What every CPA needs to know about life insurance.

• Author: Phelan, Sarah

Editor's note: Sarah Phelan is Technical Manager of the AICPA Personal Financial Planning Team.

The authors' views, as expressed in this column, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specified committee procedures, due process and deliberations.

If you would like further information, contact Ms. Phelan at (201) 938-3717 or sphelan@aicpa.org.

Life insurance is just one of the many products used to implement and secure a client's financial plan. With more than $1 trillion of life insurance death benefits purchased each year, it is clearly an important product to understand and assess on behalf of clients who might turn to their accountants for advice or even purchase.

Life insurance products have gone through a complete transformation in the last 20 years or so, and a policy purchased in 1975 bears little resemblance to one available today. This product revolution has been accompanied by an unprecedented level of competition, aided by policy illustrations. While computerized illustrations in many ways enabled the development and propagation of today's high-tech policies, those same illustrations were at the heart of class action and individual lawsuits against the life insurance industry and its agents during the 1990s--and financial reparations for "under-performing" policies have to date exceeded $6 billion.

As accountants expand their practices into financial planning in general and contemplate obtaining the appropriate licenses to be able to place the products necessary for implementation of financial plans, it becomes important that the accounting community have a better understanding of life insurance and the illustrations that presume to represent life insurance policies.

Policy Illustrations

Policy illustrations were first conceived as a practical way to show a client how a policy works. They include numerical examples that demonstrate how the payment of a (generally) level premium creates cash value, which in turn supports the affordable death benefit for the life of the insured, no matter how long he might live. The problem is that the numbers suggest a prediction or even a promise of future policy values. With the enormous flexibility within Universal Life (UL) and Variable Universal Life (VUL) policies to "pay whatever premium you like" policy illustrations conveyed a sense of security and optimism, without making certain that the policy buyer understood the risk that had been shifted when a premium less than that which would guarantee the death benefit was chosen as...