Want to drop your insurance policy? Read this.

When we no longer need an insurance policy, the first thought that comes to mind is to simply drop it. Just stop paying the premiums and the policy disappears.

However, if the insurance policy has value, the owner will receive nothing in exchange for giving up the policy. You don't give up an insurance policy you no longer need, just as you don't give up a home you no longer need.

Because if your insurance policy has no value, you could instead donate it and get a tax credit that can be very significant. Your insurance policy could be worth more than you realize and you could benefit from that value without ever having to pay a single additional premium.

Term insurance

We all have term insurance: it covers all our needs for 10 or 20 years. And this protection can be obtained at a minimal cost.

When a term policy expires, and in order to maintain coverage, a new policy must be purchased (often the best option if the insured is insurable) or the term policy must be renewed (if the insured is no longer fully insurable).

Insurability is the ability of a person to obtain life insurance at a standard price.

But this game of new policies and/or renewals eventually ends. Either the premiums become unaffordable, or the age reached does not allow for new coverage (or renewal of existing coverage). Then it's time to drop the policy.

This is where you need to assess whether the policy has value.

The transformation clause

Term policies have a "conversion" clause, and this clause can be very valuable.

Take John and his partner Gilbert. They have each taken out a $1,000,000 term insurance policy for their business. In the event of death, the policy is used to buy back the deceased's shares. The objective is for the estate to obtain the value of the deceased's shares without having to invest in the business.

But now John and Gilbert are selling their business and no longer need the insurance policies. They don't want to keep the policies for themselves since they already have the insurance policies they need for their estate plan.

John decides to drop his policy. There is no financial impact, no tax impact, the premiums stop being paid and the coverage ceases.

Gilbert, who was no longer insurable, decided instead to donate his policy to a charity. Gilbert donates the policy and stops paying premiums. However, since he is no longer insurable, the conversion clause in his policy has a value that the charity recognizes by giving Gilbert a tax receipt for $200,000. Gilbert saves $106,000 in taxes (at a marginal tax rate of 53%).

John and Gilbert no longer pay bonuses. But only Gilbert is now $106,000 richer.

The role of the charity

Before accepting the donation of an insurance policy, the charity will perform an actuarial valuation of the policy by checking the insurance product itself and the health of the insured. The market value of the policy may be zero, or it may be worth 10%, 20% or even in some cases more than 50% of the face amount of the insurance policy.

Once it accepts the contract, the organization will convert the insurance policy and pay the premiums itself until the death of the insured.

Conditions and applications

This strategy works for all term insurance policies, not just those purchased in a business setting as in our example.

However, in order for the conversion clause to have value, the insured must no longer have the health to obtain a new life insurance policy at a standard price. Thus, in assessing the market value of a policy, bad medical news (heart problems, cancer history, chronic illnesses, etc.) is good economic news, since it will make the policy worth more.

The strategy also works for other insurance contracts such as permanent policies. In such a case, it is sufficient that the policy being donated cannot be obtained at the same price today, which is usually the case simply because of aging.

Conclusion

If you intend to surrender an insurance policy, contact us or an actuary first to find out the potential value of your policy. This will help you avoid giving up an asset that has value to you and your family for free.