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Can cash value life insurance provide a useful retirement income supplement? It depends on whom you ask. Thirty years ago, I purchased a high cash value whole life policy, using my annual bonus to pay each year’s premium. When I reached retirement age, I made a tax-free exchange of the policy values into an immediate annuity that pays out a lifetime income for me and my wife.

But it doesn’t necessarily work for everyone. I met a physician recently who complained that an agent had sold him a “basket full of whole life policies” to generate tax-free income in retirement. The agent vanished, so the doctor surrendered the policies, paying a hefty tax on the gain.

There was a big difference between my situation and the physician’s, however. My policy was part of a retirement plan. His resulted from a life insurance sale with apparently little follow-up. Too often, life insurance is merely a sales idea with no real follow-up once the policy is delivered. Life insurance as a retirement strategy requires ongoing communication and administration.

While most retirees use life insurance for its death benefit, cash value life insurance policies can:

• Serve as a source of funding during the insured’s lifetime and a strategy in retirement planning.
• Pay out a tax efficient stream of income for a period of years through withdrawals and loans.
• Supplement an individual’s retirement income when heavily funded;
• Fund a non-qualified deferred compensation benefit for an executive (when a corporate owned life insurance policy, or COLI;
• Buy out a retiring owner’s stock in buy-sell situations.

Steve Parrish

In this article, I propose that advisors use this checklist, or one like it, to assure proper execution of the plan. Any checklist should cover the acquisition of the policy, the implementation of the plan during pre-retirement years, and the decumulation of values during retirement. Ongoing administration of the plan and attention to detail are essential.

Policy acquisition

Clients, whether individual or corporate, will need help choosing an appropriate policy, both in terms of its use and its risks. For example, a variable universal life (VUL) policy requires more education and decision-making than does a whole life policy. With VUL policies, the policyowner controls the investment of the cash value. With whole life, the insurer controls it.

The advisor must also ask if the policy design fits the intended investment risk strategy for the client’s retirement plan. The advisor should also confirm whether the retirement strategy will use the policy as an uncorrelated buffer asset (a case for whole life) to mitigate sequence risk or, as vehicle for tax deferral (a case for VUL).

Another important question: Is the contract flexible enough? For example, if the owner wants a monthly retirement income when he or she starts decumulating the policy, can the insurer automate these payments? A written withdrawal request to the insurer every month would be unwieldy.

The advisor also needs to determine if the policy has the right triggering points to accomplish the retirement strategy. If the purchaser plans to use the policy for a voluntary retirement, many cash value products will work. If, however, the policyowner wants access to payments for disability or long-term care, the policy will require additional riders or policy features.

During the policy acquisition process, it will be hard to tell how the policy will perform. Cash value life insurance designs are often difficult to understand, and the illustrations vary by product type. For example, from a regulatory standpoint, a whole life policy uses a different illustration regime than, say, an indexed universal or variable universal policy. Some policies are considered securities under state and federal law; others are not. This can lead to apples-to-oranges comparisons. An advisor will need to take extra steps to explain and demonstrate the life insurance retirement income strategy to a prospective client.

The purchaser must also determine how the policy strategy will integrate with the client’s overall portfolio and plan:

1. 1. In a buy-sell situation, the business needs to determine from the outset whether the policies will be owned individually by the business owners (a cross purchase buy-sell) or by the business itself (an entity buy-sell).
   2. In an individual retirement situation, the prospective retiree should coordinate policy withdrawals and loans with their overall asset location and income withdrawal strategy. If the cash value withdrawals provide an income bridge while the owner defers filing for Social Security, the policy funding must have sufficient cash values for that purpose.
   3. In a non-qualified deferred compensation situation, the company will typically own variable life insurance policies. They will want to match, at least roughly, the policy’s sub-accounts with the investment crediting strategy for the participating executives. Otherwise, the company’s liability to its executives won’t match the funds in the policies.

Plan implementation

Before any policy is actually issued and placed, certain legal issues must be addressed. When life insurance is used to buy out a retiring owner of a business, at least three legal issues arise.

First, to avoid income tax on a transfer for value, the advisor must determine if the business will own the policy or if it will be cross-owned by a business owner. If the policy is corporate owned, the notice and consent formalities of IRC Section 101(j) should be considered. Finally, the existence of the policies and their intended use should be documented in the buy-sell agreement.

If the life insurance will reside in an irrevocable life insurance trust, the policy should be issued, not transferred, to the trust in order to avoid estate inclusion under IRC 2035. Beneficiary designations should likewise be determined in advance.

While buying life insurance always requires the expertise of a licensed agent, help from attorneys and accountants will likely be needed to implement the plan. One of these professionals needs to be responsible for using a checklist to coordinate their activities.

Plan administration

When life insurance-based retirement strategies break down, poor administration and communication is often the cause. When a licensed insurance agent receives a heaped commission for placing the policy, that can be a disincentive to ongoing administration.

While the client’s attorney may be on retainer, he or she may not have the technical expertise to administer the life insurance plan. In some cases, execution of the plan may require the services of a specialist who earns a separate fee for services provided.

Other primary elements to include in a checklist for proper plan administration are:

• Monitoring and reviewing the plan with the client and other professional advisors
• Establishing triggers and procedures for implementation of the strategy upon the insured’s retirement
• Determining the amounts and timing of withdrawals when the policy is ready to be used for retirement income

In an individual client scenario, for example, the insured owner may choose to target policy withdrawals to avoid adding to taxable income (thus avoiding the NII tax, Medicare Part B increases, or Social Security covered compensation tax). In a corporate situation, the company’s advisor should determine which is more or less expensive: To access policy values or use the company’s own capital. If capital is inexpensive, waiting and using the life insurance for its death benefit may be better.

Once income withdrawals begin, the advisor should find out if the life insurer can automate the withdrawals. For example, can premiums cease and monthly payments begin automatically? When decumulation of a universal life policy begins, the owner should ideally switch from an increasing death benefit to a level one. This is often a predetermined step. It maximizes the value of the life insurance in retirement income planning. Who will be responsible for making this switch?

Further, withdrawals of the cash value should be made only until the owners recover their tax basis, and they should take future drawdowns from the policy as loans. If the insurer doesn’t offer these services, the advisor will need to help.

Every plan will need lifelong monitoring. The insurance company should be monitored for impaired financial ratings, mergers, or changes in its internal pricing of in-force policies. Tax law changes should be examined for effects on the retirement plan. And, of course, the client’s individual situation should always guide the execution of the plan. The life insurance policy ultimately represents a death benefit, and a change in the insured’s health status may alter the decision to use the death benefit or the cash value strategy.

Advisors will have their own approaches to fulfilling their duties related to a client’s retirement strategies. For the use of cash value life insurance in retirement planning, this checklist may be a useful tool. Applied throughout the period of accumulation and decumulation of the cash value life insurance contract, the checklist will help ensure the success of the retirement strategy.

© 2020 RIJ Publishing LLC. All rights reserved.

Chris Blunt has held C-level positions in asset management, marketing or annuities at Merrill Lynch, New York Life and other top firms over a 34-year career. In 2018, he became CEO of Blackstone Insurance Solutions. About a year ago, he became president and CEO of Fidelity & Guaranty Life.

That makes Blunt, who is 58, well-qualified to comment on the evolution of the life/annuity industry since the Great Financial Crisis of 2008, and on the new business model that some companies, including F&G, have adopted. RIJ calls it the “Bermuda Triangle” model. The businesses call themselves “insurance solutions” providers.

It’s an investment-driven model. Powerful asset managers like Blackstone Group, Apollo Holdings, and KKR are helping certain insurers invest a portion of the assets backing their in-force fixed or fixed indexed annuities (FIAs) in relatively high-yielding, illiquid, long-dated asset-backed securities, or ABS. The asset managers are partnering with life insurers or making equity investments in them.

The asset managers make customized “leveraged loans” to high-risk borrowers, and/or bundle those non-investment grade loans into securities called collateralized loan obligations, or CLOs. Life insurers then buy the senior, investment-grade segments (“tranches”) of CLOs—which pay higher returns than the high-rated corporate bonds that make up a large chunk of a life insurer’s assets. 

Chris Blunt

This strategy, especially when linked to the sale of troubled blocks of in-force annuities to offshore reinsurers, has helped mitigate the damage dealt to certain life insurers by a decade of low returns. Some annuity veterans worry, however, that while solving problems for annuity issuers, asset managers are bringing an overly aggressive style to the historically cautious life industry, that CLOs might prove too risky for life insurers to buy and hold, and that private equity culture may not be policyholder-centric enough.

An insider’s view

Fidelity & Guaranty Life (F&G)—built on the old USF&G and recently acquired by FNF, the title insurance giant—didn’t pioneer the “insurance solutions” strategy. (Apollo and Athene did, in 2010.) But, working with Blackstone, F&G has used the strategy to become the #3 FIA seller in the independent agent channel, where half of all FIAs are sold. It has nipped market share from established FIA issuers like Allianz Life, American Equity, and Great American.

Blunt recently talked with RIJ about F&G and Blackstone and about the insurance solutions business. Although private-equity companies created this new business, Blunt said, making private equity purchases isn’t the chief skill they bring to annuity issuers. It’s their ability to create private credit.

By buying bank loans or placing bespoke loans to businesses with weak credit ratings but real assets (like machinery or cellphone towers) or contractual cash flows (from, for example, music royalties), F&G can add 20 basis points to the average return of a life insurers general account investments, producing 5% to 10% more investment income. That’s a meaningful competitive advantage, especially when pricing fixed indexed annuities in a low interest rate environment, consulting actuary Tim Pfeifer told RIJ.   

Questions and answers

RIJ: F&G was a public company when CF Corp.—a company started and financed by William P. Foley III, owner of FNF title insurance, and Chinh Chu, a former co-chair of Blackstone’s Private Equity Group—bought it from HRG Group, formerly Harbinger, for about $1.84 billion in 2017. FNF took F&G private this year and CF Corp became FGL Holdings. How would you describe F&G as it stands today?

Blunt: We’re a life and annuity company, and we have been from our beginning as US F&G Insurance. The company used to be bigger in life insurance than it is today. Now we’re overwhelmingly a fixed deferred and fixed indexed annuity company.

RIJ: What inspired Foley and Chu to buy it?

Blunt:At the time [2017], everyone was aware of how Apollo had partnered with Athene. CF Corp. said to Blackstone: You guys have access to even bigger fixed income opportunities than Apollo does. As such, F&G should be able to become even more successful as a life and annuity company than Athene/Apollo, given Blackstone’s ability to source attractive investment-grade private debt.

RIJ: At what point did you get involved with this project, and in what capacity?

Blunt: I was hired by Blackstone in Jan 2018 and tasked with building a third-party asset management unit serving insurance companies. They knew I understood the nuances of both insurance and investments. By the fall of 2018, they saw that the key to success in the US would be to help scale F&G. At the same time, the board of F&G approached me about becoming CEO. So I left Blackstone (with their blessing) entirely at the end of 2018 and in January 2019 I became the CEO of F&G.

RIJ: What enticed you to make the move?

Blunt: It was a difficult decision to leave Blackstone, but I knew what Blackstone’s impact on the investment portfolio of F&G would be. I knew they could give F&G at least a 20 basis-point investment edge. I knew that was unbelievably meaningful, and I liked the size of the company, and the executives I had come to know there. So, in January 2019, I became CEO.

RIJ: And why did FNF decide to take F&G private this year?

F&G’s annuity business; source for charts: F&G 6-16-20 presentation.

Blunt: FNF’s insight was, ‘We’re currently the largest provider of title insurance. We do title insurance well and do really well in a low rate environment, but eventually rates will rise.’ In addition, FNF felt F&G would have a harder time raising capital in a low rate environment as a standalone company. So its thought was, ‘Why don’t we buy F&G?’  It’ll provide a buffer to FNF when rates rise, and FNF can help scale it faster.

RIJ: It feels like a number of life insurers are becoming sources of stable investment capital for private equity companies.

Blunt: It’s misleading to refer to the new wave of life insurers as ‘private equity-led.’ The relationships between the asset managers and life insurers have taken a variety of shapes. For instance, a private equity holding company might own or have stakes in the insurance company itself or simply manage part or all of their general account. Or, as in one case, a life insurer partners with two or more asset managers. Each relationship is structured differently. In the case of F&G/FNF, FNF and Blackstone have had close dealings with each other, but are completely independent entities.

RIJ: So private equity companies are not at the center of this model?

Blunt: We’re talking about the private-credit arms of the private-equity companies. Rather than taking equity positions in high-risk companies, the asset managers like Blackstone, which re-deploy fixed annuity investments, are more likely to buy or originate private investment grade loans as well as package below-investment grade loans into CLOs and sell the investment-grade senior tranches to life insurers.

RIJ: I see.

Blunt: The question we ask asset managers is, ‘Do you have access to unique private debt deals that are investment grade?’ Not everyone can do that. You have to be in that private deal world, and you need lots of people with specific expertise. Blackstone knows how to access these deals and, more importantly, how to analyze them. If you asked, ‘What’s the most impactful part of this business,’ that’s the most important piece.

Blackstone’s assets under management

RIJ: Impactful in what way, exactly?

Blunt: Maybe I pick up 20 basis points in total yield right there. We’re not taking more credit risk, but rather liquidity risk. They’re typically 4-5 year loans that are not easily tradable. By investing in private loans and structured securities, we’re picking up an illiquidity premium, a complexity premium and a size premium.

RIJ: So exactly how does this play out?

Blunt: Rather than wait for the phone to ring on a public deal, F&G will go to Blackstone Insurance Specialty Finance for example and say, ‘We want to place $1 billion in a diversified portfolio of loans, we want investment grade, we want no more than Y percent in BBB, with an average duration of X.’ Within those parameters, Blackstone goes out and sources deals for us.

RIJ: What’s Blackstone’s appeal to those borrowers?

Blunt: For a $300 million to $400 million loan, those borrowers wouldn’t go to a big investment bank. It’s too small a loan to be worth [the big banks’] while and they would, appropriately, charge a mark-up. Whereas Blackstone can say, ‘We have multiple insurance clients who would love this kind of yield/credit profile.’ The assets backing these deals can range from cellphone towers to machinery to music royalties—anything with real assets or contractual cash flows. Blackstone says, ‘Work directly with us and we’ll get all of your financing done in one place.’

RIJ: Why is it hard to find those deals? Can’t Blackstone just go into the bond market to find assets for F&G?

Blunt: The investment-grade public deals are massively oversubscribed. If we were F&G in the old days, a big life insurer would have already soaked up all the attractive investment-grade deals that were available [before we could get to them]. I’m not picking on the big insurers, but this is the dilemma in insurance.

RIJ: Which tranches of asset-backed securities does F&G buy?

Blunt: With F&G, Blackstone is looking mainly for investment-grade debt tranches. As a life insurer, we can’t own more than five percent in non-investment grade debt. That means 95% of our fixed income is investment grade. Blackstone can originate private asset-backed loans and can choose to securitize them or not. Blackstone can, for example, manage a portfolio of CLOs for us that includes Blackstone-structured CLOs as well as CLOs from other CLO creators.

RIJ: What’s your response to academics and others who feel that CLOs are too risky for life insurers?

Blunt: A lot of people don’t like securitized products. They say, ‘Oh, this could be the next disaster.’ But a single CLO has hundreds of loans from a variety of industries. They’re senior financings; which means, as the creditor, I can liquidate your property if I have to. Frankly, we believe it’s a better risk than an unsecured BBB bond from a single company in a single industry.

RIJ: So, is F&G buying BBB tranches of CLOs?

Blunt: Mainly we’ve bought the single A tranches of a CLO. The BBB grade clearly has more risk whether it’s a CLO or a bond, but we haven’t seen massive downgrades or defaults on them. I’d rather own a BBB tranche of a CLO than a BBB corporate. So where does all the handwringing come from? There’s no historical basis for it.

RIJ: Thank you, Chris. 

© 2020 RIJ Publishing LLC. All rights reserved.