The fundamental purpose of insurance is to protect against and manage risks that can't otherwise be borne by an individual, from homeowner's insurance to protect against the risk of a disaster to the home, to permanent life insurance to protect against the financial impact of an untimely death. While term insurance can and does fulfill the latter function for most, in many cases clients currently maintain an existing permanent insurance policy, in anticipation of an insurance need that will last for the rest of his/her life. Often that need really does continue for life, but sometimes it does not.
In situations where permanent insurance is no longer needed - whether because the individual accumulated enough wealth than the death benefit protection is simply no longer necessary, or perhaps because the insurance was intended to provide liquidity for estate tax exposure that is simply no longer relevant at the newly permanent and portable inflation-adjusting $5.25M estate tax exemption - the default decision is often to cancel the coverage. After all, what's the point of paying for life insurance that's no longer needed?
The caveat, however, is that in today's low yield environment, many permanent life insurance policies indirectly provide another potential value: a remarkably favorable internal rate of return if simply held until death. Given this potentially appealing "bond alternative" many clients should not only keep an existing permanent policy - despite no need for the death benefit - but even consider making ongoing premiums, paying down loan balances, or even increasing contributions to maintain the policy in force for life! Of course, if the client really needs the cash value or cannot afford premiums, this strategy is not viable, but the policy can still be sold as a life settlement instead to harvest most of the underlying value.
The bottom line, though, is that given the internal rate of return on life insurance held until death, for those who don't need the policy - but don't need the cash value, either - the best decision for unnecessary life insurance might actually be to keep it, anyway!Continue reading "Why Cancelling An Existing ... »