Volume 2, Number 1
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Life Insurance and Divorce
Who Gets What?
Life Insurance is an important matter in most divorces. There are a host of issues that are not addressed in the typical negotiation. Consider the following sample insurance clause from a Property Settlement Agreement [PSA]: "The husband shall maintain life insurance for the wife having an aggregate death benefit of $250,000. Said obligation shall be terminated if the husband's obligation to pay alimony is modified/terminated. The husband shall maintain life insurance having an aggregate death benefit of $250,000 for the benefit of the unemancipated children. Said benefit shall be reduced by $75,000 upon the emancipation of the first child and again upon the emancipation of the second child. The obligation to maintain any life insurance for the children shall terminate upon the emancipation of all Three  children."
There are many important decisions and considerations not addressed in a simplistic -- and typical -- clause like this, and practitioners need practical recommendations and advice on how better to address life insurance issues.
For the discussion below, we assume that the insured/payor client is a reasonably healthy (but not a marathon-running) 47-year-old, non-smoking male, needing $250,000 life insurance coverage. The prices are based on information obtained from various insurance companies.
Administrative Issues Time Frame and Insurance Selection
The issue of what type of insurance product to be used is most objectively dictated by the duration of the coverage. The shorter the obligation, the more likely "term insurance" will be used; conversely, the longer the time frame, the more likely some form of "permanent" insurance will be used. Insurance obligations for children are typically maintained until the children are emancipated. While this may not be a fixed date, there is almost always a cut-off date based on age. This is addressed in greater detail below. Of course, time is usually not an issue if lifetime alimony is involved, making it a lifetime obligation and "permanent" insurance coverage.
Does the Client Have Beneficiaries Other Than Those in the PSA?
The type of coverage and structure of the insurance will depend on two key factors. If the insured ex-spouse has other beneficiaries that he/she wishes to benefit after the lapse of insurance obligations under the PSA, "permanent" (typically policies with cash values) life insurance coverage and/or the use of an irrevocable life insurance trust (ILIT) might be preferable to term insurance coverage owned outright.
For example, if the insured ex-spouse has a new spouse he or she wants to benefit for life, then "permanent" insurance coverage (see discussion below) owned by an ILIT can provide protection and flexibility. The ILIT would direct insurance proceeds from policies it owns to pay PSA obligations and when those obligations end, the ILIT would direct the benefits to the insured's other beneficiaries, such as a new spouse.
There are two options to consider. Annual premium payments are best, unless the budget and cash flow situation is very difficult. This simplifies the administrative burdens, especially on the beneficiary spouse who wants to monitor the policy to assure it remains in force. Theoretically, the ideal policy would be one that is fully paid so no issue of lapse can arise, but it is unlikely that this would be financially viable or agreed to. For our hypothetical ex-husband, the single-premium cost range for a $250,000 paid-up policy is between $35,000-$50,000. If the ex-spouse is concerned about malpractice risks or other major problems, perhaps this could be considered. Another payment frequency option is to have the premium deducted automatically against the insured ex-spouse's checking account.
The beneficiary spouse should endeavor to monitor the policy to assure that it remains in force. A duplicate invoice could be requested for the beneficiary ex-spouse. Some carriers may offer an automatic notification when the premium is paid. If not, the beneficiary ex-spouse may simply be able to call a toll-free number some time after the premium notice has been received to verify actual payment. This is important because if the policy lapses and the insured ex-spouse is no longer insurable, there may be a substantial problem.
Comparing Different Prices
A client reviewing premium ranges, especially post-divorce, may choose the cheapest policy. This may be problematic for the beneficiary spouse. While life insurance seems like a "commodity," lower term insurance premiums may reflect differences in the financial strength ratings of the companies. A poorly rated company may sell a cheaper policy, but your client will be dependent on that coverage for many years; when the payor ex-spouse dies, you want to know the carrier will still be in business! Consequently, setting some minimum standards for the quality of insurance company in the PSA may be advisable.
Another difference in pricing can be due to differences in underwriting standards. The price your client sees quoted on a Web site does not reflect the standards assumed in that price. When the client applies, the policy may actually cost more than the same policy sold by a company that uses different underwriting standards and initially quoted a higher price. This has proved a costly trap for some insureds if a deadline is fast approaching: They may have sacrificed the time necessary to evaluate alternative policies.
Perhaps the best approach to resolving many of these uncertainties is to designate a neutral insurance consultant in the PSA to make the policy recommendations in a manner that is best for all concerned, and meets the criteria in the PSA. Such a consultant can also review the proposed provisions in the PSA and offer comment and analysis.
Funding Temporary Insurance Obligations
If the coverage period is 10 years or less, term life insurance is typically the preferable alternative. Term policies being sold today are sold for a fixed period of time, and the premium is guaranteed for the specified period. This type of term insurance is sold in 5-year increments. Thus, for an 8-year obligation, the insured spouse should be required to purchase a 10-year minimum term. After the 8 years have passed, the insured spouse could simply choose not to pay subsequent premiums. If the premium is significant enough, consideration could be given to paying quarterly, or changing to quarterly in the last year to end more closely to the date the obligation ends. For example, for our hypothetical ex-husband purchasing a 10-year level term, quoted premiums range from $305-$445 per year. A client might simply choose the cheapest without understanding the differences. These could have to do with ratings and other factors. This example illustrates how using consumer Web sites can be problematic: You generally do not get a better price on the Internet than you would through an agent, and you lose the ability to get advice.
How do you deal with the reductions in the above sample clause? With some companies, you can purchase a $350,000 policy and then reduce the coverage at certain points, subsequently paying a proportionately lower premium. This is not a contractual right and the insurance company can refuse to reduce the policy. This might leave the insured spouse facing the dilemma of continuing to pay for more insurance than necessary, or lose coverage and jeopardize the financial security of the beneficiary spouse.
There are several options to addressing this problem. One is to have an ILIT own the coverage, and allocate the death benefit as required under the PSA. As the PSA obligations wane, the ILIT could allocate the death benefits to other designated beneficiaries. Another option is to ascertain through the agent in advance those insurance carriers willing to allow reductions in coverage under the terms of the PSA. A third approach is to layer the policies by staggering terms of smaller policies that meet the requirements of the PSA.
Here are some of the terms and factors to consider:
• Level Term: Neither the price nor the death benefit will change during the policy period. (Renewal premiums beyond the guarantee period, however, can jump ten-fold, making the selection of the guaranteed period rather important.);
• Annual Renewable Term: There will generally be a guaranteed premium structure, but the premium will be scheduled to increase each year. This will be less expensive than a level term policy in the initial years when most divorced clients are hard pressed financially, so this may be an option to encourage greater coverage. However, in later years the increased cost may encourage default. These options should be part of the strategies reviewed in structuring the PSA; and
• Group Term Insurance: The client may be able to get group insurance through a professional organization, eg, bar association. If an employment group is used, the coverage will be lost if the insured loses employment. If the client is then uninsurable what happens? Could the client be required to convert the group term insurance to a permanent policy? If not, there may be no coverage. However, if it is converted, the cost is usually extremely high because generally only those with poor health exercise such conversion features. Few PSAs address this. Perhaps they should in the notice provision mentioned above.
Funding Permanent Insurance Obligations
Obligation periods exceeding 15 years should probably be insured with a "permanent" policy. Between 10 and 15 years is a bit of a gray area and more analysis has to be performed. There are many different types of policies to consider:
Guaranteed Premium Universal Life
This is a policy guaranteed to pay a death benefit even if the underlying cash value falls to zero. Conceptually, this is analogous to guaranteed level premium lifetime term. If the specified guaranteed premium is paid, the policy benefits are guaranteed by the insurer regardless of policy performance. For counsel representing the beneficiary spouse with a permanent insurance obligation, such as that in the illustrated clause above, this type of coverage should be required in the PSA. A 47-year-old male client required to provide $250,000 of coverage would expect to pay about $2500 per year for as long as he lives. Note, however, that there may be little cash surrender value if the insurance obligation lapses; for example, if the ex-spouse remarries or dies.
Conventional Universal Life
This is a policy that does not have a specific premium guarantee, but allows the insured to have more flexibility with respect to premium amount and timing of payments. Thus, the insured ex-spouse could skip a premium in a tough financial year. A typical premium for our hypothetical ex-husband client is approximately $3000 per year. This policy has an investment component and accessible cash values that the Guaranteed Premium Universal Life policy may not have. If the ex-spouse dies or remarries, there is likely to be some residual value to the policy.
Variable Universal Life
In this type of policy the insurance company is not responsible for investing the premium, but rather gives the insured/owner the opportunity and risk associated with this arrangement. A flexible premium, investment-oriented policy for our hypothetical ex-husband could be obtained for as little as $2200 per year, and we might expect the insured spouse to prefer this "least expensive" approach. However, applying sophisticated investment modeling tools suggests a rather low probability that $2200 per year will sustain the policy to the likely life expectancy of the insured. This is not the type of policy the beneficiary spouse will generally want!
If the client has the additional desire to continue the policy for his children, even if his obligation to his ex-wife ends, he might consider funding the policy at a modestly increased level of $2800 per year. Analysis suggests that 90% of the time (based on 1000 randomized policy returns), $2800 per year successfully sustains the policy to age 100. This greatly enhances the likelihood that the coverage will be in force when it is needed. Even more significantly, the average death benefit at age 100 in these illustrations is $4.6 million, not the base value of $250,000. For this reason, many insured spouses may prefer this type of approach. If permitted, it can benefit everyone, especially the children, but the assumptions must be reasonable and should be specified in the agreement.
Copyright © 2005 ALM Properties, Inc., All rights reserved; Martin M. Shenkman and Richard M. Weber. This first appeared in New York Family Law Monthly, July, 2005
Copr. (C) 2005 West, a Thomson business. No claim to orig. U.S. govt. works. This article is reprinted with permission from West, a primary sponsor of the General Practice, Solo and Small Firm Division.