Financial Underwriting: Red Light, Yellow Light, Green Light? Mike Hesse Assistant Chief Underwriter September 15, 2017 Overview What Color is the Financial Traffic Light? . Stop- No offer until financial issues resolved . Proceed – with caution Secure more information . Proceed Financially Risk Level is a Continuum Fundamental Questions . Why? . What is in force? . Other applications pending? . Ultimate Total Line? 3 What Factors Determine the Color? . Need . Investment . Radically new, bold, creative sale . Clear documentation is key . Company / Amount / Issue Date . Purpose of Insurance . Replacement . Company / Amount / Issue Date . Additional / Competitive 4 What Factors Determine the Color? Needs-Based Protection Against Loss and Current-Projected . Income replacement . Final expenses . Mortgage . Estate taxes (“death taxes”) . Retirement planning /deferred compensation . Estate equalization 5 What Factors Determine the Color? Needs-Based Protection Against Loss and Current-Projected . Stock redemption / buy-sell . Key person replacement . Loan coverage . Charitable contribution . Kitchen sink- liquidity . Can consider ‘stacking’ needs (income replacement + mortgage + final expense) 6 What Factors Determine the Color? Investment and Financial Planning . Asset protection . Alternative to low-interest CDs, volatile stock market . Gift tax exclusion transfer to trust to purchase life insurance on child who married poorly and gambled in the stock market 7 What Factors Determine the Color? Investment and Financial Planning . Income with Respect to Decedent (IRA- income tax due at death) . Guaranteed / current / illustrated rate of return . Estate planning / transfer during lifetime . Inside build up advantage for life insurance 8 What Factors Determine the Color? Investment and Financial Planning . Tax mitigation, deferral, avoidance . STOLI, CHOLI, Surrogate insured . Commission rebating / premium advances / early lapses . Life insurance policy settlements (sales) . Windfall probability / potential 9 What Factors Determine the Color? Income Replacement Does that hat fit? . Adjustable or Fitted? Current/future needs . Was Head measured? Needs analysis . Within sizing guide? Formula . How much hair under the hat? Earnings stability . Will the hat still fit after ‘haircut?’ Financial setback . How often does client change hats? Replacement 10 What Factors Determine the Color? Estate Planning and Funding the Premium . Current income . Assets- Liquid? Qualified? . Current budget . Liabilities? . Selling assets? . Trust funded? . Premium financed . Illustration assumptions . Medical assessment/COI 11 What Factors Determine the Color? Estate Planning-Final Goal? Protect or Create Estate? . Projection . Rate of return . Life expectancy . Calculator used . Guaranteed rates . Investment track record . Asset control/inheritance . Protection or creation? . Estate calculator 12 What Factors Determine the Color? Key Person-Gauging “Economic Loss” . Who is Key Person? • Rainmaker • Sole proprietor • Technical expertise, patent holder, special skills/experience Pinterest.com . Low compensation currently BUT • Stock options • Equity share of the company will explode • What is potential economic loss to business? • Lost sales? Customer relationships? Inability to finance debt? • High cost to replace? Business Continuation 13 What Factors Determine the Color? Buy/Sell . Know all owners and percentage of ownership . Coverage proportionate to ownership Quantafinancials.com . Need 1- 2 years business financials (trend) . Establish the value of the business . Buy/sell agreement should be in place 14 A Word About the Proposed Insured… . Occupation (Training required? Job market?) . Income: earnings history, ability to document . Net worth- composition . Reality check – income in relation to occupation income average / median . Source of premium • Income + current liquid assets in relation to premium . Beneficiary designated • Relationship • Insurable interest • Financial loss 15 How Was the Sale Made Life Insurance Sales Process . What was Producer’s role in sale? . In overall financial planning? . Relationship with proposed insured? . Fiduciary Duty vs. Suitability • Client’s interests first, no conflict of interest . How was sale developed? . What facts/analysis were used to determine Financial need? 16 Fiduciary Responsibility The Depp Riddle: Who Should Watch the Money? . February 1, 2017 - NY Times Business Section Article . Earned $650M in past 30 years . Hired Management Group to oversee his finances in 1999 . Needs to sell significant assets to settle debts and for divorce settlement . Suing advisors- instead of protecting assets, they “engaged in years of gross mismanagement, self-dealing, and at times, actual fraud.” . Firm counter-sued Depp, arguing that it “did everything possible to protect Depp from his own irresponsible and profligate spending” 17 Fiduciary Responsibility The Depp Riddle: Who Should Watch the Money? . Spending: $2M per month; has purchased 14 homes, a French town, a chain of islands in Bahamas, $5.6M interest of overdue taxes, $3M fire cremated remains of Hunter S. Thompson out of a special cannon . Depp didn’t keep track of his accounts, read documents before signing, or question late tax payments for 16 consecutive years . 2015 President Obama- Fiduciary Responsibility “You want to give financial advice, you need to put your client’s interests first” . Others in industry oppose- places entire burden of responsibility on advisors rather than client, who should pay attention, will end up costing consumer more for financial advice . People should bear more responsibility for monitoring their finances and life 18 Financial Considerations . Financial verification . Financial projections . Financial justification . Financial fantasy . Financial limits • Jumbo limit • Binding limit • Retention limit 19 Financial Justification Rule of Formulas . Income replacement multiples . Percentage of income allocated to life insurance premium . Percentage of liquid current assets allocated to insurance premium . Estate planning – net worth projection “Normal” Amount . Key Person multiples . Stock redemption / buy-sell formulas . Deferred compensation formulas . Charitable giving formulas . Where does amount requested fall on the continuum based on formula? 20 Financial Verification Representations –Most Underwriting is Based on This Information . Life insurance contract - evidence . Application representations- part of contract? Need to amend? . Inspection Reports . Telephone-interview conducted by Underwriting 21 Financial Verification ● Representations ● Validity ● Depth of Verification ● . Representation on application . Producer’s report or commentary . Inspection or tele-interview . Mainstream fits the formula assumptions . Consistency . Does it make sense? 22 Financial Verification Expert Opinion . CPA/accountant • Credential Verification • Terms/history of association . Independent Financial Planner/Attorney . Vested interest in sale (Fiduciary? Suitability? Commission?) 23 Financial Verification Documents . 1040 Tax return . 4506-T signed- Tax Transcript . W-2 statements . Personal financial compilations . Brokerage statements . Appraisals / business valuations by experts . Business financial statements (BFS) 24 When Do You Need to be Really Sure Before Proceeding? Walkway or Highway? . Less financial/medical volatility and risk exposure . MORE: High dollar risk, volatility, reputational risk, regulatory risks . Potential for Fraud 25 Is the Amount Justified? What Additional Information Might be Helpful? . How solid are the financials? • Break down of net worth into assets and liabilities? • Assets value been verified as fact? If not, can they be? . Named beneficiaries of policies in force? • Agent states she’ll drop the $500,000 term policy, if necessary, to justify the coverage (expires in 2019) • Does the $100,000 initial premium influence your decision? o Where’s the $100,000 coming from? 26 Financial Documentation Does the Documentation Support the Financial Decision? . The application . Financial supplement that may or may not be signed/dated . The producer . The producer in role as CPA/financial advisor . Inspection or phone interview . Credit reports: ‘risky’ financial behavior not just bankruptcy 27 Financial Documentation Does the Documentation Support the Financial Decision? . CPA- Credential verified or not? Existing relationship established? . Private bankers- Willing to talk? Being compensated on the sale? . Attorneys knowledgeable about finances and planning - Interest in outcome? . Business financial statements- Does it match Representations? 28 Financial Documentation Personal . Property records searches . Brokerage statements . Zillow.com search results . Income tax returns or transcripts . Personal Financial Statement prepared by CPA or Attorney 29 Tax Returns The Good, the Bad, the Ugly . Supporting schedules needed? • Depends on application $ amount, sources of income • Income-based financial justification/verification • Net worth-based financial justification/verification/inference • Beneficiary-personal or business oName of business oTrust-personal insurance or is trust used for business purpose? . Joint return: whose income is it? . Extraordinary gains, losses (and tax impact) . Average income vs. increasing income 30 Federal Tax Returns Reading the 1040…and Assorted Schedules . Salaries . Interest . Dividends and Distributions . Capital gains . Sole proprietor business income . Partnership,