By Eric S. Nelson CFP^®, CLU^©, MBA

Financial Advisor, Altfest Personal Wealth Management                  

Most people would agree insurance is complex, especially the folks purchasing and holding the policies. Although there are many varieties of insurance, I’d like to focus on life, disability and long-term care insurance in this article. As someone who’s spent years closely interacting with the insurance industry, I’ll share some pitfalls to avoid and policy options to consider if you’re concerned about adequate coverage.

In my role now as a financial advisor at Altfest Personal Wealth Management, I specialize in comprehensive financial planning with an emphasis on risk mitigation and insurance planning. As Altfest is a fee-only fiduciary, we don’t sell insurance or any other financial products for commission. That structure lets me and other advisors at our firm offer our expertise in areas like insurance in an objective way — absent any conflicts of interest.

 

Navigating a minefield

I’d like to discuss some of the less obvious details and pitfalls your insurance professional may not have brought to your attention. These situations potentially can cause huge problems for you and your family in the future. Keep in mind that I often think of navigating the world of personal insurance as being similar to navigating a minefield!

As with your health, everyone needs to have an annual insurance checkup to avoid unpleasant surprises. Typically, when an insurance policy is issued, the owner has what’s known as a “free look” period, when they can walk away from the policy and have any premiums paid completely refunded. The free look varies from 10 to 30 days, depending on the state. Despite having this free look option, however, most people never read the insurance policy until claim time. Depending on the type of policy, whether it be life, disability or long-term care, skipping a careful read can lead to fraught situations that may be very difficult — or impossible — to correct.

 

Avoiding insurance pitfalls

The first I’d suggest avoiding is the failure to review your beneficiary . In insurance case law, a famous one is Egelhoff v. Egelhoff, which involved a man by that name designating his wife as the beneficiary of a life insurance policy and a pension plan provided by his employer and governed by the Employee Retirement Income Security Act of 1974 (ERISA). That’s a federal law that sets minimum standards for most private-sector retirement and health plans to provide protection for the individuals in such plans.

In the case, two months after the Egelhoffs divorced, Mr. Egelhoff died. His children then sued his ex-wife to recover the insurance proceeds and the pension plan, based on Washington state law. The case went all the way to the Supreme Court, which held in 2001 that ERISA, not state, rules prevailed, so both the insurance proceeds and retirement benefits went to Egelhoff’s ex-wife. The moral of the story here: Check your beneficiaries listed on your life insurance, pensions, 401ks and IRAs and keep them up-to-date, unless you want an angry current spouse and a happy ex-spouse after your death.

Another pitfall to try to steer clear of arises from what are known as “kiddie policies.” Sometimes parents buy small permanent life insurance policies for their infant children. Dad or Mom serves as the policy owner and the beneficiary. When the infant turns 21, ownership of the policy is generally transferred to the now-adult child.

Fast forward 75 years, however, and Mom and Dad have passed away but one or the other is still listed as the policy’s beneficiary. When the adult son or daughter also dies, the death benefit is still tax-free, but instead of passing directly to the beneficiary, it passes to the estate. The funds would transfer according to the terms of the will and are then subject to probate. It’s not the end of the world but could be easily avoided.

Most times naming minor children as beneficiaries, even contingent ones when they’re young, can lead to disaster. In the case of a couple dying in the same disaster, a guardian in this situation would hold the funds until the children were of the age of the majority, 18 to 21, depending on the state. But what if the once-minor child beneficiary now has a major substance abuse problem as an adult? Using a trust would set a guardrail to help prevent the worst aspects of this scenario happening.

Another possible insurance mistake is failure to review the health of a permanent policy. Now for a whole life policy, it’s fairly straightforward. You make premium payments to the insurance company and it guarantees a death benefit no matter when you die, as long as you continue to make the  payments. However, one thing that can sink this type of life policy is excessive loans taken against the cash value. Typically, the interest is internally charged against the cash value of the policy. If the loan balance exceeds a certain percentage of the cash value, typically no greater than 90%, the insurance policy is surrendered, or canceled.

In the industry, this is known as “surrender squeeze” because the amount paid out on the surrender may not cover the tax bill due on a gain.

The takeaway for permanent policyholders with whole or universal life: Ask your insurer for an “in-force ledger.” It will show you how your policy is performing based on both current and guaranteed interest rates. It could indicate that your coverage may lapse at some future date unless you increase premiums, reduce the death benefit or some combination of both. All insurance companies can provide them. Sometimes you either call an agent or the customer service number. And if you need help with that, just contact us.

Another thing that could possibly go wrong is choosing the cheapest term insurance. From a death-claim standpoint, many people think: No major U.S. insurance company has gone insolvent since the 1990s, so why not go with the cheapest term policy? Well, premium costs are a factor, but policy features matter, too. Some features that matter are if the policy is convertible and what happens when the guaranteed term premium ends. Convertibility means you can convert any or all the term death benefit to a permanent policy without having to provide evidence of insurability. This is important if you develop a medical condition that makes you uninsurable at the time.

Without convertibility, once a guaranteed term premium period ends, the coverage may cease. With convertibility, you may wish to guarantee coverage by converting some, if not all, of the policy. Let’s say you have a 20-year policy you took out when you were 35. You get to 55 and you’ve been diagnosed with a medical condition that’s going to radically shorten your lifespan, or maybe you’re already having serious health issues. As a result, you may not be able to renew your policy at one-year term rates.

Rates are gender-neutral, which means that healthy women are subsidizing unhealthy men. Most work coverage isn’t portable. So if you’re getting all your insurance this way and suddenly your job goes away, you may not be able to replace it at all, or at rates you can manage, especially if you’ve developed a health condition. Rates for employer insurance are generally higher than for an individually owned policy.

 

Disability insurance coverage pitfalls

Looking at your disability coverage, what is its definition of disability? This is crucial. Is it that you’re unable to perform the duties of your own occupation, your regular occupation or any occupation?

Let’s say you’re a cardiac surgeon and purchased a disability policy early in your career, but now you supervise the cardiac surgery unit. Under your own-occupation clause, you would be considered disabled if you lost dexterity in your hands. But what if you were still able to get paid for supervising the surgery unit? With that type of policy, you’d collect the pay and the disability claim. Under a regular-occupation clause, you wouldn’t be considered disabled because you could still supervise the cardiac unit.

If you’re under the any-occupation category, you’re considered disabled if you are unable to perform any occupation for which you are suited by education experience or training. Perhaps that cardiac surgeon isn’t defined as disabled if he could still conduct telehealth sessions using his training. All these details demonstrate that the quality of the carrier matters. You want to go with a carrier that’s pricing the policy to pay claims, not just sell product.

 

Long-term care insurance pitfalls

In this case, you can wait too long to buy a policy. Standalone long-term care (LTC) premiums are generally more affordable if the policy is purchased before age 60 because that gives the insurance company a longer time to invest the premiums to pay claims when the insured is in their 80s and above. The ideal time to buy long-term care insurance is your early to mid-50s.

Another reason why waiting too long can backfire is that you may develop a medical condition that makes the policy premiums much higher or potentially makes you uninsurable. The general rule in purchasing insurance is to do so when you’re healthy, not after the fact.

Failure to account for inflation is another potential bump in the road with long-term care insurance. Consider that the potential claim may be made 20 to 30 years in the future. The cost of supplying home and nursing care has grown at twice the general rate of inflation over the years. Although inflation protection is generally an option with most of these policies, the price for that can add up to 50% to the price of the policy. The general default is but even having simple Consumer Price Index (CPI) inflation protection is better than nothing. (CPI is a measure of the average change over time in the prices paid by urban consumers for a market basket of goods and services.)

Another pitfall, as with most insurance, is failure to read the policy. A long-term care policy is a contract and it’s important to note what’s covered and what’s not. This is generally less of an issue than it was in the past since the federal government has standardized the language for a tax-qualified long-term care plan. Almost all standalone long-term care policies have the same triggers for filing a claim, which are the inability to perform two out of six activities of daily living, known as ADLs. The definitions of the ADL terms vary policy to policy. Also, you should be clear about the so-called elimination period, or the amount of time between an injury or disability occurring and the receipt of benefit payments. Is it defined as a number of calendar days or service days? Is it satisfied once, or for each and every claim? Ask your broker or insurance agent, to be prepared.

 

Find out more

We’re here to help you avoid these treacherous insurance pitfalls. We realize each client or potential client’s situation is different, so we encourage you to reach out to our firm with any questions you may have. Altfest advisors are ready to evaluate your current insurance coverage, or to help you purchase your first policy.

If you’re not yet an Altfest client, please book some time for a complimentary consultation.

 

Investment advisory services provided by Altfest Personal Wealth Management (“APWM”). All written content on this site is for information purposes only. Opinions expressed herein are solely those of APWM, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. All investing involves risk, including the potential for loss of principal. There is no guarantee that any investment plan or strategy will be successful.