Dovi Frances of Malibu California recently delivered a $201 million life insurance policy to a billionaire client. What does his client understand that most others do not?
Malcolm Forbes, the owner of Forbes Magazine died 24 February 1990. He left his estate in good order and with enough liquidity that there were no forced sales to come up with the estate taxes due.
Estate taxes and other costs in an estate are substantial and perhaps more regrettably, payable in cash. Many people think that cash is a low value asset because it earns so little. The problem arises when cash and only cash is required. Liquidity has a price, whether it is putting up with low earnings along the way, or dealing with the shortfall at estate settling time.
We can and should learn from the work of skilled and experienced people. Following Warren Buffett’s investment style is a value. What can we learn from Malcolm Forbes?
Prior to his death he arranged just short of $70,000,000 of life insurance. The premiums were substantial. Malcolm was not a dummy, so why would he choose life insurance?
He was one phone call away from any financial person in America. He held substantial personal knowledge and experience in financial matters to boot. He was a careful and skilled businessman.
His reason for choosing life insurance was simple. In his own words, “Life insurance is an efficient way to transfer money to your heirs.”
If a sophisticated financial person buys life insurance instead of using his other choices, why do others fail to do so?
Probably because they don’t know.
For the unsophisticated, by not owning life insurance, they are implicitly using one of only three other methods to acquire liquidity for their estate.
- Own cash while living. Poor choice because it earns little and the little is adversely taxed. Opportunity cost.
- Have the executor borrow. From whom? With what security? For how long? Tie up at least half the estate to get 25% of its value in cash. How to repay it? Interest is not tax deductible.
- Have the executor sell something. Again to whom? Does “Estate Sale” imply a bargain? There is a simple rule of life – In times of need you don’t sell what you want, you sell what you can. The estate will be gutted.
Estates suffer from a further serious problem. There is no do-over. You cannot learn from your own experience so you must learn from the experience of others. Perhaps Malcolm Forbes could be a worthy model.
Your executors will need cash.
Prior to your death, you have two ways to get it for them. Own cash assets for delivery to the estate or own life insurance. If you do neither, you will force the executors to look after it. They have only two ways to create liquidity. Sell or borrow.
If you analyze the four choices, you will discover what Malcolm Forbes knew. Life insurance is the most efficient way to make the cash available.
Malcolm Forbes owned a private Boeing 737 with the name “Capitalist Tool” on the tail. He was smart and careful and created another. A huge life insurance portfolio was his final “Capitalist Tool.”
Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.