there may be any question about a trustee, then it is wise to
appoint a co-trustee or not use the person at all.
Often the testator's attorney is a wise choice as a trustee or as a co-trustee if he or
she did not write up the original document. If this is the case, fees should be openly
discussed with the testator and then put in writing. After the testator's death is
certainly not the time to be negotiating prices. An eminent lawyer who handles
estates routinely feels a trusted family attorney is the best choice for a fiduciary or
trustee. He does add, however, that any estate of real magnitude and long duration
would likely be best handled by the trust department of a bank.
If you feel you do wish to use an attorney as your trustee, do not simply name one
blindly. The attorney, like the bank, needs to meet certain requirements. This
includes, but may not be limited to:
1. Their record in business and trust affairs must be impeccable.
2. The legal office must be structured to handle the mechanics of estate and
trust matters.
As stated earlier, always seek out a specialist. Just as a doctor sometimes needs to
be a specialist to best serve your needs, an attorney also sometimes needs to be a
specialist in order to do the best job possible.
Even with all the good reasons to choose an attorney as a trustee, it is still often
felt that lawyers are better suited to overseeing trustees; not being trustees. Each
person will need to personally assess his or her own situation. Whoever is named
as trustee, it should not be sprung upon them when the testator dies. Being named
trustee can be a big responsibility; one which may not be desired by the person
named. A trustee needs to be given the chance to accept or decline before the
testator's death. Even after the death of the testator, a nominated trustee can decline
the position.
Some trusts do allow beneficiaries to change trustees. That is, the trust gives the
right to change trustees. Any trustee may be recalled, however, if he or she does
not display a responsible fiduciary attitude towards the role. In that event, the
courts will make the necessary change.
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When a beneficiary has the right to make changes in trustees, there are simple
provisions regarding notices and windup accounting procedures. One should not
change trustees without good reason. If a person changes trustees too often, or
without valid reasons, he or she may find that no one is willing to take on the task
of being their trustee or co-trustee.
Although wise estate planning can give a testator control of his or her assets even
after death, if the estate is large, it is not always wise to attempt total control. Too
many conditions change from year to year. So many conditions can affect the
circumstances of the estate.
An estate is subject to both the federal government and the state government.
Both the federal government and the state government will:
1. Enforce the directions of the testator to settle his or her estate as he or she
desired.
2. Protect the rights of any creditors.
3. Safeguard the interests of minors and any person who is considered to be
incompetent.
4. Collect any taxes due.
The agencies and bureaucrats who will be involved in completing those four goals
include:
1. The probate court in one or more states.
2. The Internal Revenue Service (IRS):
(a) The estate tax division
(b) Federal Income tax personnel in some cases
3. The tax collectors of the state where probated for estate taxes, inheritance
taxes (if applicable), and perhaps income taxes. The types of taxes due will
depend upon the state where probated. In some situations, no tax will be due
at all.
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4. The tax collectors of another state if more than one state is involved in
probate due to the decedent's residency status or assets.
5. Bureaus (if any) with supervisory powers over a continuing business.
If there was a will, the person responsible with fulfilling the desires of the testator
is called an executor, or if female, an executrix. If there is no will the person
responsible for the estate is called an administrator, or if female, an
administratrix. All of these are personal representatives of the deceased person.
Their duties divide naturally into two sections:
1. The in-court probate proceedings, and
2. The actual postmortem management of the decedent's affairs and distribution
of the property.
The second duty, postmortem management, is by far the most important.
The in-court proceedings are often merely a matter of having to take the time to be
there. The term, probate, is a Latin word meaning "to prove." That actually is
what probate is all about. Probate "proves" the will is valid. The proceedings
include petitions, notices, hearings, and orders. Many states have made these
proceedings quite brief. Probate proceedings are mostly ministerial.
States can vary, but typically the probate proceedings go in this order:
1. Give notice, if required, by whatever method is necessary.
2. Prove the will is valid, or perhaps prove that there is no will at all, as the case
may be.
3. File the oath of the personal representative and, if required, file bond as well.
4. Publish a notice to creditors and send personal notices to the heirs as the state
may require.
5. Secure an order authorizing a family allowance.
6. If the estate is solvent, secure an order to give the executor maximum
authority.
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7. An accounting record is filed by the personal representative, which shows
what he or she has done. This is called a Final Report and Petition for
Distribution.
8. Notice is given to those with a financial interest in the estate and a hearing is
held at a specified date and time.
9. Once the activities of the personal representative are approved, a Decree of
Distribution is entered. In addition, receipts from beneficiaries and others
are filed and the court proceedings are closed.
When a person dies, the estate must receive immediate attention so that the assets
are conserved and managed. What is involved in conserving and managing an
estate does, of course, vary with each family, and with the types of assets involved.
Who dies and who lives (husband or wife) may also affect choices made for the
family by the fiduciary. If the person who always ran the family business and who
understood that business dies, then a director may be needed for that business to
protect the beneficiaries. If the person who dies had no direct contact with the
business, then no director is likely to be needed.
Settling the Estate after the Testator's Death
Realizing that different situations may cause different courses of action, the
following steps are those most often taken:
1. Very personal matters are handled first. This often includes funeral
arrangements and the related items concerning death certificates, and so
forth. More often than not, these items are handled by the immediate family,
rather than by the executor. Still, the executor needs to be available in case
he or she is needed.
2. Immediate funds for the family's living expenses are the next concern. Often,
there is the fear on the part of the family that probate will freeze all funds
leaving the family in a desperate situation. A responsible executor will be
quick to dispel such fears. If a business is active, this business will also need
to be managed until a family member is both able and willing to take it over.
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3. Next the will needs to be proven and court proceedings started. Note that the
family's immediate financial needs were handled even before the will.
Again, this is the duty of a responsible executor.
4. Insurance policies need to be collected and the companies notified of the
decedent's death. This will require copies of the death certificate. This will
make additional funds immediately available to the beneficiaries, as long as
specific beneficiaries were named in the policies, since anything with a stated
beneficiary does by-pass probate. It would be foolish to list "estate" as the
beneficiary, since that would then throw the proceeds into the probate
process.
5. An inventory is required in some states and that formal inventory must be
filed in the court proceedings. This is often a good idea even if not required
by the state.
6. Fiscal management may be among the most time consuming parts of the
probate proceedings. This often includes managing current businesses,
preparing an estate budget, figuring tax requirements as soon as an
approximate estate value is known, liquidating assets to meet any cash needs,
and generally just the use of good common sense in managing the estate.
7. Some states require assets be appraised by an official appraiser, generally
appointed by the court or a state taxing authority. In other states, the
executor uses opinions of specialists (that are accepted by the Internal
Revenue Service) to determine values of items in the estate. Generally, the
appraisers are going to be mainly concerned with items of value. Normally,
it is recommended that all appraisals be in writing. This protects both the
estate and the executor.
8. If directed in the will, preliminary distribution of property begins. Generally,
the estate must first be proven to be solvent.
9. Any claims against the estate can also begin to be settled in whole or in part,
as determined desirable or necessary. This needs to be balanced against the
proper applications of the assets to the various claims.
10.Any obligations owing the estate must be collected. Properties owned by the
estate must also be retrieved. Any clouded titles need to be cleared.
11.Of course, all taxes must be paid. Tax returns need to be prepared and all
supporting documents collected. Taxes may include income taxes, federal
estate taxes on assets over the exempt amount, state inheritance taxes, if
applicable, and gift taxes. Exorbitant tax demands by taxing authorities need
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to be carefully examined by an independent specialist before being paid.
Some states do not impose state death taxes.
12.The final distribution and the closing of the estate may often be very simple.
If the will was current and properly written, the vast portion will be clearly
stated. Old, out-dated wills may prove to be less simple.
13.The basis for future capital gains is something that may affect beneficiaries.
Property subject to federal estate tax gets a new tax basis equal to the date of
death value (or alternate valuation date value, if that is selected). The
executor should advise each beneficiary of the basis of the assets he or she
receives.
Certainly, these thirteen steps may sometimes overlap or come in a somewhat
different order. Some of the steps may not even be applicable. For example, there
may be no claims against the estate, except for current household expenses (such as
electricity). It is most important that meticulous records be kept by the executor
throughout the probate process.
All transactions need to be thoroughly
documented. Many times, it is wise to have an accountant prepare an audit for the
estate.
There are many things that can delay the settling of an estate. Since there are so
many possibilities of delay, we will discuss only the more common delays. These
include, but may not be limited to:
1. The principal asset is one that is very difficult to effectively apprise. It may
be real property (real estate), an on-going business, or any number of assets.
Perhaps the Internal Revenue Service (IRS) takes two or three years to make
up its collective mind. Tax litigation follows if the beneficiaries do not agree
with the IRS. Perhaps five or six years go by before the estate is finally
settled.
2. The major beneficiary (typically a spouse) and the executor resist payment of
an enormous claim made against the estate. The claim is fought for several
years through the courts before a decision is handed down and the estate can
be settled.
3. The decedent (testator) made a major mistake when making out his or her
will. Therefore, the will is left open to contest by a possible beneficiary.
Since certain family members are entitled to participate in a will, the failure
to include one member in some manner can cause delays.
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When delays occur during probate, it is important to realize that probate
procedures themselves do not cause the delays. Generally, those delays are caused
by the judicial system as a whole. Its impact can be seen in all types of legal
procedures besides probate. Unfortunately, when delays occur in probate
proceedings, its consequences touch the lives of many people. It is sometimes said
that living trusts avoid delays of probate. While they certainly do by-pass the
probate procedure, trusts cannot escape the legal system itself. Lawsuits may be
initiated by any legally interested party against a will, trust, or any type of legal
document. Since all citizens have the right to their day in court, this possibility
cannot be ignored. A well-written legal document is always worth the money spent.
A poorly written legal document (of any type) is too expensive, even if obtained
free of charge.
Small, simple estates may require as much thought and planning as large estates,
in many cases. This may especially be true if postmortem expenses must be met
and there are several beneficiaries to be remembered. Of course, the term "small"
may have vastly different meanings to different people and to different
organizations. Small estates generally always work best with a will versus a living
trust. Since a trust is more expensive to set up (and small estates could better use
the money elsewhere) and since taxation is certainly no problem to the estate, it
would be foolish to advise a small estate to go into a living trust. It needs to be
further pointed out that a living trust never avoids taxation. A trust may change
who is responsible for paying taxes, but if taxes are due, someone will have to pay
them. Taxation will depend upon the estate value. When working with large
amounts of assets, it is highly recommended that one see a tax attorney or a
specialized accountant for the best planning possible.
State taxation will vary and it is not wise to make generalizations. Every state may
be different and a testator will want to consult with a specialist in the state where
probate occurs. No estate is small in the sense of being unimportant. Every estate
is important to those involved with it. Therefore, size is important only in the sense
of how to best manage it. Some would say it is more a matter of not mismanaging
it.
It has become increasingly popular to utilize living trusts in the last few years.
Because there is profit to be made here by some individuals and organizations,
living trusts are often advertised as the way that every estate should be settled,
regardless of size or circumstance. Just as no one insurance policy is right for
everyone, no one particular estate plan is right for everyone either. Living trusts are
certainly good for some situations and some individuals. They do by-pass the
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probate proceedings, as well as offer other advantages. However, the small, simple
estate will never be harmed by the probate process. These small estates generally
need not fear delays since only if someone were to contest the will would there be a
problem. A well written will should do a very good job (for a lot less money and
time) for the small, simple estate. Even large estates fall under this category if the
assets are simple in their nature. If only the family home, personal property, and a
few thousand dollars are involved in the estate, do not advise a living trust. You
will not be doing a good job for your client.
Consider this small, simple estate:
The survivor need only:
1. Pay current household bills.
2. Pay expenses of last illness, funeral and internment. Be sure to utilize all
medical insurance policies, Medicare if applicable, lodge, union, or veteran’s
benefits.
3. Go to the bank and arrange for a new Certificate of Deposit with a new listed
beneficiary. As previously stated, anything with a listed beneficiary already
bypasses the probate proceedings.
4. Change bank accounts to survivor and successors.
5. Depending on the probate state, pay a nominal tax (on amounts over the limit
allowed for state death taxes). This would not apply in states where no taxes
of this nature exist.
Obviously, settling this small, simple estate required very little effort. The things
that needed to be done would have been the normal course of events whether a will
or living trust was in place. A will did the job very well. If only a husband and a
wife are concerned as beneficiaries, they may select only a Community Property
Agreement in those states where such an agreement would apply. An attorney will
do this for a nominal sum and it will do as well as anything else in transferring their
property to the other spouse. Use of a living trust in the estate we illustrated would
have been "over-kill" at the very least. Only those who charged the client to set up
the living trust would have benefited to any degree. The client would have spent
funds that would have been more useful elsewhere. There will always be those who
still argue that the trust is a valid tool even in such small, simple estates. The
ending statement can only be one thing: do for your clients what you would want
done for yourself or your own parents or grandparents. If you are using a living
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trust for small estates, it must be assumed that you have also arranged a living trust
for those you love in similar situations.
The fact that living trusts have become a moneymaker for insurance agents and
organizations marketing them will mean that many simple estates will be put into
living trusts. If the family is not properly advised (including possible trust
beneficiaries) these trusts will possibly end up as empty or non-funded trusts.
That is, there will be virtually nothing in them. These may be called a variety of
things, but generally non-funded trust is the term used. When a will is written, it
covers all that the testator legally owns. When a living trust is written, it covers
only those assets that are properly transferred into that trust. If property, for
instance, is not deeded over to the trust, then it is not covered under that trust.
Items with a stated beneficiary need not be put under the trust because it will pass
outside of the probate proceedings already. This would include savings and
checking accounts with Rights-of-Survivorship, life insurance policies, including
annuities, Certificates of Deposit, and many other items. Some of the "do-ityourself" trusts, which may be purchased through the mail, leave it up to the creator
of the trust to list the assets to be covered under the trust. If property is one of the
items and that creator fails to deed the property over to the trust, the fact that it is
listed will not make any difference in most cases. It was not properly deeded to the
trust. Therefore, that property is not covered under the trust under many state laws.
Many of the creators of trusts will fail to do what is necessary. If the will that
person had prior to the trust was destroyed (leaving no will in existence), then that
property not covered legally under the trust may well end up in intestacy. In other
words, if no will existed and with the trust being empty or non-funded, the state will
step in to disperse the property as they see fit. The state may not do as the decedent
would have done had the trust been properly set up (funded) or if a will had existed.
When such a situation occurs the beneficiaries will certainly file lawsuits. If an
insurance agent was the creator’s only personal contact, he or she will most
certainly also be named in that lawsuit. Since past courts have established that an
insurance agent is a "contract specialist" by the very nature of his or her business, it
can easily be assumed that he or she will be liable to some degree. Most of the
organizations marketing these trusts do have what might be termed a "no-fault"
statement for the agent to have the creator sign. These state that the creator did not
receive legal or accounting advice from the agent. When this comes to court, it is
unlikely that these statements will save the agent from the lawsuits. The fact that
the insurance agent was the personal contact and that the trust ended up being an
"empty" or non-funded trust will be the outstanding facts.
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The best way to avoid such a situation is simple. Anytime a living trust is put into
effect, a will is still necessary to back it up. The will covers any and all assets not
properly transferred to the living trust. It will also cover any and all assets acquired
after the trust was written. The will prevents state intervention. It may also prevent
a lawsuit against the agent or organization representing and selling the trust.
Preparing for postmortem management needs to begin at the earliest written will.
While it is true that first wills typically are written by young couples that will live
rather than die, postmortem is still part of every well thought out will. Most early
wills do tend to be written out of a sense of duty rather than a feeling of imminent
death. Therefore, little importance is often put on postmortem management. Yet,
we know that people do sometimes die young. Organizing the duties and problems
of postmortem management will save hours of work by the executor and that saves
money for the estate. Once the first postmortem notes are written, it actually is
much easier to keep them updated thereafter. When we wait until late in life to do
this, it is generally harder to put together. When we add the facts as they occur, the
process really is much easier.
Preparation for postmortem management falls into seven categories:
1. Consolidating holdings
2. The homeland
3. Furnishing information
4. Anticipating appraisals
5. Liquidity
6. Fees of the executor and counsel
7. Various suggestions.
Realize that number seven states suggestions, not instructions. If actual directions
are to be given, then it needs to be made a part of the actual will.
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Regarding the other categories, number one - consolidating holdings - means a
brief explanation of assets, which will be appreciated by the will's executor.
Frequently, stock certificates or other items are found in a safe-deposit box that
bears unknown names. The executor is required by law to do a thorough search to
determine their value. It is not unusual for the cost of the search to exceed the
certificate's actual financial value.
The variations of this scene are endless. The point here is obvious. When
preparing postmortem management, take stock of the assets to determine what
actually is worthwhile keeping. When examining your assets:
1. Take your losses (an income tax savings, anyway) and clear your safe-deposit
box of any worthless securities.
2. Liquidate or identify all unlisted securities.
3. Sell small, odd lots and buy one issue when possible.
Some of these types of items are more likely to be held by older people rather than
by younger people. Still, it is good to review what is held on a yearly basis, no
matter what your age.
If sale of the sound odd lots would involve irritating capital gains, one might want
to consider using them as tax-free gifts to those who would be the beneficiary of
them eventually anyway. This could produce an advantage tax wise.
Number two - the homeland - refers to the testator's residence. It is not unusual
for a person to own more than one home. Although the testator clearly views one
place as home, his or her actions may cloud where that place actually is. Perhaps a
winter home is occupied more than six months out of the year, has a telephone
number listed in the local directory, and perhaps they have even opened up a local
checking account in the town where the winter home is located. To further
complicate matters, a partial share is owned in a third residence. While these
properties can be allocated easily enough through the will, the cost of postmortem
management is certainly increased.
By prudent planning, the testator could have simplified the process. Simply put, a
person should not casually act in a manner that might cause a new domicile or a
confusion of which home is the legal domicile.
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Number three - furnishing information - is an easy thing to do, yet it is rarely done.
A simple list in a spiral notebook will be greatly appreciated by the family and the
executor. The executor ends up spending endless hours (at a cost to the estate)
compiling a list of assets. Most people could even use a loan application form from
their local bank as their list of assets. Some of the things you will want to list
include (but may not be limited to):
1. Real estate. List each parcel by the commonly used address. List the
location of the deed. Any other pertinent papers should also be listed as to
their location. If a mortgage is owed, give the name and address of the
lender, along with the account number.
2. Stocks and bonds. List all of them, even if they seem small or unimportant
and state where they are located. If they are in a safe-deposit box state the
location, the box number and who has access to the safe-deposit box.
3. Mortgages, notes and cash. List each item, stating where each document
can be found. Give the name of each bank, including the branch and account
number. If any of the accounts are joint accounts, state that also. List the
source of the funds, since that may have a bearing on whether or not they are
taxable to the estate.
4. Life and other insurance policies. Any item with a listed beneficiary
bypasses probate proceedings, which provides immediate funds for those
listed beneficiaries. Of course, if no one is aware of the policies they won't
do anyone much good. All insurance policies need to be listed, including
life, health, disability, auto, fire, or any other type of policy one may have.
Be sure to include policies provided by your employer, union, lodge or the
military. Give the company name, the company address, the policy number,
and the agent's name and telephone number, if available.
5. Jointly owned property. Describe the property and ventures of any kind
that may not be listed elsewhere. Completely spell out what the property is,
percentage of ownership, names of persons who jointly own the assets with
you, and where the property is located. Legal descriptions are helpful, if
available. List as many details as possible since all may be useful to your
executor.
6. Other miscellaneous property. This can include virtually anything. It
might include furs, jewelry, antiques, household furnishings, and so forth. It
is not necessary to provide values since generally these items would be
appraised at your death, anyway. If past appraisals have been done, however,
do include the information.
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7. Gifts that must be reported. If gifts have been made which may be tax
deductible to the estate, be sure to list them.
8. Powers of appointment. If a person has been given the right to designate a
beneficiary under another person's will, this should be identified.
9. Annuities. This may already have been listed under the life insurance
policies, but if not, do not overlook them. Again, list the company's name
and address and the policy number. If income is being taken, state the
amounts.
Every year this list should be updated. It is best to specify a time that this is done,
such as the first week of each year. By specifying a time to complete the update, it
is more likely to be done.
Take off items that have been sold, lost, or simply given away. Add items that
have been acquired. It is wise to also list what is owed to others. Do not list normal
household bills, such as electricity, water or food. You will want to list mortgages
and other long term obligations that would still exist at the time of your death.
The Gross Estate
Few people seem to realize how important a current balance sheet can be to a
professional estate planner. One, such as illustrated here, should be filled out on
both husband and wife individually.
Still under the heading of furnishing information, your executor will need to
answer many questions concerning you and your affairs. While this information is
typically easily attained, it saves the estate money to have it readily available to the
executor.
Some of the things that should be listed include (but may not be limited to):
1. The testator's full name and any nicknames used.
2. The testator's maiden name, if applicable, and all other names used in
previous marriages.
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3. The testator's date and place of birth.
4. Citizenship.
5. Social Security number.
6. Legal domicile (home address).
7. Business or occupation. If retired, the testator's former employer.
8. Military record.
9. Date of the testator's marriage and, if applicable, the date of divorce.
10.If widowed, the name of the testator's deceased spouse and the date of their
death.
11.All of the testator's children's full names, their dates of birth and places of
birth. It may also be helpful to include:
a) Children's married names
b) Children’s current addresses
c) Any special information, such as adoption dates and so forth.
12.Any illegitimate children the testator may have who might wish to make
claims on the estate.
13. The full names of the testator's parents and siblings. Give both the maiden
and married names. List dates of death for any brother or sister that has died.
14.Complete names and addresses of any people or organizations that the
testator has named in his or her will. This will simplify greatly any possible
confusion as to whom the testator meant to inherit.
Number four - anticipating what will need to be appraised - will greatly aid the
executor of the estate. Values will be fixed by the date of the testator's death. If the
testator happens to have unusual items, such as special collections, try to give as
much information as possible. If the testator is aware of specialized appraisers, they
should be listed by name and address. Telephone numbers would also be useful to
the executor. The estate will not benefit from over inflated opinions. The tax
appraiser will want to use the highest opinion available, so it would be unwise for
the testator to state his or her own opinions regarding the value of items in the
estate. If past appraisals are available, a copy of them should be included.
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Number five – liquidity - will especially affect estates over a million dollars in
value. Some liquidity will be required for federal taxes, as well as other debts and
expenses. In many states, this will also be true for state death taxes. Life insurance
policies, easily sellable securities or savings accounts may be used to supply these
funds. The IRS generally realizes the time required to liquidate assets to pay
federal taxes and allows the estate that time. Estates that are "land poor" may run
into problems if the land is not easily sold. If a person realizes their estate will have
this problem, it would be wise to buy a life insurance policy to provide liquid funds
at death.
Number six - fees of executors and counselors - are generally one of two basic
philosophies when figuring fees:
1. On a percentage basis, or
2. On a fair value of services rendered, computed in respect to each estate.
Either way can benefit the estate. It simply depends on the complexity of that
estate and how well planned it was at the point of death. For estates that are well
thought out and require little management, a "fair value of services rendered" would
be the best financial choice. On the other hand, if a continuing business, for
example, is included in the estate, that would probably require lots of time to
manage, in which case a "percentage" basis might be the best buy.
Number Seven – suggestions - is generally supplied for the benefit of the executor
of the estate. It allows the executor to do his best to carry out the testator's wishes.
If it concerns special situations, such as household pets, the testator would be the
one most likely to be aware of possible solutions for placement, for example.
Price shopping is commonly overlooked by the testator, yet it is a wise thing to do
whether utilizing a will or a living trust or trustees. It may involve looking for a
lawyer to draw up the documents or a bank to act as a trustee.
If the estate is modest in size, legal time should be at a minimum. While it is true
that you get what you pay for, it is just as true that there are a million ways to put
yourself in a position to be overcharged.
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When seeking legal advice, you will save yourself money by having everything
laid out on paper beforehand. Include account numbers, addresses, etc. The more
you do, the less the lawyer will need to do (at a price for his or her time). Know
ahead of time which people you wish to have for beneficiaries, trustees and so forth.
Be prepared with full names and addresses, including zip codes. If property is
involved, bring in property tax statements and, if possible, legal descriptions.
Anything you do to be prepared will save time and money.
A person should place in their attorney's hands:
1. A complete list of their assets;
2. Full personal data;
3. An approximation of personal obligations;
4. The roster of people and organizations that will be named in your will or
trust. Include all who will need to be mentioned, even if no actual
inheritance will be involved. This would include all children, legal or
illegitimate.
5. An outline of objectives as to each beneficiary.
Besides saving time and money, chances are the lawyer will also be able to do a
better job with the will, since he or she will have a more complete base of
information from which to work. Some attorneys now use some type of form or
questionnaire to gather complete information from their clients.
Funeral Planning
Families often draw up a will letting family know what goes where. Something
can could be overlooked is funerals. Funerals have become increasingly expensive.
Depending on where a family lives, local memorial societies can help plan for a
funeral. A one-time membership fee can help cut the costs. The fee is nominal and
often transferable if the family moves to another city. Memorial societies can even
recommend funeral homes and ceremony directors.
If a family decides to put their own package together without the help of a
memorial society, they can choose their own funeral home to go through. Some
experts recommend that a family avoid the package deals because these often
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include frills not needed or wanted. Opt for a funeral home that offers items
separately, charging separately for these.
Families have also the choice of purchasing a funeral insurance policy or burial
policy that will cover the costs of buying a cemetery plot, funeral or memorial
service, etcetera.
Some questions to consider: How do they want to dispose of the remains? There
are several options, which include donation to a medical school, organ donations,
cremation or earth burial.
Some life insurance policies may include benefits for burial and cremation costs.
Review Questions
1) To make minor changes in a will, codicils can be added to execute a formal
amendment to the will.
(T)
(F)
2) A holographic will must be entirely written by the hand of the person who
signs it.
(T)
(F)
3) There are several reasons people may want a living trust, one of these is:
a) To avoid probate.
b) To allow someone to handle their money if they are incapacitated.
c) To allow professional money managers to handle their affairs.
d) All of the above
4) If the child or grandchild is under the age of 14, any income generated will be
taxed:
a) at their parent's rate.
b) at their current rate.
c) at a general rate.
d) nothing.
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Chapter 8 - Divorce
Divorce
Divorce requires couples to make financial decisions that will alter current
lifestyles and might even have a significant impact on the long term financial
security of their family.
Retirement Accounts
A family's most valuable financial assets are often the marital home and their
retirement benefits. This may be particularly applicable for couples over age 40.
Aside from the emotional turmoil the family may be going through, one of the
most important financial factors during a divorce is the possible division of
retirement assets. Each individual’s attorney will request an organized accounting
of retirement accounts, both through employment and privately funded for both
parties, particularly if either spouse is approaching retirement.
There are two fundamentally different approaches families can take when
handling retirement benefits during divorce proceedings:
1. Leave the retirement assets with the spouse who is the nominal owner. If
both spouses work, which is common today, they may each simply walk
away with their own benefits intact. In this instance, the retirement accounts
would probably be roughly equal to each other. If this is not the case, or one
partner did not work outside the home, they may then be awarded some
other marital asset that has a value roughly equal to that of the retirement
benefits. This represents a trade-off: the spouse who earned the retirement
assets keeps them, while the other spouse keeps equal assets of another kind.
This approach does require that a value be assigned to the retirement account
in order to determine equitable compensation through another asset.
2. Divide the retirement assets by taking a portion of the retirement assets and
assigning them to the other spouse. This can be done with various types of
retirement benefits, including those that are employer sponsored in most
cases. Retirement accounts provided through qualified plans make this
division by use of a Qualified Domestic Relations Orders (QDROs). This
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was created by the Retirement Equity Act of 1984 and provides a legal
means of dividing benefits under qualified plans that did not exist prior to
that act.
Leaving the retirement assets involves trading retirement assets for other
offsetting marital assets. A major concern with following this approach is actually
determining the value of the retirement assets accumulated. Before determining
the value of these retirement assets, one must understand the different types of
retirement plans. They are either:
1. Defined Contribution Plans, or
2. Defined Benefit Plans.
Defined Contribution Plans
A major distinguishing characteristic of defined contribution plans is the one or
more individual accounts each participant in the plan has. Contributions are made
to each participant's account by the employee and/or employer, depending on the
type of plan. These contributions are made each year at a specified rate and
accumulated with investment earnings during the employee's working years. The
goal is to accumulate a sizable amount that will then be used to purchase a
retirement annuity or taken in a lump sum for the retiring employee.
The present value of an employee's future retirement plan under a defined
contribution plan as of a given date is simply the current account balance. This
current balance combined with the future contributions and interest on the account
will fund the future benefit.
Present value is a mathematical and financial concept. Present value involves
discounting the future payments back to the present time to obtain their present
value. The discounting always means discounting interest to reflect the time value
of money.
Regarding pension benefits, discounting will usually involve
discounting for mortality. Discounting, therefore, takes into account the possibility
of the employee dying before collecting their retirement benefits.
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Defined contribution plans do not need actuarial mathematics to compute the
present value of the future benefits.
Defined Benefit Plans
Under defined benefit plans, funds are segregated into separate individual
accounts for each plan participant. Defined benefit plans make a commitment to
pay each retiring employee a specified monthly or annual benefit for the rest of
their life after the employee retires. The employee's future retirement benefit is
often expressed as a specified percentage of the employee's average pays for a
period of time prior to retirement and may even reflect the employee's number of
years of employment with the employer. Defined benefit plans have the
employee's future benefits commingled (having no separate accounts). These
commingled benefits are figured with an actuarial calculation to obtain the present
value of the employee's future benefit. When treating pension benefits under
defined benefit plans as a current marital asset requires that these monthly or
annual benefit streams of future payments be reduced to present value.
The process of evaluating pensions under defined benefit plans normally involves
making a number of assumptions about the future; there can be a wide variation
between the opinions of two different actuaries as to the present value of a pension.
These differences between actuaries may lead to courtroom battles. Differences
between actuaries can occur quite often.
Dividing retirement assets either by court order or voluntarily avoids the necessity
of assigning a value to the retirement assets. Why? The benefits are being divided
equally. Both spouses are receiving equal shares of the retirement account, so then
neither has to be concerned about what the value of their share is. The division of
benefits may not always be this simple.
Qualified Domestic Relations Orders (QDROs) assign a portion of the pension
benefits of the employed spouse to the other spouse (the alternate payee). This
creates a separate account for the alternate payee under the retirement plan. The
QDRO approach may be the most sensible when dealing with divorcing couples.
Under a defined contribution plan designing a QDRO to divide the retirement
assets of the working spouse may be relatively easy, although that is never an
absolute. Under a defined benefit plan designing a QDRO to divide the retirement
assets of the working spouse is more complex and requires specialized knowledge
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to do properly. This means seeking an individual out who has this specialized
understanding.
Qualified Domestic Relations Orders can only be applied to qualified retirement
plans - those investment accounts/plans that are tax-sheltered or tax deferred. The
interest or profits that are earned on the investments within the qualified plan are
not taxed until the money is taken out, usually upon retirement. These plans do fall
under the Employee Retirement Income Security Act (ERISA). Many people,
however, are covered under retirement plans that do not fall into these categories.
They may be covered under government plans.
Qualified Domestic Relations Orders can only
be applied to qualified retirement plans.
Many of these government plans can be divided under QDROs. They may be
subject to this only through court order.
With Individual Retirement Accounts (IRAs) it is not unusual to find substantial
funds where benefits from a previous plan have been rolled over. IRAs can be
divided or transferred without the necessity of QDROs.
Property
The division of property in a divorce follows some common forms of division:
1. Equitable Distribution: Each spouse is recognized as a partner in the
marriage and the marital assets. If a couple cannot agree on the distribution
of marital assets, the court will decide on an equitable and not necessarily
equal way to distribute the marital property.
2. Community Property: All property acquired during the marriage is
considered community property, to be divided by the couple. The only
exception is property acquired separately, before marriage, inherited, or
specifically excluded from the community property by a legal agreement.
3. Common-Law: This concept of property is used only in a few states, such
as Mississippi. Distribution of property is based solely on who holds title to
the property, without any considerations of equity.
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4. Marital Property: All property acquired since the marriage that was not
acquired as a gift from a third party, through an inheritance or personal
injury. If does not matter who purchased the property if the property is
owned jointly.
Some division of property can cause specific problems, and some properties are
not divisible. With indivisible property, such as a car, the other spouse is normally
compensated with other assets. The marital home may be sold, the proceeds
divided. Family businesses present specific problems. Most experts agree that a
divorcing couple should seek out a financial planner before and after the divorce.
Life Insurance
Without the need for spousal support if the breadwinner dies, changing the
beneficiaries on the existing insurance policies may be wise. If children are
involved it can be wise to list them as beneficiaries so they do not have to suffer in
the event that financial support is interrupted due to the death of a parent. It may
be recommended to form a trust for them so the remaining spouse does not get any
of the money. In the cases where life insurance replaces alimony for the recipient
spouse after the payors death, the recipient spouse should insist on a clause in the
agreement giving them authority to obtain information from the insurance
company.
In the book, Making the Most of Your Money by Jane Bryant Quinn, the advise is
simple: "If you're getting divorced, immediately drop your spouse as beneficiary
on your life insurance policy, employee-benefit plans, and revocable trusts. If you
don't, and die, most states allow your ex-spouse to collect, even if you have
married again."
A family going through a divorce may want to invest in a term life policy that
runs out when the obligation of the financial part of child rearing is done. The
spouse that is taking care of the children may want to own the policy and make
premium payments themselves and get reimbursed by the other spouse. If the
spouse who is covered by the policy drops the policy, they may not inform the
other spouse. It may also be advantageous for the spouse who cares for the
children to carry life insurance so that if the caregiver does die, the children will be
cared for where ever they go, whether to their other parent or some other relative.
It is best for the children to have some assets.
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Medical Insurance
In years past, exiting spouses often required the working spouse to provide health
and medical benefits for them and any dependent children. With the passage of the
Affordable Care Act it is not yet clear how this will impact divorces. It is likely
that a non-working spouse will still request the working spouse to provide health
insurance benefits. If the working spouse’s employer-sponsored health care plan
does not or cannot continue to cover a legally divorced spouse, he or she may be
required to pay the premiums of another health care plan that has been selected.
Spouses have steadily gained rights to health care coverage. The Health
Insurance Portability and Accountability Act of 1996 signed into law by President
Clinton allow the remaining spouse to keep health insurance coverage for
themselves and any dependent children. Before this law was passed into
legislation, if the company employed 20 people or more spouses needed to notify
the employee benefits office within 60 days of a legal separation or divorce. Some
ex-spouses were entitled to stay in group plans at their expense for up to three
years. This applied even if the spouse remarried or had other coverage available.
The group policy had to continue covering the ex-spouse if he or she were ill and
any new coverage would not cover pre-existing conditions. Grown children could
stay on the plan for up to three years after they were too old for formal family
coverage. To keep the children covered notification to the insurance carrier within
60 days of each child's cut-off date was required.
Prior to the Health Insurance Portability and Accountability Act of 1996, if the
spouse worked for a company employing fewer than 20 people and not offering
health care coverage, the only choice was typically an individual policy that would
probably be very expensive.
Social Security
When a couple gets divorced it does not cut the other out of their Social Security
benefits. Social Security will first look to their own account to see how high the
personal benefits are before looking to the ex-spouse's account.
If the couple was married at least ten years and is now divorced, the ex-spouse is
probably eligible from the other's Social Security account if:
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1. They have reached age 62,
2. Not remarried, and
3. The ex-spouse has also reached age 62 or is receiving Social Security
disability payments.
Even if the ex-spouse has remarried, they may still be entitled to benefits if the
new spouse is receiving Social Security and the ex-spouse's benefits on the new
spouse's account would be less than they are getting from the former spouse's
account. If the ex-spouse dies, Social Security benefits could start as soon as age
60, 50 if disabled. A new spouse may worry that their benefits will be reduced if
an ex-spouse is also collecting benefits. However this is a misconception. Each
gets full payments, as if they were the only spouse around.
To collect survivor's benefits after the death of the ex-spouse there are certain
requirements:
1. The living ex-spouse must be age 60 or older and not remarried.
2. Caring for the deceased spouse's child who is disabled or under age 16. The
living spouse’s age and marriage status does not matter. If caring for a
disabled child or a child under age 16, the spouse can collect even if they
were married less than ten years.
3. The ex-spouse remarried after age 60, but is entitled to a better Social
Security benefit from the ex-spouse's account than from the account of the
new spouse.
Wills
A couple that is divorcing needs to review all their financial matters. A will is
one priority that must be handled. In fact it has been suggested to change wills as
soon as divorce negotiations get under way.
There are two ways to cancel a will:
1. Make a new will, specifically revoking all wills and codicils that have come
before it.
2. Tear up the old will. It has been suggested to do this in front of witnesses
and specifically say that this will is no longer valid. Otherwise, an heir may
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argue successfully that the will is merely missing. In that situation, a
lawyer's photocopy may stand up in court. Even if the will is successfully
destroyed, a new one needs to be written.
If a person has not changed their will and dies when legally separated but not
divorced, the spouse will collect. In fact most states will not allow couples that are
in the process of divorcing but are still legally married to completely disinherit the
spouse. During the period of separation preceding the divorce, a spouse may want
to reduce the bequest to the ex-spouse to the minimum amount allowed by law.
Then, when the divorce is final, a new will can be drawn up and finalized as well
as other estate planning changes such as beneficiaries and trustees. Pay careful
attention to guardianship arrangements for children.
There is so much to do financially speaking when a family is going through a
divorce. This chapter may not cover all necessary actions. State laws and personal
situations vary. Each partner should consult an attorney and their insurance agent.
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Review Questions
1) QDROs stands for:
a) Qualified Divorce Relation Orders.
b) Quantified Darius Requested Offers.
c) Qualified Domestic Relations Orders.
d) Quality Defused Rationed Orders.
2) To collect survivor's benefits after the death of the ex-spouse there are no
requirements.
(T)
(F)
3) If the couple was married at least ten years and are now divorced, the exspouse is probably eligible for the other's Social Security account if:
a) they have reached age 62.
b) not remarried.
c) the ex-spouse has also reached age 62 or is receiving Social Security
disability payments.
d) All of the above
4) The present value of an employee's future retirement plan under a defined
contribution plan as of a given date is simply the current account balance.
(T)
(F)
5) IRAs can be divided or transferred without the necessity of QDROs.
(T)
(F)
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Chapter 9 - Ethics
Agent Ethics
In today's lawsuit-prone society, the insurance agent or broker has a difficult line
to walk; every presentation has the potential of an errors or omissions claim. The
client’s family is often the entity that initiates a lawsuit against the agent as a result
of some financial catastrophe. They were not present during the sale and do not
know that the agent warned him or her that more life insurance was needed, or that
a nursing home policy would be wise, or that something was not insured that
should be. If the agent has not documented the conversation he or she may have a
difficult time in court.
Ethics are defined as "formal or professional rules of right and wrong; a system
of conduct or behavior." Ethics are standards to which an insurance agent or
broker must aspire to, feeling a commitment to each client. Every type of
profession generally has an informal "code of ethics," which may be more
understood than written.
Ethics are a means of creating standards within any given profession to upgrade it
and give it honor. It is a means of measuring performance and in some cases,
acknowledging outstanding individuals. Ethics often are a means of establishing
priorities and building traditions based on integrity.
We would not wish to do business with many professions if ethics did not play a
part. Can you imagine turning over your financial control to an attorney who had
no ethics? The same would be true for an accountant and many other
professionals. Ethics add an element of trust to many industries.
In many industries the professionals have specified knowledge not shared by the
general public. Individuals who seek out professional help must rely upon their
honesty and integrity so a feeling of ethical standards must exist.
Regardless of our occupation, each of us faces ethical issues every day. When
any given profession deals with a commission base, this seems to be especially
true. Ethics is a subject that could be discussed endlessly. The bottom line,
however, is fairly simple: actions are either right or wrong. The answers are not
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the same for every individual but it always comes down to doing what is perceived
to be the right thing for everyone involved.
Consider the definition of ethics:
eth'ics (eth'iks) n. pl. (1) the principles of honor and morality. (2) accepted rules of
conduct. (3) the moral principles of an individual. ---eth'ic, adj. pertinent to morals.
The New American Webster Dictionary
What are ethics? Who determines what is or is not ethical behavior? Must
religious beliefs be a part of ethical behavior? Is it possible to make your living in
commission sales and still be ethical? Perhaps more to the point, is it possible to
make a good living in commission sales and still be ethical?
While the study of ethics is actually a complex subject with many shades of right
and wrong, ethics is basically about the meaning of life. It is the abstract view of
what is right and what is wrong. There are few absolutes and many varied
definitions. Even those who make their lifework the study of ethical behavior
often do not come up with the same conclusions.
The purpose of this course is not necessarily to give any answers to the ethical
questions. Rather, it is our intent to promote thinking. A thinking individual is a
powerful person because he or she already has the answers based on their own
beliefs; it is very difficult to manipulate a person who believes they know the
ethical answers. The point of this course is to promote ethical thinking. It is our
desire to provide a few of the "tools" of logic.
Ethics do, of course, belong in every aspect of our lives, but this study book will
examine ethics in our place of business. Ethics (sometimes referred to as values)
play an important role in the decisions that are made every day. The decisions that
are made, with or without ethical considerations, have a profound effect on our
own lives and those of others.
Businesses base many of their routine decisions on financial aspects (What will
bring a profit? How can costs be cut? How can taxation be minimized?) plus a
variety of other financial questions. When an ethical context is applied to the
decisions made it affects everyone from the employees to the customers. Because
values become an integrated part of both personal lives and business conduct,
individuals are often unaware that decisions are made with an ethical view. A
person who has formed an ethical core in early life will continue to make the
majority of their decisions based on that early ethical training - even if they are
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unaware they are doing so. Therefore, it could be safely said that parents have the
most profound affect on our world; they will be producing the standards their
children carry forth into the business world as CEOs, employees, or even parents
themselves.
Just as it is true for other professions, it is also true of agents: their personal
ethical standards will carry into the sales field. A salesperson that formed their
early sales presentation on the basis of honesty and ethical conduct will, over the
months and years, make a habit of saying their presentation in a certain manner.
Court cases have been won and lost on this concept of "repeat actions." As time
goes by, this sales presentation becomes a "habit" with little variation. Eventually,
the salesperson may well forget how the original presentation was formed, but if
ethics played a part in the original presentation, ethics will continue to play a part
as time passes. The same may be said of driving a car, riding a bicycle, and other
daily habits that were initially "learned behavior" but become "reflex behavior."
Ethics began as society's code of unwritten rules. From the time that humans
began living together unwritten rules of conduct were necessary simply to survive.
Survival could not continue if the strong (typically males) took everything,
including food and shelter, from those who were weaker. The weaker individuals
were likely to be women and children. If women and children did not survive, the
species could not have survived either. These rules established the ways in which
others were to be treated for the benefit of all.
For centuries, societies have argued over what is ethical or moral. It was during
the fifth century B.C. in Greece that the philosopher Socrates gave ethics its formal
beginning. The word ethics comes from the Greek word ethos, which means
"character."
Each country will have ethics that are unique to their people; some ethical
standards tend to be common among all cultures while others apply specifically to
their way of living. In America, we have many variances in what is believed to be
ethical because we have a varied population with a varied background. A work
ethic was formed early in America (although many people have questioned
whether it still remains) because it was through work that these people were able to
obtain possessions. Clearing land, for example, was backbreaking labor, but it
produced rich farmlands that could be sold or handed down to their children.
Therefore, hard work brought rewards. Rewards provided a reason to work hard.
It is easy to see why this work ethic was easily accepted by the immigrants who
came to the New World called America. Many of these immigrants had never
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before had the opportunity to obtain possessions through personal work. Even
today, despite our concern that the work ethic is disappearing, new immigrants
continue to find satisfaction and possessions by following a work ethic.
Other ethical values have been brought in by immigrants, both in the early days
and continuing into today. One that is commonly thought of (and which many
Americans now take for granted) is education. We often forget that obtaining
education is, in fact, an ethical standpoint. It is not always easy to become
educated. Like so many values or ethics, it requires concentration and hard work.
Immigrants who come from lands where education is given only to select groups
find our open education system a wonderful opportunity. Often immigrants take
greater advantage of education opportunities than do established Americans.
When an opportunity is so widely available, it is easy to forget the importance of it.
Early Americans held their religious freedom to be highly important. Since
values are often defined as a criteria upon which important choices are made,
religious freedom must be considered a value or ethical consideration. Many early
immigrants came to America, despite the harsh circumstances of the New World,
looking for religious freedom. They held this freedom in very high esteem. The
men and women who settled along the Eastern coasts came from Europe and
brought with them their religion of choice: Christianity. Of these people, the
Puritans probably had the greatest influence on early American values and
ideology. To the Puritans, work was their most effective means of giving glory to
God, so the work ethic had a strong effect on their lives.
Our Past Becomes Our Present
Every individual is a product of their past. In some way, each of us has been
affected by the past. Even when society changes rapidly, current attitudes have
their basis in the past; ethics are certainly part of those attitudes. Whether how we
live today is a reflection of what we enjoyed or liked in the past or a rejection of
what occurred in the past, we are still affected by it. Perhaps it is impossible to
understand current ethical considerations without having some understanding of
the past and how it brought us to this point.
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Our current standard of living is strongly affected by our obtained education,
(whether formally obtained or obtained through experience). The traditional
values and ideology were generally sufficient in an unchanging society. Today our
society is rapidly changing and those changes have opened up education to the
masses. Education encourages questioning. In societies that promoted slavery,
including ours, slaves were never allowed to become educated; educated people
were much more difficult to control.
There is merit in looking at our past. Higher levels of education naturally lend
themselves to questioning. It is probably this questioning that brought about much
of the beneficial change in America. Minority rights, women's rights, the rights of
the disabled, plus many more groups have benefited from "questioning."
Who Determines Ethics?
Ethics involves the questioning of why certain things are done or thought.
Socrates' student, Plato and later Plato's student, Aristotle, further developed
Socrates' philosophy of ethics. Some say that their thoughts on ethics was so
profound and complete that nothing new has been said since Plato or Aristotle on
this subject.
In the sixties, two major movements swept America: civil rights and antiwar
sentiments. Though primarily led by our youth, the movements were backed by
the majority of our mainline churches and other organized groups. Who can forget
the images we saw of Martin Luther King, groups of protesters, and the numerous
conflicting views brought into our lives? These movements established new ideas
on ethical conduct and broadened existing views. So, the answer to the question of
who establishes our ethical conduct is simple: each one of us establishes our
country’s ethical standards through our participation. Therefore, those who fail to
vote may be doing the opposite: failing to instill their personal ethical values.
Although the seventies saw an almost immediate decline in the revolution for
change that does not mean that we have been unaware of what is around us. We
are face many ethical issues including worldwide starvation, energy problems,
environmental issues, inflation, run-a-way government spending, war, crime, drug
problems, and other issues that affect our lives on a daily basis.
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Many of the issues America and her citizens wrestle with come down to one
issue: what is the right thing to do? As insurance representatives, we do not have
the answers to the big problems, but we are often a mirror of what is going on in
our neighborhoods. If we surround ourselves with people who are primarily
concerned with themselves, it is likely that we will have the same attitude.
Therefore, if the agency in which we were trained stresses SALES, SALES,
SALES without any other input, it is likely that we will lose sight of the role that
ethics should play. When ethical behavior is not deemed important by our
immediate peers, it is not surprising that problems eventually materialize.
Setting down our priorities determines our goals in life. When ethical conduct is
involved in our goals we develop pride in ourselves and our achievements. It
might be said that ethics are a recipe for living. Our code of ethics gives each of us
our personal rules and values, which determines the choices we make each day of
our lives. These choices affect not only ourselves, but everyone around us. Some
types of ethics tell us what not to do (it is wrong to steal). Others tell us what we
ought to do (be kind to animals). In addition, there are those ethics or morals that
actually take us beyond the basics of moral obligations. Mary Mahowald, a
medical ethicist at the University of Chicago, calls this added ethical stand virtues.
Virtues might be referred to as going beyond the call of duty. It may also be
referred to as moral excellence. Such moral excellence would include those who
have no legal or moral duty to another, but go to extremes to help them anyway. It
refers to the person who gives their life for a stranger or goes to other countries to
work for people they do not know, even though there will be no personal or
financial rewards. Virtue is going beyond what we are obligated to do.
Ethics is never a separate part of our lives. It is part of everything we do and
everything we say. Ethics determine how we treat those we know and how we
treat strangers. Ethics determine our actions in financial and public matters.
Ethics belong in every profession and are especially needed in some. Because
ethics, as a subject, is so broad and complex, it may sometimes be divided into
sections such as personal ethics, religious ethics, legal ethics, professional ethics,
medical ethics, business ethics and so forth. Ethical neutrality is not possible
although individuals often try to walk that line when taking a side is difficult.
In today’s business climate, most companies establish printed ethical guidelines
for their employees; this is necessary for many reasons including legal protection.
Guidelines include office procedures, sales procedures, and personal conduct.
Every business tells their employees which actions are right and wrong as a means
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of financial protection, but that does not necessarily mean the company follows
their own codes.
Ethical Decisions
Ethical decisions are made everyday in the workplace. These decisions will
affect the quality of work performed, employment opportunities, safety of workers
and products, advertising, and simple day-to-day operations. Whether this is
window dressing for the public or a real move to business values may be debated,
but certainly the knowledge of ethical actions exists.
A business owner must be aware that without employees who are ethical, the only
restraint is the law. Without ethics, any business transaction that was not
witnessed and recorded could not be trusted. This would certainly cripple a
business if employees could not be trusted. On the other hand, when employees
cannot trust their employer to be fair, problems can also develop. Those who own
and manage the business must be just as trustworthy as their employees.
Sometimes the reason given for illegal or unethical conduct comes under a
different name. Bribery, price fixing and compromising product and worker safety
is often said to stem from pressure for "bottom line" results. A survey conducted
by Business Week stated that 59 to 70 percent of managers feel pressured to
compromise personal ethical views in order to achieve corporate goals. This
perception of pressure seemed to be especially high among lower level managers.
On the positive side, 90 percent of the managers said they would support a code of
ethics in their business place and the teaching of ethics in business schools.
It is true that an honest and ethical individual can be influenced by unethical
pressure from others. This may especially be true if that pressure is coming from
the workplace. In today's economic climate, individuals often feel that they would
be unable to survive financially if their job were lost. As a result, he or she may be
willing to participate in an activity they personally feel is unethical in order to
maintain their job status.
Steven N. Brenner stated in his book "Corporate Political Actions and Attitudes"
that individuals who worked in corporate political activities displayed a declining
interest in ethical issues. This particular area of work, in fact, seemed to show the
lowest level of ethical interest. It would be hard to know if unethical individuals
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were drawn into this line of work or if ethical individuals were simply pressured to
the point that they lost their ethical base.
It is not surprising to note that laboratory research has shown unethical behavior
tends to rise as the industry or climate becomes more competitive. Perhaps that is
why some insurance agencies push competitive contests and look the other way
when activities seem to compromise ethical behavior. These studies further
indicated that when unethical behavior is rewarded (as with prizes or additional
commissions) it further erodes ethical standards. On the other hand, the same
studies also noted that when unethical behavior was punished, unethical behavior
was deterred.
Generally, those who study the rise and fall of ethical behaviors make these
observations: it is necessary, if one wishes to preserve ethical behavior to require:
1. A sensitive and informed conscience,
2. The ability to make ethical judgments individually, and
3. A corporate climate that rewards ethical behavior and punishes unethical
behavior.
Most ethicists believe that the more complex our society becomes, the more we
need to teach ethics to the general population. In the past, ethical behavior was
primarily taught to children by their parents and by the churches to their
congregations. As our families become more complex and spread out, these
parents-to-children teachings appear to be diminishing. It has been noted that there
has been a movement back to religion in the last ten years and this must certainly
be a benefit for ethical teachings. Even so, many of our leaders see a decline in our
overall desire to have ethical behavior promoted.
As our society becomes increasingly a computer-generated one, with sales and
services moving to web-based interaction, we are seeing an interesting move away
from ethical emphasis. When an individual deals face-to-face with a salesperson
or service department there is less likelihood that dishonesty will take place; when
interaction takes place via telephone or via websites dishonesty tends to increase.
Perhaps that is because it is easier to be dishonest when there is no face attached to
the act.
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Promoting Ethical Behavior
Ethics is not entirely about oneself; it is also about others. It is not so much what
one knows that makes an individual ethical, but rather what he or she understands.
A truly ethical person realizes that their behavior is their loudest statement about
themselves and those they associate with.
Making ethical decisions addresses four basic issues:
1. Is it possible to teach ethical behavior?
2. What is the scope of ethics?
3. What does it take to be a moral person?
4. What are a person's responsibilities to other moral people?
There is no doubt that each of us, regardless of our occupation, faces ethical
issues on a daily basis. However, anyone in an occupation that has a "public
interest" is especially faced with ethical issues, some of which translate into legal
responsibilities.
Ethics are standards to which an insurance agent or broker must aspire to; it is
feeling a commitment to each client. Every type of profession tends to have an
informal code of ethics, which may sometimes be more understood than written.
Ethics are a means of creating standards within any given profession to upgrade it
and give it honor. It is a means of measuring performance and acknowledging
outstanding individuals. Ethics are often a means of providing priorities and
building traditions based on integrity.
It would be hard to imagine doing business with anyone that we knew to be
unethical. Can you imagine turning over the control of your financial affairs to an
attorney that had been convicted of stealing from his clients? Would you buy a car
from a person who had knowingly lied to others about the cars he represented?
Would you deal with an insurance agent who had repeatedly misrepresented the
products he or she sold? Ethics are the only element, other than legal mandates,
that add an element of trust to many industries. It is very difficult to mandate
ethics; only behavior may actually be mandated. If a person is ethical, that is
something within themselves that simply adds to their trustworthiness.
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No matter what one’s profession may be, as individuals, each of us faces ethical
issues each day. Some are very simplistic in nature while others are complex and
may have many sides (and many correct answers) to them. We face issues that are
personal, such as: How much should I give to the poor? Is it wrong for me to take
drugs? Should I report someone who is cheating (whether that happens to be in
school or elsewhere)? These types of ethical questions are all around us.
Some types of ethical or moral questions can be directed to our religious
institutions for support in determining the right answers. Sometimes the answers
can be found in our legal system. If our state or federal government says
commingling funds is illegal, for example, then we could also state that it must be
unethical as well. Sometimes, determining what is ethical is simply a matter of
what feels right emotionally. We have all said or heard someone else say: "It just
doesn't feel right." That feeling of right and wrong is probably the result of our
childhood upbringing. Even if we do not distinctly remember being taught that a
particular action is either right or wrong, somewhere in our upbringing or past
experiences, we have received such teachings.
While this course cannot magically inspire ethical conduct in an individual, it
may provide the tools for determining the more complex issues. By using basic
concepts and theories and by having an appreciation of what constitutes an ethical
solution, decisions may be made on the basis of logic (and make no mistake about
it: many ethical issues are a matter of logic).
It should be noted that different conclusions may be reached to the same ethical
question. It does not mean that one solution is right and another wrong. Ethical
questions often have multiple answers, all of which may be correct. Many ethical
questions involve multiple hues; some decisions may be based solely on facts,
while others may be based less on facts and more on emotional factors (or what
simply feels right).
Business leaders often question whether ethics may be taught in the workplace.
This, of course, depends upon multiple factors. First of all, does the employee
desire to be ethical or do what is right and expected of them? As with all things,
the person must want to achieve the goal at hand. Unfortunately, those who are
faced with the responsibility of hiring personnel can seldom determine the
individual's ethical desires. The best an employer can do is make their choice,
provide the information, and monitor the results.
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One of the first lessons taught to children by their parents is sharing. Even this
lesson is a form of ethics. Sharing is the opposite of greed. As adults, we learn to
share in numerous ways, but sharing begins in childhood. The shift from securing
our own interests to sacrificing on behalf of others is an essential part of what is
meant by "ethical decision making." This may especially come into play for
insurance agents. The choice to make a sale and earn a commission in any way
necessary rather than sacrificing the sale on behalf of honesty is an ethical
decision. The selfish person cannot routinely make such moral decisions, or
perhaps more correctly will not make such decisions.
It is necessary to understand that one of the general features of taking an ethical
point of view is the willingness to take into account the interests, desires, and
needs of others (clients in the case of insurance agents). A person may argue that it
is necessary to look out for one's own interests, desires and needs. While this is
certainly true to a point (we must cloth, feed and house ourselves and our families),
taking our own interests into account need not mean making unethical or immoral
decisions regarding others. Even commission salespeople are able to make a very
good living while still maintaining ethical behavior. In fact, the best salespeople
do not need to behave unethically because they have mastered their trade through
the development of communication skills and professional training. The
professional agent will not sell or place a product that does not meet the client’s
goals or needs; they don’t need to because they have the products at hand to meet
the goals without incorrectly placing a product.
When a child asks his or her parent "Why do I have to share my toys?" the reply
may be "Because if you don't share your toys with your sister, she will not share
her toys with you." This simple logical answer teaches the child a valuable lesson.
Our interests are tied to the interests of others. Just as the man who is known as a
liar or a thief will find others unwilling to trust him, the insurance agent who is not
ethical will, at some point, find making a living impossible because no client will
wish to deal with him. We are better able to achieve our goals when we recognize
the goals and interests of others. Plato argued that immorality (unethical behavior)
is ultimately self-defeating. While the con artist may not believe this and some
unethical people do seem to prove the point by becoming wealthy from their illegal
activities, most people still believe the old saying: “what goes around comes
around.” The Bible says it another way: we will reap what we sow. Even if we do
not get back what we give others (whether that be good or bad), most people would
agree that it is easier to be happy with ourselves when we feel we have done the
right thing. Perhaps the wealthiest among us are those that have found personal
happiness.
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Egoism versus Egotism
Not everyone believes it is in their own self-interest to be ethical. Some who
reject the idea of other's interests and desires are called egoists. Do not confuse
this with egotism. An egotist is a person who is self-absorbed or stuck on
themselves. These people make poor egoists. Webster's dictionary defines egoism
as the doctrine that self-interest is the basis of all behavior whereas egotism is the
habit of being too self-absorbed, talking too much about oneself or conceit.
Psychological egoism maintains that people are always motivated to act in their
own perceived best interest. Psychological egoism is not an ethical theory since it
does not tell people outright how to behave. Rather it attempts to explain why
people behave in certain ways. Ethical theorists consider this theory because it has
a bearing on their own theories of ethical behavior.
Another version of egoism is a genuine ethical theory. Traditionally named
ethical egoism, it maintains that people ought to act in their perceived best interest.
An ethical egoist argues that people should act in their best interest at all times
because it is good for the general economy (providing industry and jobs, for
instance).
In the marketplace we all want to buy low and sell high. That is certainly an
attempt to pursue our own self-interest. It is unlikely that the buyer worries about
the seller, nor does the seller worry about the buyer. Individual self interest is at
work. Even though this may be an excellent example of ethical egoism, it tends to
be both orderly and productive to our society. It demonstrates that this theory has
positive dimensions to it despite the selfish basis.
A political economist, Adam Smith, believed in ethical egoism. He felt that
people, while being interested in their own needs and desires, created good for
society as a whole. Smith felt that economic conditions were created and
expanded when people acted in their own behalf. It must be noted, however, that
there is a strong difference between acting on one’s own behalf and taking an
unfair advantage of another.
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If we were to fully believe in psychological egoism, which states that humans
automatically act in their own behalf, many of the acts of heroism that we see
could not be explained. Those that help others when it causes a personal loss are
certainly not acting on their own behalf. There have been situations where one
person actually sacrificed their life on behalf of another, sometimes strangers. This
certainly is not acting on their own behalf.
There is more day-to-day heroism than one might realize. Such simple things as
the child who shares his lunch with another student, the woman who gives her last
dollars to a homeless person, the man who donates his only day off for a food drive
are all acts of kindness that consider the needs and desires of others.
This still brings us back to the basic question: Is it possible to teach ethical
behavior to others? There is no clear answer. An agent who has never
considered ethical behavior might suddenly begin to do so if the agency where he
or she works begins a strong ethics campaign. On the other hand, an agent might
continue to act unethically even if threats are made to recall his or her license to
sell insurance. One thing is certain: the effort must be made to emphasize ethical
behavior because there will always be those agents who will respond favorably to
such efforts.
Question number two asked: What is the scope of ethics? This is a massive
question that could be carried to great depths. In many industries, including the
insurance industry, the professionals have knowledge that the general population
does not have. As a result, those individuals who seek out the professionals must
rely upon their honesty and integrity. Therefore, a feeling of ethical standards
must exist. It was the potential for abuse of power that provided a set of rules for
what is commonly called "ethical behavior." Sometimes, ethics are written
standards, which may be mandated by law on either a local or federal level. The
premise upon which practical ethics must be based, according to Stephan R.
Leimber of the American College where he is a professor of taxation and estate
planning, is that power must be exercised in the interest of the clients who seek the
professionals out and may not be exercised solely in the best interest of the
professionals themselves.
Parts of the insurance industry have been labeled (often unfairly) as lacking
ethical standards. Usually what we find is not an industry as a whole without
ethics, but rather some individuals who have received much publicity. The
insurance industry, which deals with senior products, is one section that has
received bad publicity off and on. Part of this has to do with the age of the
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consumer. If a 25-year old person is taken advantage of, many would think he was
simply stupid or uneducated to have allowed it. If a 75 year old is taken advantage
of, however, publicity is sure to follow. This is not surprising since a 25 year old
is more likely to have the ability to make sound judgments in comparison to a 75year old person. Also, our older population controls most of the nation's wealth. If
a salesperson (in whatever industry) is greedy and unethical, he or she is most
likely to hit those with money. That would typically be older people.
We should also ask ourselves why society seems to consider it less offensive to
take advantage of a 25 year-old person. If unfair advantage (a con job) exists, why
does it matter how old or young the victim is? Perhaps that is an ethical question
in itself.
When we look at what the scope of ethics is or could be, one might be surprised
at the extent to which it could be taken. Amy L. Domini and Peter K. Kinder have
jointly written a book called "Ethical Investing" which looks at how our standards
may even be brought into the field of investing. For example, if an agent were an
animal activist, would it be ethical for them to represent companies that use
animals in the laboratory or for testing? If a client is an environmentalist, should
he or she invest in any type of investment that is detrimental to the environment?
Sometimes, people or cultures do not agree on what is ethical behavior. What
one culture or society may consider ethical another may not. Even within the same
culture or society, people may disagree on what is and is not ethical. We often see
these differences between religions as well.
Every person probably has some degree of greed or selfishness within them. The
ethical person realizes this possibility. Since ethics is a code of values to guide
man's choices and actions, the ethical person will bypass their own greed and do
what is perceived as best for the majority of people or best for the person they are
dealing with. In choosing his or her actions and goals, constant alternatives are
faced. It is not always easy to decide which choice is best and ethical. Without a
standard of values, ethical choices would be very hard to make. At some level, our
religious background may set the standard of values by which we make our
choices. However we arrive at it, at some point, understanding of how others feel
determines many of our ethical decisions.
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Our third question: What does it take to be a moral person? is probably more
simple than any of the other questions asked. Most people do know right from
wrong. While what is right may not always be agreed upon, as long as a person
acts on what they perceive to be right, then they are acting ethically.
The ethical person simply believes in right and wrong and chooses to do right.
The ethical insurance agent does not believe it is necessary to trample their
potential clients in order to get the sale; they do not believe it is necessary to tell
half-truths or leave out needed information. Of course, it is also necessary to be
well prepared and to understand good communication techniques. In fact most
professions would benefit from these skills.
It is common for ethical people to have some form of religion in their lives. They
make no apology for accepting God and religion into their lives and work. Ethical
people tend to be warm and caring by nature, it is said. Whether or not this is true
we cannot say, but ethical people do certainly seem to place a value on others. In
fact, valuing others is an aspect of ethical behavior. Perhaps you cannot have one
without the other.
It is not possible to be one person off work and another person on work. Who we
are is defined everywhere we go and in everything we do. Three questions must be
addressed:
1. What kind of person am I?
2. What quality of work do I want to perform?
3. What do I want my legacy to be?
Just as a man is defined by the lies he tells, and a thief is defined by his actions,
we are defined by our every-day activities. We do not necessarily have to be a liar
or a thief to define ourselves as less than honest. Many of our political figures are
not actually dishonest and yet they are not perceived as honest either. How do we
want ourselves defined? Answering such questions cannot be avoided. Even when
we try to ignore them, we are still answering the questions by our actions. It must
be realized that the questions are asked in the minds of every person we come in
contact with. They look at us and they form opinions to these questions. Coming
to terms with the basic philosophical questions about what we are doing with our
lives may be the most practical of all possible ventures.
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If we have children, it should also be pointed out that they are very good at
defining who we are. Children may not voice the image they see, but little is
missed. How do you wish your children to view you? What you do in your every
day lives will form their opinions. It will also demonstrate to your children what
path in life they might take.
When we ask: “What quality of work do you want to perform?” we are referring
to the quality, not quantity, of your work. Forging signatures, misstating health
conditions, omitting information for the sake of a sale, and so forth, determines
your quality of work. True professionals simply feel their integrity is worth more
to them than a quick commission. Certainly, anyone can make an error and that
may not be a reflection of their professionalism, as long as the error is corrected. If
an error is made (even an honest error), and no effort is made to correct it, then
again that reflects on the type of work performed.
The question: “What do I want my legacy to be?” refers to how others will
remember you. Some may not care about this point, but it will be important to
those who love you. Most of us probably do wish to be remembered in a favorable
light. Can you imagine being remembered for the quantity of errors made or for
the dishonest and unethical actions taken?
Good business requires that you know what you are doing. Sometimes this
involves competency. Of course, most people would not view themselves as
incompetent even if they were. Sometimes, the industry itself must remove those
within it that are not competent. Sometimes, competency is merely a matter of
obtaining required or necessary education within any given industry. It is always
interesting to note the amount of sincere education acquired by the leaders in an
industry. The leaders are nearly always more concerned with educating
themselves to a greater degree than are those at the bottom. Education and ethics
do tend to go together. It should be noted that success and education also go handin-hand.
How many times have you, as an insurance agent, sat in an educational seminar
and observed the quantity of others who are obviously not interested in learning.
Of course, it is also the responsibility of the educators to make the seminars
interesting. However, there are always those who attend simply because they
must. In our business, this constitutes unethical behavior. Constant learning is
very important in the insurance industry and those who realize this will be better
equipped to do a good job. Can you imagine feeling confident going to a doctor
who did not want to continually upgrade his industry's education? If your doctor
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said "I don't bother going to all those boring classes, but don't worry. I read all
the brochures," would you feel confident in his or her work?
It is also important to know why you are doing what you do. For insurance
agents, that means it is important to understand why your industry and services are
valuable. We have all known an agent who seemed to just be going through the
motions of their job (selling insurance) without any pleasure being received from
it. Whether a person is an insurance agent, a plumber or a teacher, there must be
pleasure derived from what they are doing. Unless there is some pleasure in the
job, the job will be done poorly. Few of us could do an outstanding job at
something we hate.
Often the reason an agent is not enjoying their job is simply because they do not
understand why they are doing it. If their agency has lost sight of ethics chances
are their agents will not know why they are doing the job (beyond making money
for the agency). In the midst of the Watergate investigation, Jeb Magruder
announced that he became involved because he had misplaced his "ethical
compass." Newspaper columnists grabbed on to that phrase and many jokes
evolved from it. The truth is, however, that it is a very fitting way to describe the
situation. The majority of people know the difference between right and wrong.
That is not to say that, if surrounded by only one type of morality, that one's
"ethical compass" cannot only be misplaced, but set off its direction as well.
It is unlikely that most agents would consider who they work for to be a matter of
ethics. However, it may end up being connected if ethical behavior is not deemed
important by the company. When an agent (or anyone, for that matter) feels that
their role day-in, day-out is primarily connected to making money without any
regard as to how the money is made, ethics may easily take a back seat.
How does an agent know, except in the extreme cases, if their agency lacks
ethics? It may not always be a black-and-white situation. Sometimes the decision
can only be a personal one if the agency is not noticeably to one extreme or the
other. One would not expect an agency or brokerage to be outright unethical.
Each state has mandated certain procedures that a company must follow which
usually prevents such outright unethical behavior. It is more likely that the
company would ignore unethical or questionable actions of their agents which
would, therefore, condone such actions.
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Some examples of this might include:
EXAMPLE #1
Joan, an insurance agent, is sitting in the agent's room of the agency where she
works. As she is completing her paperwork on the business she has written that
week, she notices that she forgot to have one form signed. Another agent in the
room, Matt, suggests: "Don't worry about it. Just put one of his signatures against
the window pane and copy over it onto the one you need."
Joan: "Isn't that illegal?"
Matt: "Maybe, but everyone does it. If you're not, then you're the only one who
isn't."
As Joan asks around, she discovers that Matt was correct. Virtually everyone she
spoke to about it confirmed that they too copied signatures where one was
forgotten. Joan found that nearly every agent intended to get all required
signatures, so it was not a matter of purposely omitting them. Rather, it was an
easy way to perform below necessary levels of competence. Several agents even
mentioned that the management had sometimes been present when signatures were
copied. They simply left the room and acted as though they had not seen it.
While we know Joan was unethical in copying the signature, there are additional
ethical questions involved. Is Matt unethical for advocating that another person
forge a signature? Is the agency unethical by ignoring the behavior going on? By
ignoring the behavior, is the agency condoning it? If Joan had decided against
forging the signature would she then be free of any other agent's ethical behavior?
Or, having the knowledge of what was going on, would she be unethical to remain
at the workplace? Should she go elsewhere to work and leave it at that or, in the
interest of ethical behavior and responsibility, should she report the behavior to the
State Insurance Department and perhaps to the insurance companies as well?
Since Joan had developed several good friendships among the agents, how does
loyalty to those friends and her responsibility to ethical conduct correspond?
As you can see, ethical behavior is not a simple matter. Do your standards of
what is ethical apply only to yourself or to others as well? If your views do not
correspond to the views of others, who is right?
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EXAMPLE #2
John works for a large investment company. John is a strong believer in
environmental issues. Because of his beliefs, he will not refer any client to any
stock or company that John feels harms the environment. John seldom allows his
clients to see any investment that he does not agree with. John's company knows
that John will not present any company that he does not agree with. The company
says nothing as long as John brings in a good quantity of business. If his business
is down, however, they do bring up the matter.
Is it ethical of John to only show those companies that he agrees with? Secondly,
is it ethical of the company he works for to only be concerned about it if his sales
are down? Could John ethically represent companies that he opposes? Which set
of ethics should come first: his own regarding the companies or his responsibility
to his clients to allow them to make their own choices?
If the company that employs John should require that he show all options to their
clients, is John ethically bound to follow his employer’s requirements? Whose
ethics come first? John's, the client's, or the employer's? Different people or
groups often do not agree on what is or is not ethical. Who should decide which
ethics come first? This question might come under the heading of "What are a
person's responsibilities to other moral persons?"
Basically, all of these concepts or questions bring us back to the original point. A
person must know why they are doing a particular thing. In the case of selling
insurance, if the agent does not understand the reasons why insurance policies are
important to own, it would be very easy to lose track of important ethical elements.
The lack of this understanding might eventually force the agent to deal with the
basic inquiries that come about when ethics are pushed to the background.
What are our responsibilities to other moral persons? (Question #4).
Most people realize that they are responsible for their actions. In sales, we often
hear the statement "For every action, there is a reaction." This is generally true in
life as well. It goes beyond the obvious situations (if you smack someone, they
may smack you back). If you are rude to a person, you may not realize the
"reaction" at that moment, but one will surely follow. The reactions may not
always be noticeable to others. This is especially true when it involves emotions,
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such as hurt feelings. Since each of us is responsible for our actions, the question
then is "Are we responsible for the reactions that follow?"
Some reactions are directly tied to our actions and are predictable. If we lie in
order to obtain money, our actions are then directly tied to the reactions that occur.
What we did was deliberate and the "reaction" should be no surprise. In such
situations, we are responsible for the reactions.
In other situations, we cannot be responsible for the reactions. If we act in a
responsible manner and a reaction occurs that hurts or offends others, we may not
necessarily have any responsibility. What a person does in every day life is the
result of multiple decisions made over their lifetime. Those decisions include our
perception of whom and what we are. Our character (or lack of it) is made up of
our day-in, day-out decisions. The irresponsible person will not care what his or
her responsibility to other moral people may be. Therefore, we will look only at
what an ethical person's responsibility is towards other ethical persons.
Let's look at the example of John, the investment counselor. He would not
present any investment to his clients that he did not personally agree with. Let us
assume that most of John's clients are themselves ethical people. Since his clients
are themselves ethical, is John wrong in making such investment choices for them
without giving them a chance to bring out their own sets of ethics? What is John's
responsibility to other moral or ethical persons?
Moral or ethical responsibility is not a single choice. Such choices are made daily
in many things that we do. If we assume that our children are basically moral
people, then what are our responsibilities towards them? This may also be said of
our peers at work. If the majority of the agents at the firm we work for are ethical
people, do we then owe it to them to also be ethical?
Agency XYZ prides itself on being ethical. The owners and managers stress such
behavior at all company meetings. While sales are certainly promoted, it is made
clear that the sales must be honestly come by. XYZ Company seeks out the very
best products available so that their agents can present a superb policy to their
potential clients. Training and education is given a top priority by the company as
well.
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It would probably be safe to say that XYZ Company has invested not only time
but money into their company and their sales force. Since they have stressed
ethical behavior, it is also probably safe to say that they do not feel such behavior
will hurt them financially. In fact, they probably feel it will benefit them
financially. Given this scenario, XYZ Company has probably attracted those
insurance agents who also give a high priority to ethical behavior. If an unethical
agent came to work there and misrepresented the products (theirs or others), XYZ
Company, or any other aspect involved in the sale, how would this affect the
ethical agents?
An agent once relayed this true story. She had been building a client base for
about two years when the agency she worked for became the subject of an
investigation by the state's insurance department. Since she had always prided
herself on giving her best efforts to her job and her clients, it was distressing to see
the agency she worked for on the evening news. It did not matter whether the
agency had actually done anything wrong. It did not matter whether she had done
anything wrong; simply being connected by virtue of employment caused
credibility problems.
In this same context, the agents at XYZ Company would be affected by an
unethical agent even though the other agents were very ethical in their behavior.
People believe in the old saying "It only takes one bad apple to spoil the whole
barrel." Therefore, one unethical agent will affect how others in the same agency
are viewed. In this context, every agent has a moral or ethical responsibility to all
the other agents. In the case of the agency being investigated, that agency had a
moral or ethical responsibility to all of its agents. Of course, it is the job of the
state's insurance department to investigate any complaint. That certainly does not
mean that anyone is actually guilty of doing something wrong. Chances are,
however, if it hits the evening news or the newspapers, it will not matter whether
there is any guilt or not. Opinions will be formed. Therefore, each insurance agent
and each insurance agency has an ethical responsibility to act in a way that will not
cast doubt on themselves or others.
Selling Ethically
No matter how ethical an agent may be, if he or she cannot support themselves or
their families he or she is not likely to do the consumer much good. Therefore it is
not enough to merely be ethical. The agent must be both ethical and skilled in his
or her trade. In fact, it seems probable that the financially successful agent is more
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likely to be ethical since there will be less stress involved, less desperation to make
the sale.
Education
Certainly, education plays a role in ethical selling. Why is education important?
It is common to hear agents and agencies alike complain about the educational
requirements of their state. The agent may look for the shortest or easiest
educational course to simply get their educational requirements out of the way.
Consider this:
You are not feeling well so you go see your general practitioner. Your doctor
states that you must go to a specialist because he or she suspects that you have a
heart problem. The specialist that is recommended has a booming practice and
obviously does very well financially. The office is plush and he or she drives into
the complex parking lot in a fancy foreign sports car. There is lots of office staff
and everyone seems intent on pleasing the waiting patients. Even so, you ask the
medical specialist some questions that are important to you about their schooling.
The specialist replies, "Oh, don't worry yourself about that. I finished school ten
years ago, and I haven't had the time to attend any of the seminars or other
educational programs. But don't let that worry you. I've had lots of practice and I
make a point to read all the brochures sent to me by my suppliers."
Of course, we realize that a heart specialist is not an insurance agent. Even so,
the point is the same. How much confidence would you have in such a doctor?
Why should a consumer have confidence in an agent that does not consider
education important?
Probably every agent alive has attended a seminar where educational laziness was
obvious. Of course, it is the responsibility of the speaker to be interesting and
cover a topic in an organized and practical fashion. Having stated that, it is also
the responsibility of the agent to attend the seminar in a prepared manner. He or
she should have a notebook, ink pen or pencil or a tape recorder. Notes may be
optional, but if the seminar is truly educational it does seem that notes would be
appropriate.
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It is not appropriate for the attending agent to talk to those around him (which is
likely to interfere with the enjoyment and learning of others), read the paper or a
magazine, write personal letters, or work on personal business during the seminar.
It is not unusual to observe an agent or two sleeping through the seminar waking
up only long enough to sign the roster that is passed around for attendance.
Certainly, the agent who signs in and then leaves for an hour or two is not learning
anything. Although most states have specific rules about such actions, they still
occur. The agent who must be policed into being responsible about his or her
educational actions cannot be considered ethical or even professional.
As an educational company, we have heard complaints from agents who feel they
have been in the business too long to learn anything new. Again, we refer back to
the medical doctor who feels education is not necessary for their continued medical
practice. Just as you would not feel comfortable with such a doctor, would your
clients feel comfortable with that attitude from you?
Getting Education in a Timely Manner
It is impossible to truly be a professional unless education is made a priority.
Every educator's dream is to no longer hear "How easy are your courses?" It
certainly does separate the serious career agent from the average agent.
Most states do now require that education be obtained. How much education is
required varies greatly from state to state. It is the responsibility of each agent to
know and understand their state's requirements. Each agency is responsible for
promoting education as an important feature necessary for the welfare of both the
agent and the consumer. An agency should never resent the time an agent takes
out of the selling field to acquire education. In the end, the agency also benefits.
The words, "in a timely manner," seem to be a key phrase. It is very difficult to
get all that is available out of a course, whether in a live seminar or in a homestudy program, if the agent must rush through to meet a state deadline. Not only
does the agent miss a great deal, but the true value of the course is also lost.
Education is the mark of a true professional.
What about getting education that is not required by the state? Some agents
complete education, which gives them specific designations, such as Chartered
Life Underwriter (CLU) or Registered Health Underwriter (RHU). These
designations are the result of additional education specific to certain insurance
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lines. While such designations do not necessarily mean the agent is a wiser or a
more skilled salesperson, they do show that the agent is serious about his or her
profession. Regardless of the line of work a person is in, additional education is
always a sign of a true professional. This is true of a teacher, a doctor, a lawyer,
and certainly an insurance agent.
It is true that there are agencies that do not seem to appreciate agents who desire
additional education. In fact, there may be situations where an agent might wish to
consider changing who they work for if education is not only unappreciated, but
even degraded. It is hoped that this is not a normal situation. It is hoped that most
agencies do promote additional education.
There is another side to education besides formal, credited courses.
Angie is a fairly new agent having only been in the sales field for about six
months. She works for a large agency with a very large field staff. While the
agency does hold product meetings, it is not unusual for new items to be added
before they have been formally introduced in the product meetings. As a result,
Angie is often given brochures and applications for products that she is not familiar
with.
Angie's field manager, Reggie: "Angie, here are some brochures for a new cancer
policy we just got in. It's fairly simple, but if you have any questions give me a
call. Just read the brochure. That should do it."
Angie reads the brochure and does understand the basics of what it is selling.
What Angie is not sure about is where such a policy fits in and who might benefit
from buying it. She knows that major medical policies are supposed to cover such
things as cancer. Since Angie sells mostly life insurance, however, her
understanding of medical policies is not great. Angie makes the determination that
many plans must not cover cancer, otherwise why would there be such specific
policies on the market? Angie sells two cancer policies in the first week and is
highly praised by Reggie. Being so new, Angie does not often get praise, so now
she begins to make a special point of suggesting her clients buy the cancer policy.
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We are not trying to suggest that cancer policies are either good or bad. The
question here does not necessarily concern the value of the policy itself, but rather
how Angie handled a situation concerning education. Since Angie was not sure
where this new product best fit in, what should she have done? It was obvious that
Reggie felt the brochure should answer her questions, but he did offer his
assistance if she wanted it.
What were Angie's options?
1. She could have called Reggie or cornered him at the office to ask
questions.
2. She could have asked other agents more experienced than she.
3. Angie could have waited for the product meeting and asked questions.
4. Angie could have called the insurance company marketing the product.
Most companies do have a product support department.
Did Angie need to do any of these things? Since she was able to sell the product
even though she was not sure where it fit in, did any questions even need to be
asked? Remember that Angie did not have a great understanding of medical
policies and made the assumption that some plans must not cover cancer. Is it
possible that she misrepresented existing medical policies due to her
misunderstanding? We know that Angie would not have purposely misrepresented
other policies, but does this lessen her liability? If Angie did misrepresent other
plans, what will this do to her credibility if her clients discover her error? If Angie
did not bother to explore this product completely, is it possible that this is a work
pattern that repeats itself with other products also?
Does the agency bear any responsibility here? Although they do have product
meetings occasionally, is it their responsibility to have such meetings before
releasing a new product to their agents? Since the agents are basically selfemployed, does this mean that education is solely the agent's responsibility and that
anything the agency does is more of a courtesy than a responsibility?
We are not attempting to answer these questions. Often the answers vary so
much depending upon such things as contracts, etc. that each agent must determine
their own answers. However, it is certainly true that each agent must take on a
degree of responsibility when it comes to education in general. To rely upon
another person or agency to fulfill educational needs is foolish, both personally and
financially.
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Laying Out Policy Benefits and Limitations
Once the consumer has agreed to hear the agent's presentation (we dislike the
word "pitch" since it suggests trickery) the agent enters into many possible pitfalls.
Policies can be very difficult to understand. Most presentations involve a few set
items, which include premium rates, benefits, agent services and company
stability. Of these, the premium amount should be the least important, although
our clients do not always allow this to be so. As a result, rates often take up the
majority of the presentation, yet an Errors and Omissions claim has never occurred
due to the premium quoted. Probably 98 percent of the E&O claims filed relate to
the benefits of the program and how those benefits were discussed (or not
discussed, as the case may be). Obviously, more time needs to be devoted to that
aspect. Then, as an agent, you must hope that the client remembers what was said
and understands the concepts discussed.
The insurance contract can be very intimidating. Technical in nature, complex in
its subject matter and seldom read in full by either the insurance agent or the
policy-owner, it is bound to be misunderstood at some point by somebody. It has
been said that insurance contracts are the number one unread best seller. More
insurance contracts are probably sold than nearly any other type of contract, yet
they are seldom read by the consumer. Unfortunately, policies are seldom read in
their entirety by the selling agent either.
To our clients, the most important part of the policy is the part that begins, "We
promise to pay . . . ” In reality, all other parts are, of course, limitations and/or
conditions on the policy.
In some ways, life insurance policies are more easily understood than other types.
After all, a person is either dead or alive. If the insured dies while the policy is in
force, the promise of a payment is kept. In a medical policy, there may be
numerous limitations or conditions of payment that the consumer (policyholder)
has difficulty understanding. Medical policies contain such things as co-payments,
stop-loss provisions, elimination periods, plus a variety of other confusing and
easily misunderstood clauses. All of the provisions can create dissatisfaction,
which can cause questions regarding an agent's diligence in presenting the policy
and providing services. This is not to say that a life policy should not also be
clearly explained to a client. Any contract can be confusing to the consumer. Any
contract can cause a misunderstanding.
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There are steps that an agent can follow to minimize possible misunderstandings:
(1) Full disclosure is always necessary in any type of policy being suggested
to a client. Where different interpretations are possible between a brochure
and the actual policy, the policy is always the final authority. A brochure is
simply a selling tool; never the final answer. The statement the agent
receives over the telephone from the agency or home office also takes
second place to the actual contract. The policy is the final word every time.
An agent who has not read the contracts he or she is selling, is an agent
waiting for a lawsuit to happen.
(2) An agent should always be slow to replace an existing contract of any type.
This is not to say that an existing contract should never be replaced.
However, to do so without fully examining what is currently in place would
be foolish. The agent should first be fully informed of any new or
preexisting health conditions, take-over provisions and limitations that may
exist in the new plan. Health problems of any dependents that may apply
should also be reviewed.
(3) Sometimes owners/employers may not be enrolled in and paying premiums
for worker's compensation coverage. While this does not typically apply
to the senior clients you will encounter, older age people are still working
and might need consideration.
(4) Whether you are dealing with a health program, a disability program, or a
life insurance program, make sure that health questions are clearly
understood and correctly answered. A term that has come into wide usage
lately is clean sheeting. It means that an agent knowingly fails to correctly
list existing or past health conditions of the applicant. The agent is
presenting a "clean" application so that the company will accept it and issue
a policy. This is obviously illegal and will not be tolerated by any insurance
company!
(5) Sometimes an agent simply is not aware of existing health conditions. If
the applicant does not fully understand a health question, it may be
incorrectly answered through no direct fault of the agent. We say direct
fault because it is ultimately the responsibility of the agent to present the
questionnaire in a way that is understandable. Even if the agent thought the
health portion of the application was correctly completed, it will not alter the
insurance company's view of it. A policy may be rescinded (taken back) by
the insurance company for incorrect or undisclosed information. This may
occur, for example, on a question, which asks if the applicant has high blood
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pressure. Since the person is taking a medication that keeps his or her blood
pressure under control, they may answer the question "no" when, in fact, it
should have been answered “yes.” Since these types of misunderstandings
can easily happen, an alert agent will want to closely monitor the questions
and answers on applications.
(6) Eligibility of applicants is always a concern when replacing an existing
coverage. Do not overlook the eligibility of dependents also. An
employee's spouse or disabled child may be especially vulnerable.
(7) Any time an existing coverage is being replaced with a new policy,
continuity must be considered. The old plan should never be dropped until
the new plan is firmly in place. The policy should actually be in hand and
reviewed for accuracy before the old policy is dropped.
The actual way in which a plan is presented can be very important since so many
of the consumers will not understand industry terminology. The weight falls on
the agent to present the policy in such a way that understanding is possible. Again,
this often comes down to good communication skills. We also suggest that you
pay close attention to the "body language" of your clients. It is often possible to
tell that your client is lost merely by the expression on their face. Many people
feel awkward saying that they are lost. This might especially be true if they feel
their agent is in a hurry to get on to another appointment.
There are also those agents who cannot seem to resist being overly technical. The
agent may feel that such technical explanations are necessary or he or she may
simply be trying to impress the client. These agents may be extremely
knowledgeable, but they are unable to present their knowledge in a way that is
understandable to the layperson. While this relates more to skills than it does to
ethics, an ethical person will put a priority on client understanding. If the agent is
trying to impress the client, then we must ask the question, does ethical conduct
allow for such self-serving purposes?
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Policy Replacement
Insurance is a replacement business. Even the most ethical agents realize this is
often part of their sales day. In some areas of insurance, policy replacement
became such a problem that state and federal legislation was enacted to protect the
consumer.
Most states require that comparisons (for the purpose of replacement) be precise
and done in a manner that fairly compares the two policies. Often there are
specific forms, which must be utilized if replacement of an existing policy takes
place.
Agents often complain that it is very difficult to compare policies if the types do
not have much in common. It ends up comparing apples to oranges rather than
apples to apples. Whatever the situation, an ethical agent WILL fairly compare the
two products, not only because he or she is ethical, but also because it is simply
smart to do so. We live in a lawsuit prone society and it is not surprising that many
consumers are all too willing to sue.
Most consumers are aware that competing agents will be attempting to replace
each other's business. Realizing this, consumers do tend to use judgment before
replacing their policies. Replacement practices may not be as obvious to the
consumer when it involves an agent replacing their own policy. Consumers
seldom question a replacement when it is the same agent (versus a competitor)
doing the replacement.
Why would an agent replace their own business? For several reasons, some of
which may not be sound or ethical.
One of the major reasons that some types of policies are replaced by the writing
agent is to gain another commission or a higher commission, depending upon the
type of product. For example, in states where commissions are not controlled, it
has been a standard practice for agents to replace their own Medicare supplemental
business. In many areas, the first year commission was high, with the
commissions from the second year on being considerably lower. By replacing
their business every year or even just every two years, agents were able to keep
their commissions high. This is usually a disservice to the client, especially if
preexisting conditions played a part in the replacement. The standardization of all
Medicare policies should put these replacements in check or at least dramatically
reduce it. Many states have put limitations on the commissions paid on Medicare
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supplemental policies. The controls do make sense as far as replacement business
goes, although the reduced commissions also generally mean less claim service for
the consumer. Now, instead of receiving a large first year commission and reduced
subsequent commissions, the agent receives a level commission from the first year
on in more and more states (as more and more states adopt this format).
Another reason, and a common one, that agents might replace their own business
has to do with the mobility of the industry. It is not unusual for agents to work for
a period of time for one agency and then, for one reason or another, move on to a
different agency. If an agent is not meeting production standards, the first agency
might terminate the agent or terminate benefits, such as providing leads. When the
agent moves on to another agency, he or she often feels that his or her clients
belong to them. Legally, this may not be true, depending upon the agent's contract
provisions with the agency. Whether or not it is proper legally, the agent often
tends to attempt to bring his clients with him to the new agency. Since the agency
is benefiting from the additional business, few agencies worry about the ethics of
such replacement business. In fact, it is not unusual for agencies to actually
encourage the practice.
Another reason for policy replacement deals with company stability. The
industry has seen some ups and downs in the financial stability of some insurance
companies. If an agent feels that he has clients in a company that may be suffering
some financial problems, the agent may change their client's policy in an effort to
protect the consumer. Certainly, it is best to try to use strong companies so that
this will not be necessary, but even the most careful agents may, at some point,
find their clients with an unsound company.
Replacement of business is sometimes proposed by the agencies that have legal
rights to the business but, due to contracts with vested agents, are paying part of
the commissionable earnings to those terminated agents. The agencies may be able
to move the business within their agencies and, therefore, discontinue the
commissions paid to those agents who have been terminated. As we have stated,
not only individual agents, but agencies as well have a duty to behave in an ethical
manner. That does not necessarily mean that they do. Most insurance laws protect
the consumers, not the agents.
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When the Agent Allows Misconceptions
It would probably be surprising how many policies are sold on the basis of
assumed facts or misconceptions. We are not saying that the agent outwardly
misled consumers, but rather, they allowed the consumer to make assumptions that
were incorrect.
An agent relayed this story:
I was sitting in the home of an older client who was interested in investing in an
annuity product. I was showing him several plans available. One was paying a
higher interest rate than the other two, and the consumer liked the higher rate. I
made a point of telling him the ratings of the companies, carefully pointing out that
the higher paying company only had a "B" rating.
After a moment's pause, he replied: "Hell, I would have been happy with B's when
I was in school."
It is obvious that the consumer did not understand the importance of financial
ratings. It would have been easy to simply fill out the application and never
address the obvious misconception on the part of the client.
Any agent who has spent time in the field can probably tell their own stories of
people who made incorrect assumptions placing a sale directly into the lap of the
agent. Some misconceptions may simply be amusing, while others may cause
serious legal problems. Sometimes it can be so difficult to clear up a false
assumption that the agent simply lets it slide by. This is seldom wise. It is always
better for the client to correctly understand what they are buying. The next agent
in their home may clear up the matter, making the first agent appear either inept or
unethical. As one agent relayed, he hates coming into a home where he must
spend most of his time correcting the false information left by the agent before
him. While this does tend to cement the sale, it is also a waste of time and energy
for the second agent on the scene.
One other point should be made at this time. Insurance agents tend to have a
reputation only slightly higher than that of a politician. Why does this happen? It
is probably safe to say that the majority of this reputation comes from consumers
who feel that they were "taken" by an insurance salesman. Either the consumer did
not get what they thought they were buying or they felt pressured into buying
something they did not really want or intend to buy. We often hear people say that
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the "big print giveth and the small print taketh away." In reality, print size is
generally mandated by each state. There is no "big" or "small" print. What the
consumer really means is that claims were not paid due to policy limitations or
gatekeepers. A policyholder that knows a specific claim will not be paid is not
likely to be upset, but a policyholder that thought a specific claim would be paid
will be most upset when he or she is turned down for the claim. That policyholder
will probably feel the salesperson misled them or, at the very least, failed to fully
disclose the conditions and limitations present in the policy.
When the Premium Appears too High
Another area of ethical behavior that should never happen still needs to be
addressed. It needs to be addressed because it does happen. There was the client
who thought he was paying the premium for a full year only to discover that it was
a 6-month premium. There was the woman who was told her bank would be
drafted one amount only to learn that the draft was for a much higher figure.
Sometimes when an agent fears he or she is losing a sale due to the amount of the
premium, figures may be incorrectly stated for the benefit of the sale. We would
like to think that such situations are merely misunderstandings, and certainly
misunderstandings may happen. There is never any excuse for purposely
misstating premium amounts.
Premium amounts may be misstated simply because the agent is inexperienced in
using premium tables. So many types of policies have formulas for figuring rates.
For example, many long-term nursing home policies have premium rates that vary
according to multiple factors, each of which must be considered. Major medical
plans are based upon ages, the plan selected, and sometimes health conditions.
Obtaining Proper Signatures from the Client
The practice of forging client signatures is not only unethical, but illegal as well.
Despite this fact, it is much more common than many people might realize.
There are many reasons why signatures may not be obtained from the client.
Often, it is merely an oversight by the agent. Such oversights clearly state
disorganization on the part of the agent. New agents might benefit from
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highlighting signature lines on all their forms before entering the field. Doing so
could prevent the omission of needed signatures.
In some cases, signatures might be purposely overlooked as a way of avoiding the
explanation of certain forms. This commonly occurs when replacement forms are
required and the agent feels inadequate explaining the information contained in
them. Again this is not only unethical, but generally illegal as well since all forms
need to be disclosed to the client. In addition, the well-trained, well-organized
agent simply does not need to omit signatures, whether by oversight or by
intention. Anytime an agent feels uncomfortable about a particular form, he or she
should seek council from an experienced ethical agent.
Keeping in Touch after the Sale
The hardest policies to replace are those belonging to the agent that keeps in
touch with his or her clients. Aside from the business retention standpoint, what
are an agent's ethical duties regarding service after the sale?
This often depends partly upon the arrangements made between the agent and his
or her agency or insurance company. Some companies have a separate servicing
staff so that the selling agent is not expected to do any further service work. Most
agents, however, are probably expected to do any necessary service work
personally. Even if the selling agent is not expected to do so, most professionals
do feel that referrals and additional sales result from close client contact. In
addition to that aspect, everyone likes to feel that they were more than a
commission to a salesperson. Even a simple birthday card at the appropriate time
is appreciated by the consumer.
Many agents want to provide service to their clients. Not all agents or agencies
feel this desire. Many simply do not wish to take on the burden of service after the
sale. Certainly, servicing one's clients is prudent, but is it required from an ethical
standpoint? Some states mandate that each client must have an assigned agent.
This means that the insurance company must assign an agent to every account if
the writing agent is no longer with them. Those states then expect those assigned
agents to handle any claim requests that might occur. Many of the states report
that the lack of claim service is the number one complaint from consumers.
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Earlier in this text we pointed out that it is only possible to mandate behavior, but
not necessarily ethics. Is it possible to force an agent to properly service their
clients? Probably not. If the agent is not smart enough to understand that service
promotes sales and helps business retention, it is unlikely that he or she will be
smart enough to understand service requirements imposed by his or her state. In
fact, an agent who is unwilling to service his or her accounts, probably will not
even be educated enough to know how to service the accounts. When this
happens, one can only hope that the insurance company or agency will step in and
handle the matter. If no one handles it, eventually the client will simply change
agents and insurance companies.
Selling the “Fast Buck” Items
Some might consider this an unfair statement. However, we feel the evidence is
compelling that many people, not just insurance agents, will quickly step forward
if there appears to be a "fast buck" available by selling a particular item. There
may be differing opinions on what constitutes a "fast buck" item. In fact, it is often
true that the fast buck lies not in the item sold, but in the manner in which it is sold.
In some states, selling Revocable Living Trusts has become big business. While
there is no doubt that a living trust can be very beneficial in the proper
circumstances, many of these trusts have been sold for inflated prices to people
who did not benefit in any way. Sometimes the consumers do not benefit because
the trust is not properly executed; sometimes the consumer simply did not need the
trust, so their purchase was unnecessary.
Perhaps the most perplexing aspect of the sale of these revocable trusts has to do
with the way in which they are sold. An item is definitely a "fast buck" item when
the seller says anything necessary to get the sale. Consumers have been told so
many incorrect things about trusts that it has become clear to many state regulators
that the aim of many trust companies is simply to bring in cash. If this were not
the case, there would be more control exercised over the sales force. Unfortunately
for those who are honest in their promotion of revocable living trusts, many states
will be addressing the abuses currently happening. How the situation will be
addressed will vary from state to state, but it is likely that some type of legislation
will limit who may represent them.
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A "fast buck" item does not intend to imply that particular items are in this
category. Actually, it has to do with how the items are sold. Any product, which
pays a fairly high commission or finder's fee, can become a "fast buck" item. "Fast
buck" has to do with the attitude of the salesperson. Is the salesperson thinking
almost entirely about making some fast money or are they considering where the
item fits and whom it best serves?
As we saw with the living trust sales, a valuable estate planning tool was misused
by salespeople for the sake of making a fast buck. There was often little concern
for the consumer or the consumer's needs. Therefore, this item is both a useful
vehicle in the right circumstances and a "fast buck" item in the wrong
circumstances.
Commingling Funds
Any professional should always be shocked when they hear an agent express
ignorance regarding the hazards of commingling funds. This is something that
every agent should be aware of. While state laws do vary, the basic concept
remains the same: insurance funds and personal funds should never be mixed. By
this, we mean that two separate accounts must be kept. It might even be wise to go
a step further and use two separate banks, one for your personal account and one
for your insurance account. Most professionals have an operating account and a
trust account. The trust account is used for funds that do not belong to the
insurance agent or the insurance agency. The operating account is used for
commissions that are due and payable to either the agent or the agency. The
operating account is used to pay the routine bills that come with running a
business. The trust account holds funds "in trust" for either the insurance company
or the policyholder.
Any agent that is not clear on this should contact their state's insurance
department for that state's specific requirements.
Following Regulations
In today's lawsuit prone society, the wise insurance agent or brokerage will make
a point of following state regulations, but ethics actually goes beyond what is
simply mandated by state or federal governments. Ethics define who we are. A
man who tells constant lies is known to others as a "liar" (although studies show
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that 90 percent of us lie regularly). A man who steals is known to others as a
"thief". An insurance agent who is unethical will also earn a reputation for such.
It has been said that legal authorities may be able to mandate behavior, but not
ethics. Technically, this is probably correct. A person who would like to steal
may not do so because of the consequences such behavior would bring about.
Therefore, his behavior is controlled, but his ethics are not. Although he does not
steal, he would still like to.
Controlling a person's behavior may, however, eventually lead them to an
understanding of ethical behavior. It is not unusual for an individual to become the
person they pretend to be. A person who acts ethically, even if they do not desire
to be, may eventually soak in the ethical behavior and adopt some of that potential.
In fact, since morality is about the way we live, we do learn it over our entire
lifetime. To think that a person who is not ethical today will never be ethical is
simply wrong. In fact, it could go the other way as well. The person who is
behaving ethically today may not do so tomorrow. Even so, it seems to be true that
most of our ethical behavior is learned during childhood and adolescence. Perhaps
that is why ethical parenthood is so vitally important in the eventual outcome of
our children's lives.
Children learn from what they see and hear. Children and animals tend to be very
good at sensing adults as they really are. Children also tend to imitate the behavior
they see, especially if it is coming from the adults that are close to them, such as
parents. As a result, parents who set good moral or ethical examples are teaching
their children to do the same. Unfortunately the reverse is also true. In homes
where prejudice, racism, sexism and other immoral codes are practiced by the
parents, children from those homes are very likely to act in the same manner.
Children learn from what they see, good or bad. We have all heard adults say "Do
as I say, not as I do." The chances are, however, that the children will do as they
do.
It seems to be a popular notion that toughness is needed in the business world.
Ethics may be perceived as a quality that does not belong to toughness. This is
actually far from the truth. As many religions will be quick to confirm, toughness
is often a vital part of ethical behavior. Children are the first to realize this. Peer
pressure often demeans behavior that is ethical. Certainly the child that can
withstand the stress of peer pressure is displaying toughness.
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To some measure, toughness is probably necessary to succeed in business. The
insurance salesperson that cannot take repeated rejection will not likely stay with
the insurance industry. At least not as a salesperson.
Toughness that is coupled with a code of high ethics may not always experience
smooth sailing, but it is likely that the combination will produce an atmosphere
that promotes business and that is always desirable. Toughness with ethics gives a
passion for productivity and efficiency, along with the spirit of competition, all of
which contributes to the traditional measures of economic success.
It cannot be overlooked that America was founded on the beliefs of many people
who questioned the actions of the countries they came from. Those looking for
freedom, religion, the right to work for themselves (rather than others), the right to
own possessions and land, and the right to make their own decisions all came
together to form America.
Many Americans at least partially arrive at their code of ethics through their
religion. In fact, the Bible sets down many prescriptions for ethical behavior. The
Bible is probably the best known source of sound ethical advice. Even so, not all
have agreed with the concepts stated there. Karl Marx, the father of communism,
called religion the "opiate of the masses." Even Sigmund Freud, the father of
modern psychology, regarded organized religion as institutional "wish-fulfillment."
As we stated, moral or ethical conduct is continually learned. Susan Neiburg
Terkel reported in her book titled Ethics, when Mahatma Gandhi, India's beloved
leader in the struggle for independence from England, was asked why he had
changed his views over the course of a week, he explained, "Because I have
learned something since last week."
It is doubtful that any person is only good or only bad; each of us has shades of
each. We continue to learn as new ideas are presented and new experiences
encountered. Unfortunately, if we have been poorly educated on ethical conduct,
we might be faced not only with leaning the basics of ethical behavior, but
unlearning bad conduct as well.
Ethics are not always merely a matter of how we think and act. Often it is also a
matter of character. So many things come together to form our character that all
must be taken into consideration. Values, principles, emotions, plus many other
factors all contribute.
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There is little doubt that each of us is influenced by others. Even so, for each path
chosen, we alone must take responsibility. Each of us has the ability to build,
change, or destroy our own character. Part of our character is, of course, our
ethical guidelines.
It should be noted that no single act defines our personal character. Each of us
has likely participated in an act that was wrong. That one action does not define
our total character just as one kind act does not build our entire character.
Character is more a matter of adding and subtracting our actions and thoughts. A
good person can do something unkind, yet still be a good person. A bad person
can do something kind for another and yet remain basically a bad person. We refer
to these isolated deeds as being "out of character." An action that is not consistent
with one's normal behavior is not likely to form or change the character of a person
(although that single action can affect another in either a positive or negative
fashion).
Competency
To be ethical one must be competent. Of course, most people would not view
themselves as incompetent. Sometimes the industry itself must remove those
within it that are incompetent. Sometimes, competency is merely a matter of
obtaining required education within your given industry on a timely basis (and
taking responsibility when it is obtained past time requirements).
It isn’t always easy to remain competent in all areas. Companies routinely create
new products, urging their field staff to promote them. Agents who are not fully
prepared may be incompetent without realizing it. It is easy to assume that one is
knowledgeable when important facts are actually missing.
Ethics often involves due diligence; a term familiar to insurance agents. Due
diligence involves doing what is required in a reasonably prompt manner. It also
means knowing enough about the companies represented to feel comfortable about
their financial strength.
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One area of ethics often overlooked is confidentiality. It is very easy, in the
excitement of selling, to tell some bit of information about someone else. While
we might assume that one client does not know another that is not always the case.
Especially in small communities, people often know each other for miles around.
If a client discovers that an agent is sharing information they consider private, that
agent is sure to experience trouble.
Ethics often involves conflicts of interest. While this is less likely to happen in
the insurance field, it does still apply in some cases. Some actions could border on
or involve fraud. For instance, if an agent were to draft some type of legal paper or
contract giving him or herself, or any member of their family, an interest in a
client's estate or assets, that would most certainly involve a conflict of interests. In
many cases, it would also be illegal.
Sometimes estate planners could become involved in what is called simultaneous
representation. This means they are representing two different parties who have,
or may have at some future date, conflicting interests.
Most often, ethics simply means being honest. It is representing each client
without regard to one’s personal financial gains, but rather with the client's welfare
in mind. It is the act of full disclosure on all products represented.
It is not enough to voice an opinion that ethical behavior is desired; such ethical
behavior must be exercised on a daily basis in all business functions. It is the
insistence that others in your profession do the same. The public often believes
that no profession will turn in another within it, whether it is a doctor, attorney or
an insurance agent. Ethical behavior would actually dictate that a professional
must turn in another member who is not ethical in their professional manner or
ability. This is harder to do than it sounds. Where commissions are involved,
turning in another agent could probably be considered a way of beating out the
competition and may not be taken seriously by the authorities. Therefore, it can be
very difficult to police the industry. That is where the state Insurance
Commissioner's office comes in. They are charged with removing the unethical
agent. Their job is very difficult; there is only so much they can do if the conduct
is overtly illegal.
Ethics involve not only individuals, but businesses as well. Every business,
individual insurance agency and brokerage has a responsibility to develop a code
of ethics for their employees or agents. If such a code of ethics is not consistently
applied, not only may state regulators be paying them a visit, but also agents within
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the company may find themselves in a position of fighting each other for
commissions in the same household or business.
Aside from the in-house
problems this would create, honesty for the sake of honesty is reason enough to
develop a code of ethics within the workplace.
Any industry involved with the public's money (as the insurance industry is)
suffers when scandals occur. Public confidence is eroded and business is affected.
Therefore, it is in each insurance agent's interests to promote ethical activities
within the industry.
Some types of unethical actions are commonplace. It is not unusual for
signatures to be forged on insurance forms. Commingling funds also happens
routinely. While no agent would likely admit to such actions (because they know
they are wrong), most businesses are aware that they are occurring. By not
addressing the issue, those businesses are not only allowing unethical behavior
among its agents, but also condoning it.
It is not always easy to determine if an action is actually unethical or merely a
difference of opinion. Replacement business is one area where a variety of
opinions exist. Insurance is a replacement business and much of the replacement is
for the good of the consumer. However, there is also an ugly side to contract
replacement. When policies are replaced merely to obtain another commission it is
seldom for the good of the consumer
As we know, agents have an ethical obligation to describe accurately to the client
the financial strength (or weakness) of the insurance company being proposed.
This is true of any insurance policy being proposed or replaced. In fact, it has been
held that an agent has a legal obligation to accurately describe such financial data.
A lawsuit could be brought against an agent who causes a client to suffer
financially as a result of the agent's failure to fulfill these "due diligence"
responsibilities.
We believe that an agent wishes to give his or her client the best products
available. Certainly a career agent would want to do so simply to remain in
business. Often, it is the agent's lack of understanding of or attention to some of
the technical terminology used in documents pertaining to the financial strength of
insurance companies that causes the agent problems down the road. In other
words, many agents either do not understand or fail to read much of the material
that is available regarding the companies they deal with. Terms such as admitted
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assets, consolidated assets, projected mortality plus many others do not completely
register understanding. The agent may have a vague idea of what the terms mean,
but not an actual understanding. Certainly, much of the printed material available
is not stated in a way that makes the information easily readable.
Many of the terms used are associated with the company's balance sheet, its
statement of assets, liabilities, and the owner's equity.
Admitted Assets are those assets the company is allowed by state regulatory
authorities to include in its statutory annual balance sheet. Some of a life insurance
company's assets may be excluded in the interest of balance sheet conservatism,
although most assets are admitted. If an asset is a nonadmitted asset, it is
generally regarded by regulators as less sound than admitted assets. Nonadmitted
assets are typically thought to provide less security for the company's
policyholders. Nonadmitted assets include such things as the agents' balances
owed to the company, office furniture and mortgage loan interest income that is
overdue by more than a specified length of time.
Consolidated Assets are the total of the assets of the parent insurance company
and all the subsidiary companies, if more than 50 percent of the voting stock is
owned. Even though the assets are owned by two or more separate companies, for
the purpose of the balance sheet, the assets are combined and treated as if they
were owned entirely by the parent company. This is due to the voting control the
parent company has. Even the assets of subsidiaries not engaged in the life
insurance business are included in the consolidated assets of the parent company.
Investment Grade Issues are something often seen in percentage forms. These
are bonds whose insurers have been evaluated by a recognized rating agency that
has placed them in one of the agency's few highest quality rating classifications.
Generally speaking, the higher this percentage is, the greater the safety of the
bonds in the portfolio. Therefore, the greater the insurance company's financial
soundness. Even so, the rating assigned to any particular bond issue can be
lowered without warning as a result of many circumstances or events.
It is common for insurance companies to advertise that their assets exceed large
quantities of money, for instance $2-billion may be stated. While it is important to
have sufficient quantities of assets, the amount of those assets will mean nothing if
the company's liabilities equal or top the amount of assets. The size of company
assets is less important than the percentage of liabilities to assets. There is a basic
balance sheet equation:
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Assets = liabilities + owners' equity.
All three components must be considered before the strength of a company may
be correctly judged.
Owners' Equity is the amount of the insurance company's assets that are
financed with funds that were supplied by owners rather than by creditors.
Contingency Reserves are accounts (from owners' equity) that are voluntarily set
aside by the insurance companies for the possibility of unforeseen future adverse
circumstances. Usually the board of directors will not pay dividends from these
reserves.
Unassigned or Permanent Surplus is the amount of the mutual insurer's owners'
equity that has not been set aside for any specific reserve or purpose.
Common Stock that is referred to in financial statements is the total number of
shares of common stock outstanding. They are usually valued at an arbitrary (and
usually low) dollar amount. This may be called par or stated value per share.
Additional Paid-in Capital and Contributed Surplus is the same thing. It is
the excess of the selling price of the stock at the time it was issued over its par
value. Neither the amount of the capital stock account nor the additional paid-in
capital account has any relationship to the present value of the stock life insurer's
common shares.
A balance sheet also contains a section on the company's liabilities. The largest
amount listed will be for amounts owed to policyowners and the beneficiaries of
the life insurance policies. There may be (though not always) the normal borrowed
funds and accrued expenses payable.
Mandatory Securities Valuation Reserve is also generally listed in the liability
section. This is a reserve (as the name implies) of some of the assets (not
necessarily cash), which is set aside to prevent changes in the amount of the
company's unassigned or permanent surplus that may result from fluctuations in
the market value of other assets such as bonds, preferred stock and common stock.
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Even though the Mandatory Securities Valuation Reserve is listed in the liability
column of the balance sheet, it is not a true liability. It is more like a reserve for
amounts owed to others. State regulatory authorities decide the size the reserve
must be which is determined by a number of factors.
Capital Ratio is the portion of the company's total assets that are financed by
owner's funds. This is often the measure used to determine the insurance
company's financial strength. It may also be called Capital-To-Assets Ratio or
Surplus-To-Assets Ratio. The higher this percentage is (if all other things are
basically equal) the greater the company's financial strength is thought to be.
Notice that the previous statement said: "if all other things are basically equal."
Since the Capital Ratio is so often used to compare the financial strength of
companies, it is important to realize that different ingredients may be used in
determining the ratio.
Sometimes an insurance company will make reference to its income statement as
a basis of financial strength. Income is only part of the picture, of course. A
company's direct premium income does not show any premium income or outlays
resulting from reinsurance transactions, for example.
Net Premium Income is typically defined as its direct premium income plus
premiums it earns from reinsurance it assumes, minus premiums it gives up due to
reinsurance that it transfers to another company.
The equation is basic:
1.
2.
3.
4.
Direct premium income
+ (plus) premiums earned from reinsurance it assumed
- (minus) premium it gives up due to reinsurance it cedes to other companies
= (equals) Net Premium Income.
Even though this formula may be used by an insurance company to suggest its
financial strength, it really is only about half of the needed information to make a
sound judgment call. In fact it is more likely to tell an agent the size of the
company, rather than its financial strength.
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Surplus Reinsurance is the transfer of a portion of the amount of coverage under
a life insurance policy to a reinsurer. The ceding or surrendering company then is
allowed, if regulatory requirements are met, to also transfer to the reinsurer a
corresponding portion of the aggregate reserve liability under the policy. The
ceding company (transferring company) receives a credit against its liability for the
portion transferred. Some feel the use of surplus reinsurance may be a sign of an
insurance company's financial weakness.
The terms from an insurer’s balance sheet may be overlooked by many agents.
Typically, agents are more concerned with a company's rating from the rating
firms, such as A.M. Best. That information is certainly easier for the agent to
obtain and understand. It is also probably easier to relay to a potential client in a
sales situation. However, it is becoming increasingly evident that such rating firms
are not infallible. There are also differing opinions among rating firms. Which
one is the correct rating? There have been insurance companies who enjoyed a
high rating and yet ended up in financial trouble. A career agent simply must look
beyond the rating of the companies he or she chooses to recommend.
Some states have noted that agents tend to ignore such things as balance sheets
when their state has a guaranty fund. Not all states have such funds. Many agents
probably are not aware that such state guaranty associations typically cover only
the guaranteed values of the policy, not the projected, assumed or illustrated
values.
There are so many things that play a part in an insurance company's financial
strength. Things such as underwriting standards, how reserves are set up, risk
spreads, management, and reinsurance practices are a few of the things that will
affect a company's financial strength. An agent cannot know all that is involved in
a company, but an agent can look past the surface of the brochures put out.
Remember that any given company is selling itself not only to policyholders, but to
the agents as well.
Since insurance companies are also selling the insurance agent so that insurance
agents will sell their products, the agent can take a common sense approach to due
diligence. For a busy agent, it can be difficult to follow through on all financial
details involved in an insurance company's financial report. While the technical
analysis is certainly important, such analysis is not always possible.
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When using a common sense approach to determine financial solvency there may
be a combination of factors to consider. A company that makes one or more
obviously big financial mistakes may end up with financial problems. An example
of this is the companies that invested in junk bonds. Although the bonds looked
good at the time, there was no lack of warnings from the professionals about the
problems that could occur.
Watch out also for losses within a company that exceed the gains. While this
may occasionally happen, it is most definitely a warning signal. Losses eat up
capital and surplus funds. In fact, if money is going out faster than it is coming in,
for whatever reason, a red flag should go up.
Sometimes a lack of public trust can cause problems. If the consumers perceive a
problem within a company, they will begin to withdraw funds or quit paying
premiums. A company that is trying to hang on may be pushed over the edge
when such actions occur.
Perhaps the best common sense approach is simply looking at the products being
offered. If any given product seems to give much, much more (commissions plus
high interest rates for the policyholder, for example) than other similar products,
then it is possible that trouble is waiting down the road. Product design may also
reflect the company's outlook and philosophy. If gimmicks rather than sound
design seem to hold the product together that could well be the philosophy of the
company. Is the product set up to "catch and hold" a policyowner rather than
benefit them? Could you find yourself in an embarrassing situation down the road
when your client requires service or benefits?
If a company is not a mutual company, then it is often a good idea to know who
owns the company. The company's owners will reflect their own values and ethics
throughout the company itself. While it may not be possible to know what the
values and ethics are of any given person, the agent can look to their past history.
Do they come from the insurance field? What financial education do they have?
Looking at their backgrounds can give the field agent a general idea of what to
expect.
The object of using these common sense approaches is not necessarily to find the
best companies, but rather to weed out the worst of them. An alert insurance agent
must keep their eyes and ears open. Listen to other agents. Follow the service
given to clients from the home office. Does service start out well, but then steadily
decline? These are signs of problems. While it may be something as simple as a
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poorly managed department within the company, it may also be something as
major as an entire company ran poorly.
Probably every agent alive has run into the client that is sure that he or she knows
more than you do. Generally, what it really amounts to is an underlying mistrust of
insurance companies and their agents as a whole. Such people will often bring up
the stories of the "pending disasters" in the insurance industry. Is this really a
worry?
Some have compared the insurance industry to the savings and loan industry and
that is absolutely not a valid comparison. The financial strength and condition of
the insurance industry (especially the life insurance portion) is one of the most
financially solvent industries in the United States. One major difference between
the insurance companies and the savings-and-loan institutions, as pointed out by
Frederick L. Huber who is the administrator and assistant to corporate counsel of
Brokers Marketing Service in Los Angeles, is that the insurance industry has never
been subsidized by the taxpayers.
Certainly, there is concern in any industry if the number of insolvencies
dramatically increases. Currently, about 30 insurance companies become insolvent
each year. The majority of those companies are in the property/casualty field.
Insolvency usually reflects poor management and/or the amount of claims
incurred. Natural disasters can contribute to property/casualty failures.
Real estate investments have haunted the insurance industry to a certain degree.
However, when you look at the types of loans made by insurance companies when
compared to the savings and loan industry, the differences cannot be overlooked.
Most of the commercial real estate loans made by the S&Ls were for new
construction. The primary loans made by insurance companies were on completed
projects that were occupied and did, therefore, have a cash flow. In 1989, the
delinquency rate on real estate loans by life insurance companies was around 2.47
percent. That represented about .5 percent of their total assets.
There is one area where many businesses, including the life insurance industry,
have attempted to divert attention. In the past, debt levels were highly stressed.
We are now seeing the emphasis placed more on returns and profitability. An S&L
may boast about the amount of deposits they have. What they fail to mention is
that deposits are actually considered liabilities; not assets. An insurance company
may flaunt the amount of insurance in force. Again, this is a liability; not an asset.
Financial strength is based upon assets and profitability.
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Persistency of in force policies is one of the best indicators of strong products and
good service. Persistency is a measure of marketing strength and service effort. It
is also a measure of how well the agents have matched products to a client's needs.
It is never an easy task to be both a successful agent in the field and an ethical
person as well. Over the long run it will pay off, however. Think of each contract
(policy) as a personally signed document. You place your name on each policy
you write. Do you want your name on anything less than the very best?
Review Questions
1) Clean Sheeting means that an agent fails to correctly:
a) record the age of an applicant
b) record an existing health condition of an applicant.
c) state the policy provisions to an applicant.
d) estimate premiums for an applicant.
2) Full Disclosure is always necessary in any type of policy being recommended
to a client.
(T)
(F)
3) Capital Ratio is the portion of the company's total assets that are financed by
owner's funds.
(T)
(F)
4) Net Premium Income is typically defined as its direct premium income plus
premiums it earns from reinsurance it assumes, minus premiums it gives up due to
reinsurance that it transfers to another company.
(T)
(F)
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This completes your course reading material.
Thank you for ordering from
8213 – 352nd Street East
(253) 846-1155
www.uiece.com
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Family Insurance Needs - UIECE.com: Insurance Continuing

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