Some Nonprofits Mismanage Their Life Insurance Assets

Posted at Advisors4Advisors.com on November 19, 2015

When you give a life insurance policy to a nonprofit organization, what do they do with it?

The planned giving office of an Ivy League university recently told me that they "would at once surrender the policy" for its cash surrender value. They don't check the rate of return that they would earn by holding it for a month or a year or more? Apparently not. They just cash it in and move on.

Wow.

It's certainly reasonable to think that nonprofit organizations shouldn't own life insurance. After all, tax-exempt entities don't benefit from the tax advantages of life insurance. When I calculate the expected net present value of death benefits minus premiums for new cash value policies using an after-tax discount rate, the result is usually positive. With a pre-tax discount rate, it would usually be negative.

Even a modestly negative net present value might be acceptable, however, if a life insurance gifting program brings in donations that would otherwise not happen.

Existing life insurance policies can be more valuable. In some cases, keeping them should be a no-brainer.

With traditional whole life policies, you generally forfeit the annual dividend if you surrender the policy before the end of the policy year. So if the policy anniversary is approaching, you could get a good rate of return by waiting to surrender.

Whole life policies may also provide a rate of return on the cash value — ignore the death benefit — that is better than the returns on other fixed-income investments that have more risk.

Many universal life policies have a declining surrender charge, and the year-to-year drop can offset the policy's charges. One of my clients has an indexed universal life policy with three more years of surrender charges, as follows:

  • $20,156
  • $19,118
  • $18,112
  • $0

Suppose she gifts the policy just before the surrender charge disappears, when the monthly charges are about $1,000 and the cash value is about $165,000. How can it make sense to cash out that policy?

Mismanagement is not universal. I know a planned giving officer who has an appropriately nuanced view of life insurance. And the Planned Giving Design Center gets it right. In "Understanding and Drafting Nonprofit Gift Acceptance Policies," Kathryn W. Miree says "the nonprofit should have a committee or group that reviews the policy and makes a decision on a case-by-case basis."

According to the National Council of Nonprofits, "the board of directors of a nonprofit has a fiduciary responsibility to protect the assets of the nonprofit and to use those assets to further the nonprofit's mission."

That's the theory. What's the practice?