Term

Making the Case for One-Year Term Products
by Bruce A. Guillemette, MSM, CLU, ChFC, FLMI,

Let’s face it, about the only time anyone discusses one-year term insurance in the advanced markets is this way: an alternative term rate when measuring the economic benefit of split dollar arrangements or qualified plan-owned life insurance. Using a carrier’s term rate for these purposes, instead of the now defunct P.S.-58 rates, grew out of IRS Revenue Ruling 66-110. It allowed an insurer’s one-year term rate to be used in place of the P.S.-58 rates.
A number of life insurers offered one-year term rates to be used instead of the much higher P.S.-58 rates. The intent was to lower imputed income to participants in these plans. (“Imputed income” is the term the IRS applies to the value of any benefit or service that should be considered income for the purposes of calculating your federal taxes.)

To keep the rates to a minimum, these products did not offer renewability and convertibility, which are the most attractive features of term insurance beyond price. The IRS sought to end perceived abuses with Notice 2002-08. That notice made the conditions for using the life insurance carrier’s rates more uncertain by requiring the following:
• The insurer must generally make the rates known to people who apply for term insurance coverage.
• The insurer must regularly sell term insurance at those rates and sell to people who apply for term insurance coverage through the insurer’s normal distribution channels.

These requirements apply to arrangements entered into after January 28, 2002. They can also apply to grandfathered arrangements that have been modified so that they have lost their grandfathered status.
The second requirement surely ended what the IRS considers “fictitious term rates.” Yet, some insurers still offer their own one-year term rates. Clients’ tax and legal advisors may or may not decide to use them. Insurers that want to meet the guidelines set forth in Notice 2002-08, need to find ways to distribute their one-year term products on a regular basis.

Suppose you are looking for a viable one-year term rate for reporting imputed income for split dollar or qualified plans. You may be asking, “Who would need life insurance that only lasts a year?” As it turns out, there are more answers to that question than you might expect. The most obvious case is probably when a breadwinner needs to ride out temporary cash flow issues. A client may want coverage to bridge the gap when they start a new job and when they expect to have money from a bonus later in the year for permanent life insurance. A one-year term policy may also be a logical solution if the new employer does not offer group term or the client wants a cheaper alternative to group term until they can buy permanent life insurance protection.
Clients may understand the need to insure their life due to life-changing events such as births, marriages, or mortgages, but aren’t sure which coverage will suit them best. With one-year term, they can meet their immediate insurance needs while they consider which type of policy would be best for them. Clients who have a life insurance need while waiting for a windfall of cash from an inheritance can purchase permanent insurance once the decedent’s estate is settled.
Moving a little farther along the spectrum of client sophistication, a common situation arises with estate planning cases. One-year term life insurance could be helpful for a high net-worth client when their attorney has not yet set up the trust. The client could buy the one-year term policy on their life and own it directly. They may want to buy a larger face amount to take the additional estate taxes into account since the policy would be included in the client’s estate. At typical one-year term rates, the additional cost could be relatively insignificant. After the trust is set up, a new permanent life insurance policy could be purchased, avoiding the three-year estate inclusion look-back, which would apply to gift of a life insurance policy to the trust.
If the one-year term policy has a conversion privilege, the client could sell the policy to the trust once it has been set up. Selling the policy also avoids the three-year look-back. Selling to the trust would be treated the same as selling the policy to the insured as long it is a grantor trust for income tax purposes. This is one of the exceptions to the transfer for value rule under §101(a)(2)(B). This approach would bring much better economic results for the family if the insured dies while waiting for the trust to be drafted before buying life insurance.
There are also business applications for one-year term insurance even outside of split dollar or tax-qualified benefit plans. For example, newer businesses with unpredictable cash flow may still need key person coverage. Also, if the one-year term coverage offers an option to convert, using a one-year term policy for a portion of the year may help businesses ease the administrative burden of buying life insurance on key employees. In such cases, the company can align policy anniversaries and premium billing. They would buy one-year term coverage on employees who are added to the company’s key person insurance or executive benefit programs and convert the policies to coincide with the anniversary dates.

A conversion option may be helpful in most of these situations, but even without such a provision, one-year term life insurance coverage may be better than no coverage at all. The insured may still be eligible for coverage when the time is right to buy permanent coverage. On the other hand, a conversion privilege in the coverage period can make life easier for the client and the financial services professional.

Some very high-end clients, who invest in short-term, high-profit, and high-risk projects, may have temporary protection needs. Their firms need to protect venture capital investments with key person insurance when the key person’s services are needed for one year or less. This commonly applies to actors, but could also apply to project managers, such as architects, engineers, or other consultants.

Professional sports franchises often invest a substantial amount on veteran players. Lately, contracts on high profile major league baseball pitchers, such as Roger Clemens and Curt Schilling, span only one year even less in Clemens’ latest contract. While it is regular practice for teams to insure their contracts in case of a player’s injury, a one-year term life insurance policy could be a very inexpensive way for a team to recoup its losses in case of the untimely death of a one-year contracted player.

One-year term has a place in the broad array of client needs that you may encounter. A one-year term policy may help you meet some clients’ temporary term needs whether or not you use split dollar or private split dollar plans in your practice. I hope that you will recognize some of these sales applications of one-year term life insurance in your client relationships and use this as a source to stir some other useful ideas.
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Bruce A. Guillemette, MSM, CLU, ChFC, FLMI, is assistant vice president of Advanced Markets Case Design for AXA Equitable’s independent life channel, AXA Distributors, LLC. He can be reached at bruce.guillemette@axa-equitable.com.