The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) can dramatically affect life insurance plans. A 12-month repeal of estate taxes that will take place in 2010 will affect plans made now by many life insurance policyholders (see HEALTHCARE FINANCIAL MANAGEMENT, May 2002, pp. 90-94). Assume, for example, Mary has an irrevocable life insurance trust that has owned a whole-life policy for several years. The policy has a fixed premium, and dividends are being used to purchase paid-up additions that increase the death benefit. The insurance company's most recent "in-force" illustration projects that several more premiums will be required before the policy is self-sufficient. Mary would like to maintain the current amount of insurance.

In light of EGTRRA, Mary believes she no longer needs to build an increasing death benefit. Therefore, she can reduce the gifts she has to make to the trust each year for premiums or change the dividend option from buying paid-up additions to reducing the premium. Under the second option, the insurer would apply the dividend to the premium and "bill" the policy owner for the net difference. Use of this dividend option would stop the growth of the death benefit. It also would reduce Mary's annual outlay, although premiums would be required for many more years than would have been the case if she paid full premiums until the policy became self-sufficient. Still, the dividend eventually would exceed the premium, at which point the dividend could be used to pay the full premium plus paid-up additions.

To maintain the existing life insurance coverage but significantly reduce her outlay, Mary can exchange the whole-life policy for another life insurance product, such as whole-life/term blend, universal life, or variable universal life policy. If Mary does not want to be concerned about the investment of the cash value, a variable universal life policy is not an option.

Any discussion of life insurance policy exchanges must distinguish between internal replacement and external replacement. An internal replacement involves the exchange of a policy within the same carrier, eg, the policy owner might exchange a whole-life policy for a universal-life policy issued by the same carrier. In an external exchange, the policy owner moves the business to a new carrier.

The trustee should find out if the existing carrier offers an internal exchange program whereby the existing policy can be exchanged advantageously for a new policy from that company. The trustee might find that the exchange would not require full medical underwriting or that the commission on the new product, the sales loads, and other policy costs can be reduced or eliminated.

The whole-life policy uses a fixed premium that the carrier has determined to be sufficient to endow at guaranteed (and very conservative) levels for mortality, expenses, and interest. The dividends reflect the difference between the insurer's current experience in those areas and the conservative guarantees. With the whole-life/term blend and the universal life policy, however, the trustee can select the premium and determine the balance between coverage at the guarantees and at current experience. Because cash value growth for its own sake is not important to Mary, the trustee will focus on maintaining the death benefit at the lowest prudent outlay.

The design of the potential new policies will have a significant effect on the merits of the exchange. For example, the whole-life/term blend policy may be designed with a minimal amount of base whole life and a substantial amount of term, with a rider for additional premium or paid-up additions. The universal life policy's death benefit, on the other hand, may be composed of a relatively low amount of base and a large amount of term rider. These policy designs can make the products even more cost-competitive than they otherwise might be.

The trustee will be rolling over a substantial amount of cash value from the current policy. For the whole-life/term blend policy much of the large, up-front premium will be applied to paid-up additions. The ongoing premium necessary to service the whole-life component, allow the dividends time to grow, and give the paid-up additions time to displace the term component probably will be very small. If the ongoing premium is small enough to be paid by the dividend, the trustee would not have to pay ongoing premiums.

For the universal life policy the large, up-front premium from the rollover will bolster the cash value, thereby reducing the net amount at risk, which is the difference between the policy's face amount and the cash value. Again, with reasonable assumptions for interest and costs of insurance, the new cash value may be adequate to support the death benefit for Mary for a long time.

Basis for Making the Decision

In comparing the benefits of whole-life, whole-life/term blend, and universal life policies when the policyholder already owns a whole-life policy the trustee first should determine whether the blend or the universal life policy offers superior performance and is suitable. The preferred option then should be compared with the whole-life policy. The exchange makes sense if, and only if, the blend or the universal life option will credibly generate an appreciably greater death benefit and internal rate of return than the whole-life, not just at the outset but also at and beyond life expectancy.