A declined life assurance application does not always mean an inheritance tax planning strategy has to be abandoned. Gregor Sked, Senior Protection Technical Manager at Royal London, explains how a notional decline can help preserve a joint life second death solution and the planning considerations that follow.
A declined life might appear to rule out a joint life second death policy. But, in some circumstances, the original planning objective can still be achieved, although the solution may require some additional stress-testing.
As wealth moves through families, we need to think about more than the value of the assets or the potential tax liability. Who owns the money? Who controls it? Who ultimately needs it? And will it actually be available at the point they need it? These are all essential considerations when setting up a protection policy intended to deliver the right outcome.
Inheritance tax planning is a good example. We can identify a future liability and consider ways of reducing it, but there may still be a need to create liquidity for whatever tax remains. Protection can potentially provide that liquidity.
But there’s another variable that can change the planning altogether: what happens when underwriting changes the solution we originally had in mind?
It’s particularly interesting with joint life second death cover and something known as a notional decline.
When one life is declined
Imagine a couple applying for joint life second death cover. One is accepted at standard rates. The other is declined.
Our immediate reaction might be that the original recommendation has failed. Depending on the insurer and contract, that isn’t necessarily the case.
Some insurers may allow a notional decline. One person cannot be accepted on the insurer’s normal underwriting terms, but can remain part of the joint life second death arrangement, with the premium determined by reference to the life the insurer is prepared to cover.
You might be thinking that sounds counter-intuitive. How can someone who has been declined still be included?
Well, remember what we’re insuring. The policy isn’t intended to pay when the first person dies. It pays on second death.
The mechanics of that second-death arrangement can therefore allow an insurer to accommodate a life it wouldn’t ordinarily insure individually.
That doesn’t mean the declined client has suddenly been accepted at standard rates. They haven’t.
Let’s meet David and Sarah
They’re both in their mid-60s, non-smokers, and have accumulated considerable wealth through property, investments, cash and pensions.
Their adviser identifies a potential £1.5 million IHT liability on second death. They want their children to have sufficient liquidity to deal with the tax bill without assets having to be sold simply to raise cash.
Joint life second death cover looks like a natural fit. The application goes in, but the underwriting outcome isn’t quite what was expected.
David is accepted at standard rates. Sarah is declined. The insurer is prepared to consider the arrangement using a notional decline, with the premium based on David as the standard-rate life.
That’s actually a positive outcome. Despite Sarah being declined following underwriting, the original planning objective hasn’t necessarily been lost.
They can still potentially have cover structured to pay on second death, at the point the IHT liability is expected to arise.
But the notional decline does change one part of the equation. It gives us another scenario worth stress-testing.
What happens if David dies first?
Under the joint life second death arrangement, there hasn’t yet been a claim because Sarah is still alive. The policy continues and Sarah will need to maintain the premiums if the family wants to preserve the cover.
Her circumstances could look very different by then. Household finances may have changed following David’s death and her health could potentially bring additional financial pressures of its own.
That doesn’t make the joint life second death recommendation unsuitable. Far from it. Its fundamental advantage remains that the payment is aligned to second death, when the IHT liability is expected to arise.
But premium sustainability following first death is something we should have considered and documented.
This is where the planning needs a little more thought.
If the cost of the notional-decline arrangement is being determined by reference to David as the standard-rate life, an adviser may want to understand how that position compares with insuring David alone.
We’re not suggesting that single life cover is automatically preferable. It solves a different problem.
If Sarah dies first, David’s single life policy continues and eventually pays when David dies. But if David dies first, it pays immediately. Sarah no longer has a policy premium to maintain, but the family now has the opposite problem: the money has arrived before the liability it was designed to fund.
Potentially, many years before it.
Depending on how the policy has been structured, trustees or beneficiaries could therefore have responsibility for a substantial sum long before the IHT liability arises. Circumstances change.
Relationships break down. Financial difficulties happen. Money gets spent. Investment values move.
And that’s where the two approaches start to look quite different.
With the joint life second death arrangement, we need to think about maintaining the cover after first death. With single life cover, we potentially need to think about maintaining the proceeds after first death.
Getting the money early isn’t necessarily better. For an IHT liability expected on second death, there is considerable logic in having the insurance proceeds arrive at broadly the same time.
When we look at protection through a wealth and intergenerational planning lens, the policy itself is only part of the answer.
We start thinking not simply whether we can arrange the cover, but what happens to the money as circumstances change and wealth moves through the generations.
Main image: protection, mehdi-mirzaie-G2j6asJEdhs-unsplash
