Survival Kit.

With a myriad of applications for preserving assets, survivorship life policies will survive--even if the estate tax is repealed.

Transamerica Occidental Life Insurance Co. moved ahead in February with plans to launch a flexible-premium survivorship variable universal life policy, the latest of several insurers in recent months to introduce second-to-die products.

Under normal circumstances, this would have been a no-brainer. The big run-up in stock prices over the past decade has made millionaires of many and has prompted them to plan for the federal estate tax. According to Limra International, the Windsor, Conn.-based marketing and research organization, about 47,500 estates paid estate taxes in 1998. Of those, about 2,900 estates were worth more than $5 million, and they paid $10.4 billion in estate taxes, more than half the total collected.

But since the presidential election of George W. Bush, who campaigned on getting rid of "death taxes," the odds have risen that death taxes will be phased out, a change that could adversely affect a product like survivorship life. In his address outlining the budget to Congress Feb. 27, Bush again called for repeal of the estate tax. "It's not fair to tax the same earnings twice--once you earn them, and again when you die--so we must repeal the death tax," he said.

"We obviously followed this closely," said Bill Tate, chief marketing officer for Transamerica Occidental. "But we've seen tax legislation come and go through the years. If we had a crystal ball, we'd feel better. But today we have an estate tax, and dealing with it is important to clients. So we believe our timing on this product is good, and we feel good about it."

Survivorship life is a great fit for estate planning, because it insures two lives and pays a death benefit only after both die. Annual insurance costs, therefore, are less than for single-life coverage, and the product is well-suited for passing the estates of married couples to the next generation. The product was created shortly after the 1981 Economic Recovery Tax Act, which deferred estate-tax liability for married couples to after the second death.

But even if estate taxes are removed as a planning concern, second-to-die products would continue to serve other purposes, and insurers and producers say they would find other ways to serve aging and wealthy clientele. "We're confident we would adapt to new circumstances," Tate said. "We've been serving this market many years. Regardless of tax law changes, the needs of this market will be dependent on good, solid advice."

Growth Spurt 

Survivorship products have grown rapidly in the past four years. According to Limra, annualized premium grew by about 1% in 1996, but at about 8% in 1997, 9% in 1998 and more than 23% in 1999. (See "Growth in Survivorship Sales," below.) Last year, premium growth fell to 10%, apparently due to concerns over potential estate-tax legislation. "We've seen an uptick in the sales of survivorship policies, and the average size has gotten much larger," said Thomas E. Norton, vice president and managing actuary at Aon Consulting. But all of the talk about an estate-tax phase out has had a "chilling effect" on the product line, he said.

"They've become more efficient, and certainly the repeal of the estate tax would have a great effect on their sales," said Chuck Osmond, vice president of advanced underwriting at Union Central Life Insurance Co., Cincinnati. "It wouldn't eliminate the policy's effectiveness in providing a low-cost death benefit, however."

Transamerica, based in Cedar Rapids, Iowa, has been selling second-to-die products for about 12 years and has about $18.5 billion in force. "It's been a significant growth segment for us," Tate said. "Last year was huge. Our average policy size was $2.3 million, and our average premium was just over $32,000."

According to A.M. Best Co. data, John Hancock Variable Life Insurance Co., a part of the John Hancock Financial Services Group, issued $3.7 billion worth of the product in 1999. New York Life Insurance Co., Manulife Financial and New England Financial (an affiliate of MetLife Inc.) all announced new survivorship products within four days of each other in October.

Phase-Out Effects

Last fall, Congress voted overwhelmingly to phase out the estate tax, but then-President Bill Clinton vetoed the legislation. As of late February, Congress again was considering several versions of estate-tax reduction. While they would clearly cut into the smaller end of the survivorship market, the top end probably still would have needs. "At the high end, there's still going to be some tax, and there's always going to be the fear that what goes away today comes back tomorrow," said Amy Loether, a vice president and consulting actuary with Aon Consulting. "If you're 60 years old and you think it might come back in 10 years, you're not going to wait 10 years to buy survivorship. You need to buy it today, because it's the most efficient way to do it. It may be very difficult to obtain when you're 70."

Limra has come to a similar conclusion based on its research. In a September report, the organization estimated that if an estate-tax repeal ended all survivorship life sales--and they were not replaced by other sales--new premiums for the life industry would drop by about 8%, or $1 billion. But the report's author, Elaine Tumicki, said the actual effect probably would not be that drastic, because estate taxes are likely to be phased out gradually. And survivorship life has other functions: It can be used for estate equalization, wealth replacement and in some small-business applications.

Survivorship policies also can be structured as efficient cash accumulators, said Osmond of Union Central. Under tax law, policyholders can withdraw amounts up to premiums paid without penalty, and then they can access additional cash value through low- or no-cost loans. However, enough money must remain in the policy to avoid lapse, which can trigger high costs. Osmond said younger affluent couples often use survivorship policies in this way to build cash values and to ensure a guaranteed asset for their children, if the parents die prematurely. Cash values also can be used in corporate-owned life policies as supplemental employee retirement benefits, Osmond said, and for a corporation to recoup its contribution to the plan.

Some professionals in the industry already have seen effects from the pending legislation. Norton of Aon Consulting said he had encountered at least one insurer that had delayed plans to build a survivorship product until there is more clarity on the tax-reduction package. And Eleanor I. Johnson, a principal with Highland Capital Brokerage, said clients have postponed decisions on large purchases, initially because of the presidential election, then the Florida election recount and then to wait for the outcome of potential estate-tax modifications. Seattle-based Highland Capital is one of the nation's largest life brokerages specializing in the affluent market, said Johnson, who is the firm's designated insurance specialist in Washington state for PaineWebber, a national stock brokerage firm.

Inevitability of Change

David Potter, a spokesman for Hartford Financial Services Group, Simsbury, Conn., said the industry has been saying reform is more likely than repeal. Government revenue needs will increase dramatically by 2010. Government spending has grown at a 5.5% annual rate the past three years, and if that continues, the surplus will be dramatically smaller.

Potter said both Republicans and Democrats agree on many points about tax reduction, but phasing out the estate tax is not one of them. A proposal by moderate Democrats to reduce the estate tax's top rates from 55% to the top ordinary income rate, currently 39.6%, may garner support on both sides, he said. The proposal also would provide relief for small businesses. Potter also pointed out that the Republicans have a very slim majority, so blocking legislation can be easy.

Highland's Johnson predicted that there would be some change to the estate-tax system. "But if it turns out there is only a tweaking of the system, such as taxing estates of $5 million or more, it would really only make it like it was five years ago," she said. "We would still have a huge opportunity with clients [whose estates are worth] over $5 million, and they're everywhere. We regularly deal with estates of $10 million to $100 million, and they don't believe their tax liability will be eliminated."

Part of that liability could be triggered if Congress repeals the step-up in cost basis. This is a provision in the tax code that allows beneficiaries to report the current value of inherited securities to determine capital-gains tax liability--even if the deceased had bought the securities at a lower value. Johnson said clients with high-net-worth estates have not paid much income tax on stocks and bonds that they have held for many years. Those assets, she said, have built up large, unrealized gains. If the step-up in cost basis is repealed, these clients' heirs will face high capital-gains taxes, which could be funded with a survivorship life policy.

Johnson acknowledged that wealthy clients are skeptical of the proposal to repeal the estate tax over the next eight to 10 years--at which time a different presidential administration will be in control. "But let's say the tax is eliminated," she said. "Then the kids and charities get more, and that's not such a bad thing. It's really the clients who aren't excited about doing the planning in the first place who are using this [skepticism] as an excuse."

But Johnson is not ready to discount people with estates of $2 million as new customers, because their estates might need liquidity after they die. New distribution rules on individual retirement accounts, for example, allow minimum withdrawals to be stretched over generations. Insurance could help keep those tax-deferred plans in place by providing money for estate liquidation to other parties, legal expenses or future estate taxes, she said. "It can be a diversification tool," Johnson said. "If you look at the internal return of even some of the fixed universal life contracts, clients are repeatedly surprised at how favorable those rates of return are. If they die early, the returns are huge. In later years, they still provide bond-like returns."

Considerations like that could drive insurers to modify their life products. Johnson said they could become more investment-oriented. Without having to worry about the death benefit adding to an estate, clients might use survivorship life policies as tax-deferred retirement vehicles. Clients interested in charitable giving would be more inclined to use life policies as asset-replacement vehicles-they would donate to charities while alive and enjoy the tax deductions, while passing a replacement estate to children through the life policy. The same advantages could be applied to estate-equalization needs when a business owner dies; the deceased owner's life policy provides cash to a child not interested in maintaining the business, while the other child receives the business. And life insurance would become more attractive in buy-sell business agreements. in which life insurance would pay off the estate of one of the business's owners and leave the other(s) with the business financially intact.

Survivorship policies are well-suited for such uses, not only because their insurance costs are lower than those of individual contracts, but also because they can be made more cash-intensive, Johnson said. "Every time there's a change, there's an opportunity," she said. "We'll position ourselves for that shift. The type of producers and the number of them in the market may change, but we feel well-positioned to take advantage of opportunities and work with carriers to develop products that fit those opportunities."

A phase out of the estate tax would probably have a more muted effect on in-force life policies. According to A.M. Best Co. data through 1999, nearly $96 billion was in force among 26 companies that responded to a questionnaire.

A lot of in-force business is likely to stay that way for a couple of reasons, said Loether of Aon Consulting. One is that many policies are in irrevocable life insurance trusts, so the insureds do not have much, if any, control of them. But beyond that, she doesn't expect any dramatic increase in lapse rates. "If you have a couple of 45-year-olds with a $2 million estate and they just bought a policy last year, maybe they wouldn't keep it," she said. "But there are a lot of other people who would."

[Graph omitted]

Growth in Survivorship Sales

Survivorship life insurance products have registered significant growth since 1996, according to Limra International, Windsor, Conn. Policy size has also grown quickly with the average last year reaching $2 million. Limra's data is based on surveys of 40 companies in 2000/1999 and 33 companies in 1999/1998.

According to Limra, about 47,500 estates paid estate tax in 1998. Of those, about 2,900 estates were worth more than $5 million, and they paid $10.4 billion in estate taxes, more than half the total federal estate tax collected.

[Graph omitted]

More Investors Opt for Flexible Products

In the beginning, second-to-die life insurance came packaged on a whole life or universal life chassis. But in recent years, variable life has gained in popularity

"Clearly in the upscale market, there's much more of a trend toward variable," said Thomas E. Norton, vice president and managing actuary at Aon Consulting. "People have become much more comfortable with it, even with survivorship policies issued to people over 80."

On the surface, variable life for octogenarians makes as much sense as betting their retirement portfolios on the Nasdaq. But Norton said that when both insureds must die for the death benefit to be paid, as is the case with survivorship life, a policy's time horizon increases greatly, making a bet on equities more likely to pay off.

"Even with 75-year-old spouses, there's a good likelihood that one will make it to 95," he said. "So with a 15- to 20-year horizon and interest rates trending lower, they probably won't maximize their performance without equities."

The trend toward variable survivorship is due to the same reasons for the trend toward variable products in general, said Elaine Tumicki, assistant vice president in product and distribution research at Limra International, Windsor, Conn. "The product is easier to sell because the stock market has done so well, and interest rates have not been that high," she said, adding that she is starting to see more interest now in fixed products.

Variable universal life has grown so fast that it is now the product of choice for survivorship policies, Tumicki said. As of September, it represented 50% of new survivorship premium, compared with 31% for universal life and 19% for whole life.

Investors in variable policies, however, must recognize that an extended down market can cause them to lapse, which can be very expensive, not only in loss of benefits and wasted premiums, but in income taxes. "There are very real dangers in underfunding a variable life policy," said Eleanor L. Johnson, a principal with wholesale life firm Highland Capital Brokerage, Seattle. "Sometimes I'm alarmed at how people will focus on the illustration instead of reality. A 10% compounded rate of return is not the same as a 10% average rate of return, and the risk with variable life if you put in the minimum premium per illustration, barring some safety net to the contrary, is that you'll need to put in new dollars to cover the loads and expenses monthly," she said.

To stave off unexpected costs or policy lapses, insurers are developing no-lapse features, some for as long as 20 years. But insurers cannot provide guarantees as long as for universal life policies, since they provide a minimum annual interest rate, and variable life provides no minimums.

Because of that, younger clients are the ones who buy variable life products, Johnson said. "I've encouraged older clients to go with the guaranteed universal life policies," Johnson said. "Sophisticated older clients will already have a large percentage of their investments in equities, so the insurance becomes a diversification tool. They're diversifying in taxability, asset type and risk type."

Flexibility is another major trend in survivorship variable life policies, both to help the broker sell and to help the client achieve goals. Transamerica Occidental Life Insurance Co.'s new product, TransSurvivor Life VUL, for example, allows a choice of three death-benefit options, provides a guaranteed death benefit during the first 20 years, regardless of investment performance, and allows the policy to be split into two individual fixed policies under certain conditions. The policy also provides four-year level term insurance to cover the risk of having death benefits included in the estate under certain conditions. Other features are dollar-cost averaging to eliminate the guesswork of investment timing, automatic account rebalancing and up to 18 free transfers a year among subaccounts.

Wealthy Americans Speak Out Against Repeal

Some of America's richest people have come out against President Bush's proposal to eliminate the estate tax.

Calling an estate-tax repeal "a terrible mistake," a group of more than 100 prominent business and philanthropic leaders--including William H. Gates Sr., father of Microsoft Corp. Chairman Bill Gates; and Steven C. Rockefeller and other members of the Rockefeller family--issued a joint statement and petition against ending the tax. Ben & Jerry's ice cream co-founder Ben Cohen, art patron Agnes Gund and other philanthropists and representatives of new entrepreneurial wealth and old inherited wealth also have signed the petition.

"The billions of dollars in state and federal revenues lost by ending the estate tax will inevitably be made up either by increasing taxes on those less able to pay or by cutting Social Security, Medicare, environmental protection and many other government programs so important to our nation's continued well-being," the petition stated in part. "Let's fix the estate tax, not repeal it."

A conference call featuring the senior Gates and other critics of estate-tax repeal was sponsored by Responsible Wealth in February. Chuck Collins, co-director of United for a Fair Economy, also took part.

Boston-based Responsible Wealth describes itself as a national network of business people, investors and affluent Americans who are concerned about deepening economic inequality and who advocate widespread prosperity. Responsible Wealth is a project of United for a Fair Economy, which was founded to support organizations and individuals who work to address the widening income and asset gap in the United States.

Strategies to avoid paying the tax have been beneficial to charities. Eliminating the tax would hurt public charities, ranging from institutions of higher education and land conservancies to organizations that assist the poor and disadvantaged, the wealthy petitioners contend.

If the federal government gives up the estate tax, it would lose about $26 billion in revenue in the first year, about $236 billion over the next 10 years and about $750 billion between 2011 and 2020, said Bennett Cooper, senior consultant in distribution at Tillinghast-Towers Perrin, New York. (See "Tax Avoidance Is Big Business," page 112.)

For many reasons, the insurance industry is not "jumping up and down" saying it wants the estate tax repealed, said Cooper, who has spent years consulting insurers on distribution. Insurers are getting significant dollars in second-to-die life insurance premiums that are sold as estate-preservation methods, Cooper said. "Many insurers have between 25% and 38% of their life premiums in second-to-die policies," he said. "On average, small-business owners will invest more than $318,000 to pay for the insurance that will anticipate the estate taxes due."

In the petition, "A Call to Preserve the Estate Tax," the signers said the estate tax has been a constructive part of the U.S. tax structure for 85 years. Only the richest 2% of U.S. families currently pay any estate tax at all, the group said.

The estate tax is assessed on the net worth of an individual at death. There is no tax on the first $675,000--twice that amount for married couples.

Various bills have been introduced in the House and Senate that would end or make changes to the estate tax, including a Senate bill introduced by Sens. Phil Gramm, R-Texas, and Zell Miller, D-Ga., and a House bill introduced by Reps. Jennifer Dunn, R-Wash., and John Tanner, D-Tenn., both of which would eliminate the tax.

As part of a tax-cut package Bush unveiled Feb. 8, Bush said he wants to phase out the estate tax over eight years.

"The punitively high death tax can fall most heavily on small business and family farms that are asset-rich but cash-poor," said Rep. Dick Armey R-Texas, in a statement outlining and supporting Bush's tax-cut initiative.

According to a 1993 survey nine of 10 successors whose family businesses failed within three years of the owner's death listed the estate tax as a contributing factor, Armey said. Finally, by encouraging intricate planning techniques to reduce taxes, the tax has created an entire industry of specialized lawyers and accountants. The added complexity and compliance costs make this one of the least efficient federal taxes, he said.

"Eliminating the death tax will allow family farms and businesses to be passed from one generation to the next without having to break up or sell the assets to pay a punitive tax to the federal government," Armey said. "As a result, wealth would be taxed only when it is earned, not again when entrepreneurs and senior citizens pass the fruits of their labors to the next generation."

The wealthy opponents of estate-tax repeal said they recognize the importance of protecting family farms and small businesses, but they argue that the estate tax has many special provisions that do this. Concern for such enterprises can be addressed by amending the existing estate-tax system, they said.

The group came Out against a bill last summer to repeal the estate tax, which passed both the House and Senate but was vetoed by then-President Clinton. "This time around, there will be no presidential veto of an estate-tax repeal. So we have to focus our efforts on blocking the repeal in Congress," the group said.

Warren E. Buffett, chairman of Berkshire Hathaway Inc., was quoted in a New York Times article as opposing an estate-tax repeal, but he didn't sign this petition. "Without the estate tax, you in effect will have an aristocracy of wealth, which means you pass down the ability to command the resources of the nation based on heredity rather than merit," Buffet said in the newspaper interview.

Dennis Kelly