Coming back strong: sales of last-to-die life insurance rebounded greatly in 2004, fueled by estate-tax uncertainty and old-fashioned industry innovation.

No one knows what the future holds for estate taxes in the United States, but that uncertainty didn't stop insurers last year from dramatically increasing their sales of survivorship life products, the kind of insurance best suited for estate planning.

According to marketing and research organization Limra International, survivorship sales rose 19% in 2004, the fourth year that a 2001 law has been lowering estate tax rates and raising amounts of family assets exempt from estate taxation. The sales increase reverses sales declines of about 26% in 2001 and 11% in 2002, and it builds upon a 1% increase in 2003. Elaine Tumicki, corporate vice president heading Limra's product research center, estimated that survivorship products account for 6% of the industry's life insurance premiums.

Why the positive trend even as current law phases out the estate tax over the next five years to a full but single-year repeal in 2010, and as Congress this spring--for the fourth consecutive year--considers permanent repeal? Many of the possible answers still come back to a sense of uncertainty, especially since the law would, in 2011, reinstate the estate tax to its early 2001 provisions. But some answers reflect the ability of the life industry to make its new products more appealing and able to help buyers even if the estate tax disappears.

Survivorship, or "last-to-die" policies, are well suited to estate planning because they insure both spouses and pay a death benefit only after both die. They are usually less expensive than insuring both lives separately, and they provide often-needed liquidity to disburse assets to heirs and/or to pay estate taxes. Tumicki said a "pent-up demand" may have fueled sales last year if the slowdown in previous years was due to people waiting to see if the estate tax issue was going to be resolved. "Perhaps some people got nervous about waiting," she said. "They may have concluded they could not count on the tax going away and that Congress had been working on the issue for four years without resolving it."

John Vaccaro, chief marketing officer for the Hartford Financial Services Group's individual life division, said he expects survivorship sales momentum to continue to build this year. "One driving factor to the sales is that since the election, estate planners are now figuring out that this estate tax is not going to go away,' he said. "There could be a raising of the exemption, but not an outright repeal." He said that a proprietary Hartford survey last year found that 53% of respondents among a broad swath of Americans contacted believed the estate tax would remain in effect for the foreseeable future.

"Through President Bush's second term, there will still be a market for last survivor, whether for wealth transfer or estate planning" he said. "There could be a compromise in Congress that might shrink the estate-planning market as we see it today, but that doesn't mean states won't introduce something. There's still a lot of uncertainty, and death and taxes are the only things that are certain."

Survivorship policies generated about 10% to 15% of all life insurance revenues for Hartford last year, Vaccaro estimated. Through last year, all of that revenue came through survivorship variable universal life policies, but Hartford in March launched its first survivorship universal life product to broaden its portfolio and take advantage of new market trends away from SVUL and toward SUL. In 2000, SVUL generated 57% of new survivorship premium industrywide, while SUL premium accounted for only 28%, according to Limra. Last year, SUL accounted for 72% of new premium, while SVUL accounted for only 20%. Vaccaro said the company expects its new product, Advanced Last Survivor UL, to be a growing part of its survivorship business.

Innovation Drives Sales

Indeed, survivorship sales growth last year may have been due as much to product innovation as it was to concerns about the estate tax. "We can attribute much if not most of the sales lift over prior years to a replacement of outdated survivorship design with new guaranteed-premium product design," said Jim Gelder, president of ING Life Distribution in Minneapolis and a 30-year veteran of the industry. "A certain amount of sales every year are replacement sales. When new product design comes onto the scene, it often will cause a spike-up in sales replacing older-generation products."

The Limra-reported industry sales trend of the past few years from variable universal life products to universal life coincided with new-product development in universal life, more recently with secondary guarantees on the death benefit. Gelder said trends in the single-life market have moved into the survivorship market. "So companies were developing and rolling out these SUL products in 2003 and 2004, and all of that had an effect on sales year over year" he said. "Cases started to come to fruition in 2004, certainly in the last quarter."

Gelder also suggested that buyers of survivorship policies may be realizing that they have many more uses than paying estate taxes. These could include charitable giving, preservation of family income and lifestyle, and providing some economic benefit to future generations. Second-to-die contracts can be particularly useful when assets are not liquid and buyers want to use the death benefit to distribute assets to family members, he added. "The federal estate tax is not the only cost associated with an affluent person's death" he said. "Many states have state inheritance taxes, and there are other expenses sometimes associated with the settling of an estate that go beyond the cost directly linked to the federal estate tax. We tend to be focused on the big bad guy and forget about the little bad guys that add up at a person's death"

Gelder's company, part of a U.S.--based group of subsidiaries of Netherlands-based ING, last year parlayed a broad lineup of survivorship products into strong sales. The company's survivorship sales last year generated 14.8% of its new life insurance premium, making it an industry leader. The lineup included Guaranteed Premium SUL and three SVULs: Variable Estate Design, Variable Accumulation Design and Variable Survivorship UL. The company reported that of survivorship sales, SVUL accounted for 37.7% while SUL accounted for 62.3%. Interestingly, the company does not rely heavily on secondary guarantees in its SUL product; less than a quarter of all survivorship sales were guaranteed SUL, and only 38.1% of SUL products had secondary guarantees.

Gelder said that since the company's independent distributors are the people who take products to the market, the company's market focus is largely distribution-driven. As a result, ING launched an SUL product in March to expand its product portfolio. The new product, Explorer Survivorship Universal Life, is designed for cash accumulation and is particularly useful when buyers use loans to finance the premiums. In those cases, the cash value can serve as collateral for the loan, he said. Through a rider, the policy offers a death benefit "C", which pays a death benefit equal to the face amount, the cash value and all premiums paid. That increasing death benefit option can be enhanced to include the interest rate the owner pays on a loan that is financing the purchase of the insurance contract, Gelder said.

"We've got a guaranteed-premium product," he said. "We needed to refresh our accumulation-oriented product, and our research said there were opportunities."

Repeal of Estate Tax Could complicate Estate Planning

Repeal of the federal estate in wouldn't end the need for estate planning, and could complicate it, according to an estate attorney and financial planner based in Summit, N.J.

Many of the complications stemming from the permanent-repeal bill passed on April 13 by the House of Representatives would come from a little-publicized segment of the bill that would institute a capital gains tax on the appreciation of inherited assets, said Mike Provine, founder and principal of Tradition Capital Management. Under the law currently in effect, these assets acquire a new tax basis at the date-of-death value or, in some cases, six months later. Maintaining the historical cost basis would add significant record keeping problems for many taxpayers because they would have to, at best, sift through many years or decades of records, Provine said.

In fact, Congress in 1976 considered eliminating the step-up in basis, but dropped the idea after financial advisers, asset managers, brokers, bankers, taxpayers and others argued such a scheme would be unworkable. "It would place an unreasonable burden on taxpayers to try to discover what the original cost basis was when the records may have been long ago lost, stolen, destroyed or otherwise forgotten" he said. "Frankly, it would complicate things for the IRS as well"

Complexities aside, the prospect for elimination of the step-up in basis may partly have fueled last year's surge in survivorship life sales, Provine said. Another factor might be worry about how states might respond to a repeal. Many states collect an estate or inheritance tax with amounts linked to the federal estate tax, and the federal tax allows a credit for taxes paid to a state. But the increasing federal estate tax exemptions and decreasing rates since 2001 have left fewer taxpayers liable for the federal tax, and states have seen their revenues decline, said Provine. Some have already "decoupled" their estate taxes from the federal tax, and it's likely more of them would if the federal tax were repealed, he said. "The very knowledgeable and savvy life industry has probably found that as a potential reason to buy a survivorship policy" said Provine.

Better Chance for Permanent Repeal

This is the fourth consecutive year the House has passed a permanent-repeal bill. The Senate has not advanced the legislation, but chances are better that it may this year. "This could be a close call," said Ted Kurlowicz, the Charles E. Drimal professor of estate planning at the American College, Bryn Mawr, Pa., and a practicing estate attorney. Among the reasons: support among some Democrats, the fact that some senators voted in principle last year against the tax, and the results of last November's election. He also said that the public may have misconceptions about the tax and may not understand that a repeal could cost the government $1 trillion or more in tax revenues over a long term.

Election gains by Republicans may be a factor because 60 votes are needed in the Senate to stop a filibuster. Provine explained that in 2001, the estate-tax legislation was part of a budget bill, which under Senate rules cannot be filibustered. But budget bills can have no more than a 10-year life, which is why the current law sunsets in 2011" tat solution must be by means of a tax bill, is subject to filibuster, said Provine.

The situation today demonstrates why permanence is preferable, Provine said. "What is fundamentally unfair now in the Tax Code is that it's difficult to plan because we have this sunsetting law," he said. "What estate practitioners have done is create estate plans based on the best documents under current law, take advantage of current exemptions, and then see what happens if the law changes."

Provine said the estate tax as we know it has been around since 1916, when a populist initiative pushed it through Congress as a way to prevent huge accumulations of wealth in the wealthiest families from being passed down to younger generations. "It was presumed that would adversely affect the economic fabric of the country, but today, with inflation, many people have the potential of having the estate tax, or any form of transfer tax, affect them," he said. "It now has a much broader reach than it had back in the early part of the last century."

Still, if a Democrat-supported alternative to repeal (permanently higher exemptions) were passed as a compromise, the tax would affect only one half of 1% of all taxpayers, Provine said. "Under those circumstances, one might argue that maintaining the tax would seem fair since it would not hit too many people," he said. "But you still have to go back to the fundamental issue: Should we have a transfer tax on assets that were already taxed? It's hard to justify the estate tax on that basis."

End of the Step-Up?

Of course, an argument could be made the up cost basis on inherited assets is also unfair. So what would happen if Congress got rid of both the estate tax and the step-up in basis? Would that combination be revenue neutral? Provine said that with higher exemptions on current law, the government could both lose revenues from a large share of the estate tax and continue to collect nothing in capital gains on inherited assets, so a case could be made for revenue neutrality if heirs actually sell assets. "But that remains to be seen," said Provine.

Jim Gelder, president of ING Life Distribution, said it looks like Congress may be headed toward some kind of permanent solution. "The public is better served with a permanent solution rather than a repeal solution that has potentially misunderstood sunset provisions that could negate reform in any form," he said. "Without a permanent solution, people are not able to understand clearly what they need to do to plan the management of and distribution of their personal wealth after death."

And how would a permanent repeal affect the insurance industry? "The reality is our industry has remained incredibly resilient and has always figured out how to rise to whatever the new rules of engagement are," said Gelder. "People still need a vehicle that will provide cash at times of certain contingencies." If a capital gains tax on inherited assets becomes a reality, "then that actually could affect more people and have more far-reaching cost consequences at people's deaths," he said.

Key Points

* Life insurance buyers may have been motivated last year by the idea that Congress will never completely kill the estate tax.

* Even if the estate tax disappears, survivorship policies will help pay for other taxes or new taxes on the settlement of large estates.

* Survivorship sales last year were driven partly by people replacing existing life contracts with new and better products.

Survivorship Universal Life Sales Lead the Way

As in other life markets, universal life has become the dominant seller in the survivorship market. UL product innovation and aversion to equity investing inside life products account for the change.

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Annualized Premium Percent Change, U.S. Survivorship Life Market

The effects of Congress' estate-tax phaseout legislation in 2001 are clearly seen as sales fell in that year and in 2002. But sales have picked up as people have concluded estate planning is still necessary.

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