In my previous 3 articles, we explored the many insurance opportunities we find when working in the business owner marketplace. The opportunities ranged from risk protection applications, such as key person protection, buy/sell funding, and business loan protection, to estate/tax planning strategies, such as the Corporate Estate Bond strategy, Corporate Insured Retirement plan, and Immediate Financing Arrangement. Some of these applications can be fairly simple and straightforward to submit and administer, but others may require some additional preparation and attention to detail, specifically when trying to justify the coverage amount to the underwriter. This article will tackle the often overlooked, but ever-so-important cover letter. I will share with you an actual case that I recently worked on that included a cover letter to to justify to the carrier why we recommended the insurance coverage applied for.
For larger, more complex cases, it often takes months if not years from the point of initial contact with the client and/or their tax and legal advisor to when the file lands on the underwriter’s desk. In any case, you’ve invested a great deal of time and effort and your application deserves a solid cover letter. When working on complex cases, cover letters are an integral part of the package. Cover letters can assist you by helping to describe an unusual business situations, health history, or provide additional information relevant to the underwriting risk. In these cases, a letter is invaluable to the underwriter, and it helps to speed up the underwriting process. A well-written letter will paint the broader picture of your case, filling in the gaps by explaining the sale and any unique factors which provide insight into how the face amount was determined and other key details.
Generally, a good cover letter should include (although not exhaustive) the following key points:
why the face amount is higher than usually allowed
details about how long you have known the client and how the sale came about
additional details about your client, such as career history, community involvement, leisure activities (playing golf/hockey/tennis weekly), etc.
any and all calculations used to arrive at the face amount; these should be reasonable and currently achievable and not possible only if your client is deceased.
your contact information and the best time to call during the day if your underwriter needs to call you
Let’s focus on the importance of FINANCIAL JUSTIFICATION:
When we submit these large or complex cases, it isn’t guaranteed that they will pass the financial underwriting test (justification for coverage amount), let alone get approved medically. To demonstrate the importance of a cover letter, I’ve attached a recent HNW case cover letter that we used to help sell the case to the carrier, or in other words make the case for the insurance being applied for. Before we dive into the cover letter, let me provide a brief explanation of how we got there.
The “Corporate Estate Bond” (or Corp Investment Strategy, Corp Asset Transfer Plan, etc) was the initial sales concept we used to position the insurance recommendation. As you may recall from the previous article, The Corporate Estate Bond Strategy is a corporate insurance concept designed to increase the after-tax value of the corporation to the heirs. It positions a tax-exempt permanent life insurance plan as an alternative to traditional investments, offering the opportunity to minimize taxes during the accumulation phase and minimize taxes during the distribution phase (either while alive or on death via CDA). The Corporate Estate Bond works by simply redirecting existing, redundant assets or cash flow (not needed for lifestyle goals) that is taxable surplus into a non-taxable surplus solution. In this case, we used a $400k deposit for 10 years, with an initial death benefit of $4.8 Mill. Although this is a very popular strategy in the corporate market space, this IS NOT considered justification for the coverage. We still need to establish a NEED for permanent life insurance. Gladly, most carriers (although they do vary) will provide us with guidelines as to how to establish this need. In the HNW space, the general approach is to establish a need based on the anticipated taxes on death.
As you read through the cover letter, bear in mind that the corporate client had a very complex organizational chart, and with the help of the accountant, we put together the cover letter that eventually the carrier deemed worthy of the insurance being applied.
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ACTUAL COVER LETTER
June 6, 2022
To ABC Insurance Company
Re: Policy #
Owner: H
FMV: $23.6 Mill
PUC/ACB: $10
Insured: Mrs. X April, 1961
See the shareholder organizational chart
Attention ABC Insurance Company. This cover letter was also reviewed by Head Underwriter at your firm before submitting.
We are applying for a single life plan for $4.8 Mill WL Par Policy on the life of Mrs. X, ($400K deposit for 10 yrs) to be owned by Holdco Co. Inc. The purpose of insurance is to address the tax liability anticipated at death. We are only insuring Mrs. X since her husband Mr. X had a heart attack 4 years ago and has liver issues. Currently, there is a personally held permanent UL coverage of $4 Mill JLTD in force with XYZ insurance company, issued in 2003 and fully paid up. They have 2 children, X and Y.
Although the existing share structure does not include Mrs. X, there is an insurable interest in her life since her spouse, Mr. X owns over 50% of the common “growth” shares through his Family Trust (Class E shares). The beneficiaries of Mr. X’s Family Trust are Mrs. X, Mr. X, and his two kids, X and Y. Assuming he dies first, his shares will rollover to Mrs. X, therefore transferring the eventual tax liability to her estate. The other 50% of the common “growth” shares are owned by Mike Smith Family Trust (Class D shares). The beneficiaries of Mike Smith Family Trust are Mike and Anne Smith (Mr. X’s parents who are both 87 yrs. old) and Mr. X and any corporation controlled by one or more beneficiaries, any trust for the benefit of one or more beneficiaries. Mr. X is also the only child of both Mike and Anne Smith and the ONLY heir/beneficiary of their entire estate. It is highly likely that both Mike and Anne will predecease Mr. X. The tax liability pending on these shares (held by Mike’s Family Trust) will likely roll out to Mr. X and subsequently, rollover to his wife Mrs. X. This should confirm Holding Co. Inc. having an insurable interest on her life. (see Org chart for reference)
Holding Co. Inc. is currently worth approximately $24 Mill. Aside from the common shares discussed above,…there’s a small amount of fixed-valued preferred shares owned by each party directly (not via Trust). Mike and Anne Smith own P/S worth $672K each and other P/S worth $100 each. Mr. X owns P/S worth $2.3 Mill.
Financial Justification:
Holding Co. Inc:
Tax liability (capital gains taxes still need to be paid from the sale of a property within Holdco)
FMV: $23.6 Mill
Less shares of Anna/Mike $1.3 Mill
Less capital gains tax (approx. corp tax) $6.0 Mill
Less shares of Mr. X $2.29 Mill
Equals $14 Mill divided by 2 (50/50 Mr. X FT & Mike FT) = $7mill
plus Mr. X’s shares $2.29 Mill = $9.29 Mill
FMV Mr. X’s portion (corp shares): $9.29 multiplied by 6% (growth rate) over 20 yrs = $29.83 Mill
Tax liability based on 2 Post-Mortem planning options (using Mr. X’s 50% common shares and P/S only:
1) Assuming Pipeline strategy (apply capital gains tax rate of 26.765%): $7.98 Mill
2) Assuming Section 164 Loss Carry-back (apply non-eligible dividend tax of 47.74%): $14.24 Mill
Important note: The accountant has confirmed that the client will undergo Section 164 Loss Carry Back for post-mortem planning.
If we assume that the other 50% common shares held by Mike’s Family Trust rollover to Mr. X, this will increase Mr. and Mrs. X tax liability by another $10.6 million (Mike’s $7 Mill c/s value at 6% for 20 yrs X 47.74%). This will bring Mr. and Mrs. X’s tax liability to $24.88 Mill ($14.24 plus $10.6). Based on this calculation, we believe the amount applied for of $4.8 Mill additional coverage (above the existing $5 mill in-force) is financially justified.
Thank you
Mr. X’s Advisor
Technical input from Tony Gallippi Advanced Case Consultant at Qualified Financial Services Inc.
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Conclusion:
As you can appreciate, there are a lot of moving parts in this case. As previously highlighted, the justification to the insurance carrier is to address the tax liability anticipated at death for Mr. and Mrs. X. Unfortunately, given the ownership structure, it wasn’t obvious that Mr. and Mrs. X would bear the entire burden of the tax liability, since both Mr. X’s parents owned the other half of the shares through their family trust. It was important to emphasize this fact to the underwriter. Having their shares held in a family trust with Mr. X as a beneficiary, his parents were more inclined to roll out these shares to him upon their passing as opposed to triggering the tax liability on their terminal tax return. This would defer the disposition of those shares until both Mr. and Mrs. X have passed away, therefore incurring the entire tax liability to them.
Your underwriter is always looking for ways to reduce the number of times they have to ask you for information. By submitting a complete package with the application will save you a lot of time in the long run. A cover letter with your signature is as valuable to your underwriter as any third-party evidence they obtain during the underwriting process. Your cover letter will help your underwriter get a better feeling about your case. Investing a relatively small amount of your time with the support with the help of other resources will increase the chances of your case getting approved as applied for.
Tony Gallippi, B.A.S (Hons.) CFP CLU
Advanced Case Consultant
QFS
This communication reflects the views of Qualified Financial Services Inc. as of the date published. The information in this publication is for general information purposes only and is not to be construed as providing individual legal, tax, financial or other professional advice. Qualified Financial Services Inc. assumes no responsibility for any errors or omissions in the information contained herein nor for any reliance placed on such information. Please seek independent professional advice before making any decisions.
