I am a fan of Roccy DeFrancesco, JD. I particularly like when he goes deep on helping advisors understand the complexities in Life Insurance products. This is a good insurance lesson from one of the better teachers out there.
From Roccy-
Since we are doing education on IULs in a webinar series, I thought I’d do some general life insurance education on a topic that is not widely known or understood.
In fact, I’ve always been amazed at how few advisors know what CVAT or GPT means in the context of designing cash value life insurance policies for clients. So, I thought I’d do a newsletter on both.
What are CVAT and GPT, and why are they important?
CVAT is the abbreviation for Cash Value Accumulation Test, and GPT is the abbreviation for Guideline Premium Test. These terms refer to the two basic alternatives for determining whether a product meets the requirements to qualify as a life insurance contract (not whether a policy is a modified endowment contract or not).
Both tests define the relationship between cash value and the death benefit that is required at all times for a contract to qualify as life insurance but, as you will see later, they do it using two different approaches.
What happens if a product fails to meet one of these two tests?
The product is then no longer taxed as a life insurance contract. Instead, the growth on cash is taxed annually as an investment.
Most life insurance software defaults to running a GPT. So, without a majority of advisors knowing it, they have been running GPT-tested cash value insurance illustrations for clients.
The real question is: Why run an illustration using CVAT?
The non-technical answer is because you can pay larger premiums into the policy quicker with a lower initial death benefit and a higher cash surrender value.
If that’s the case, why are we not running all of our illustrations using CVAT?
Again, giving a non-technical answer, the reason is that when you get into the borrowing phase of the contract, even though CVAT starts with a lower death benefit (which you would think would accumulate more money in the policy quicker), a policy tested using GPT will almost always allow the client to borrow more money from the policy in retirement.
Example illustrating why CVAT shouldn’t be used most of the time
Let’s look at a 45-year male old who pays a $50,000 a year in premium until age 64 and then borrows from the policy at age 65.
|
Initial Death Benefit
|
1st Year CSV
|
CSV at age 65
|
|
|
CVAT
|
$1,029,473
|
$12,973
|
$1,992,500
|
|
GPT
|
$2,517,141
|
$0
|
$1,712,404
|
Because the initial death benefit is lower and the cash value is higher, you’d think the CVAT policy would yield more of an ability to remove cash from the policy, but that’s not the case.
|
Loans from the policy every year from ages 65-100
|
|
|
CVAT
|
$129,305
|
|
GPT
|
$176,691
|
While it makes little sense, GPTing allowed the client to remove more money from the policy from ages 65-100 even though the CSV (Cash Surrender Value) just prior to borrowing was higher with CVATing. The required death benefit with CVATing rises much quicker in the borrowing phase vs. GPTing. This is why GPTing almost always allows a client to borrow money from a policy vs. CVATing.
When do I see the CVAT used?
CVAT is used routinely in whole life policies (yet another reason I don’t like WL).
Unfortunately, I also see it used quite a bit in the college funding arena. Why, unfortunately because agents and insurance companies use CVAT testing to prop up the cash value in the policy in the early years to make it look better than it really is (and there are a number of short fund situations where clients want to shove a lot of cash in quickly).
As I’ve stated a number of times over the years, cash value life does NOT work for the vast majority of clients when trying to save/pay for college. If you would like to read my 10-page summary on why cash value life doesn’t work for college planning, click on the following link:
When “should” you use the CVAT?
Potentially in a premium finance situation where you need high cash value in the policy to help with collateral.
Otherwise, you should use GPTing (especially if the goal is borrowing from the policy).
Summary
While you may not use CVAT too often, or even never, if you are in the financial services field and certainly if you sell cash value life insurance, you should know your trade and, therefore, you need to know the difference between CVAT and GPT and when to use one over the other.
Roccy DeFrancesco, JD
Benton Harbor, MI 49022
269-216-9978
www.strategicmp.net
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