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 write an article on both.
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 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 is taxed annually as an investment; and the death benefit is also taxed.
Most life insurance software defaults to running a GPT test. 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, 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.
When would CVATing work best?
When you are paying into a policy using a single premium (which will MEC the policy). Why? Because the death benefit is lower in the early years and the cash value is higher.
For example, let's look at a 50-year-old male who pays a $500,000 premium into revolutionary life who will remove money from the policy at age 66 for 20 years.
|Initial Death Benefit||1st Year CSV||CSV at age 65|
You'd think that with the above, the CVAT policy would yield more of an ability to remove cash from the policy, but that's not the case.
|Cash from the policy |
every year from ages 66-85
*I ran the illustration using a 6 percent rate of return and a 6 percent loan and they are both "max-borrowing" illustrations.
While it makes little sense, GPTing allowed the client to remove more money from the policy from ages 66-85, even though the CSV just prior to borrowing was higher with CVATing. If you looked at the actual illustrations, you'd see that 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?
Unfortunately, I 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 like a better than it really is.
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).
While you may not use CVAT too often or even ever, 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.
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