Over a lifetime, you may encounter
financial situations where circumstances don’t
align with opportunities; you don’t have the
resources or the timing isn’t right. There’s a
house that would be perfect for your family, but
you can’t afford the mortgage. Or a business is
for sale, but the money to buy it is stuck in your
401(k) – and you don’t turn 59½ until next year.
With hindsight, you may reflect wistfully on
these missed opportunities. It turns out the house
was perfect, and that business would have been
an ideal second career. Conversely, later
developments might reveal you were fortunate to
have missed that opportunity: Stretching to buy
the perfect home could have meant bankruptcy
after you lost your job, and new technologies
dramatically reduce the profit potential of a VCR
business.
But even when the timing and resources are
right, the uncertainty of future outcomes
challenges us, often making it seem that an
impending financial decision is nothing more
than a leap of faith. For example, there’s a
current mortgage lender advertisement that
begins “Mark and Alissa Anderson must really
believe in themselves. Why else would they
purchase a 30-year mortgage?” There’s nothing
wrong with believing in yourself, but is that all
they really can rely on? No. Smart consumers
also look for ways to hedge their financial
decisions.
Hedging
Hedging strategies attempt to reduce the
financial risk – of either suffering a loss or
missing a gain – and are used by both institutions
and consumers. There are multiple forms of
hedges, but they all share a common structure: for
a fee, one party guarantees some aspect of a
transaction for the other party; a guaranteed interest
rate, a guaranteed price, a guaranteed period, or
some combination. Hedges increase the total cost
of a transaction, but put boundaries on the risks.
For life insurance, consumers have several
hedging options for circumstances where their
current financial circumstances may not quite
match their opportunities.
A conversion privilege or guaranteed
increase agreement is an add-on to an existing
life insurance policy which gives the policyowner
the right (but not the obligation) to buy a specific
amount of life insurance at a specified price
within a fixed period, or on the occurrence of a
specific event (i.e., the birth of a child).
With these agreements, a policyowner pays
a small fee (relative to the current premium) to
ensure the right to either change the format of
coverage or purchase additional coverage at a
later date. The fixed price for future purchases
will be higher than the current price because of
advancing age, but it is also guaranteed,
regardless of other factors that might affect the
actual price of life insurance in the future.
Conversion Privileges – A Hedge for
Permanent Life Insurance
As our financial lives unfold, it may become
apparent that owning a permanent life insurance
benefit, i.e., a benefit intended to be in force for
the duration of one’s life, would be desirable. A
permanent life insurance policy could be used to
fund an estate plan, offset long-term care
expenses, supplement income, be a permission
slip to spend other assets, etc.
Under ideal circumstances, consumers might
buy permanent life insurance simply because the likelihood of dying is 100 percent, and a permanent policy would eventually result in a claim. But in real life, the premiums required to secure permanent life insurance may be presently unaffordable, particularly for consumers who are just beginning their financial lives. They may first need to reduce debt, build emergency reserves, or attend to other financial issues.
Term insurance, with its lower premiums, may solve immediate life insurance needs, but comes with an expiration date. When the term ends, the insured must either apply for new coverage, or forgo it. New coverage can be problematic: Because of advancing age, every new life insurance application has the certainty of higher premiums and the uncertainty of whether one is still healthy enough to be insured.
A conversion privilege hedges against this dilemma by guaranteeing the policyowner the option to exchange some or all of a term insurance benefit for a permanent policy without a reassessment of the insured’s health. The cost of adding a conversion agreement to a term policy is a fraction of what it would cost to purchase permanent insurance right away. However, the premiums for the new permanent policy will reflect the age of the insured at the time of conversion – the longer you wait to convert, the higher the annual premium.
A conversion privilege is not only a hedge against expiring term, but against declining insurability, and the challenge of even higher premiums or an outright decline of future coverage.
Guaranteed Increase Agreements- A Hedge for More Permanent Life Insurance
For those who already have some permanent life insurance, it might be desirable to have more at some point in the future. Guaranteed increase agreements allow a policyowner to purchase additional permanent life insurance at specific times or on the occurrence of specific events. Here’s an example of a guaranteed increase rider for a healthy, non-tobacco-using, 35-year-old male, attached to an existing $1,000,000 whole life policy:
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A new policy with a face amount up to $250,000 may be purchased without underwriting on each option date.
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There are five option dates, which occur every three years, beginning at age 37 and ending at age 49.
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An option may be exercised early if the insured gets married, at the birth or adoption of a child or grandchild, purchases a home, enrolls a child in college or has an increase of 20% or more in annual compensation.
The projected annual premium for the $1 million policy is almost $13,000. The annual cost for this rider, which allows for an additional $1.25 million of whole life insurance to be purchased, is $270, and payable only during the 14 years when the options can be exercised. As a hedging strategy for future insurance purchases, $270/yr. provides some fairly substantial financial leverage.
Exercising Your Hedging Options
These hedging concepts for life insurance options are relatively straightforward, but the details will vary by insurer. Some term policies have conversion privileges included in the base premium. But some “built-in” conversion privileges may not match the policy’s term; a 20-year term policy may be convertible for only the first 5, unless a separate 20-year conversion agreement (with additional cost) is added. Likewise, Guaranteed Increase Agreements vary in the frequency, events, and ages that trigger the option to add coverage. You’ll need the assistance of a life insurance professional to ensure these options match your circumstances.
Today, you may not have the resources or clarity to make the best decision about the ultimate configuration of your life insurance program. But your insurability might never be better. Conversion privileges and guaranteed increase riders can allow you to take advantage of your present good health to ensure options for the future, when both your objectives and circumstances may be better-defined.
Does your life
insurance program have
hedging options?

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