The classic view of life insurance is that it is purchased as long as needed or desired, and then lapsed (or if there's any cash value, surrendered) when it is no longer necessary. Term insurance policies are usually expected to lapse, and in practice even "permanent" insurance often ends out being surrendered before it is ever paid out as a death claim.
Technically, though, there is a third option to the "keep versus lapse" decision of life insurance: to sell the policy to a third party in a transaction called a "life settlement" to an (institutional) investor who might be willing to pay more than just the policy's cash value (or the $0 value that might be available if the coverage just lapses on its own). After all, in the hands of an investor, a life insurance policy is simply an "investment" that has ongoing cash flow requirements (premiums) but will eventually mature as a (much larger) death benefit later. So as long as the time horizon is "reasonable", the policy can actually have a remarkably appealing implied rate of return to an investor, for which the current policyowner can be paid!
In this guest post, Lingke Wang - co-founder of Ovid Life, a technology firm aiming to create a centralized transparent marketplace for life settlements transactions - provides a "Financial Advisor's Guide To Life Settlements" with a detailed review of the life settlement industry, what a life settlement provider is and how life settlements operate, and the mechanics of how an investor evaluates a prospective life settlement contract purchase (which is important to understand for any policyowner who might be selling their life insurance policy!).
Ironically, the biggest caveat of engaging in a life settlement is the reality that any life settlement policy worth selling to an investor is worth even more in the long run for the policyowner to just keep themselves, where the internal rate of return will be even more appealing (since the investor has both transaction costs to acquire the policy, and does not enjoy the death benefit tax free as the original policyowner would). Nonetheless, that appealing internal rate of return for keeping a permanent life insurance policy only applies by continuing to maintain the policy, including ongoing premiums. So for a policyowner who simply doesn't want to - or can't afford to - keep the policy in the first place, a life settlement may still be a more appealing exit than just letting the policy lapse away!
Life settlements are an important financial tool that many financial advisors and consumers know surprisingly little about. When used properly, life settlements can help supplement underfunded retirement accounts by converting an otherwise ‘idle’ life insurance asset. This article will give advisors an overview of the product and industry, when one should consider using this tool, and how the transaction works in detail.
What is a Life Settlement?
The definition of a life settlement is simply is the sale of a life insurance policy from the original policyowner to a third-party investor. The selling policyowner receives an upfront cash payment in exchange for transferring ownership of the life insurance policy - typically more than any existing cash value but less than the policy's full death benefit - and the investor as the new owner then continues to make the ongoing/annual premium payments. When the insured passes away, the investor collects the policy’s death benefit.
The life insurance settlements market is still relatively young but was born as a result of a number of judicial rulings over the past hundred years. The most notable of them was the US Supreme Court case of Grigsby v. Russell, 222 U.S. 149 in 1911. Justice Homes wrote “So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.” This opinion set forth the foundations of the life settlement market: life insurance is a private asset that the owner should be able to sell.(1)
What Is The Difference Between A Life Settlement And A Viatical Settlement?
One important distinction to make is the difference between viatical settlements and life settlements. The two are similar because in both cases, the insured is selling their life insurance policy to an investor. However, viatical settlements are arranged for individuals who have a life expectancy of under two years (i.e., those who are terminally ill) while life settlements are for individuals who have a life expectancy greater than two years (i.e., those who are otherwise ‘reasonably’ healthy). In addition, there are different regulations covering viatical settlements. This article discusses only life settlements and, although some of the information is applicable to viatical settlements, does not aim to cover that topic.
Why Would Anyone Want to Sell Their Life Insurance?
The annual US life insurance lapse rate is 4.5%(2). This means that out of the $20 trillion of in-force life insurance, roughly $900 billion of life insurance death benefits lapse every year(3). Of course, part of these lapsed death benefit values are for term life insurance - which is designed to be used for only a period of time and then lapse. But what about permanent life insurance - the type of coverage that is meant to insure a person for their entire life, and theoretically should be held until death without lapse?
It turns out that 88% of all universal life insurance never materializes into a claim. Even 76% of universal life insurance purchased by seniors 65 years or older is not actually held until it matures as a death benefit claim!(4)
The fact that policies are being bought to secure a death benefit but lapsing before that eventuality occurs results in a tremendous transfer of economic value from the consumer’s pocket to the life insurance companies’ bottom line.
Of course, the reality is that many policies are never claimed simply because circumstances change and the coverage is really no longer necessary. The reasons why someone initially purchased the policy may no longer be relevant decades later. Here are some common cases:
- An elderly man purchased a permanent policy when he was working to protect his family. 30 years later, his kids are financially self-sufficient. Recently, his health has declined and he requires significant medical treatment. Rather than burdening his children for money, he considers surrendering his policy to extract its cash value to pay for the medical bills.
- A married couple each purchased a policy naming the other as the beneficiary. After many decades, one passes away. The living spouse collects the policy benefit but still has a remaining policy.
- Two business partners executed a buy-sell agreement funded with a life insurance policy so that the survivor could carry on the business in case one of the partners passed away prematurely. However, the business eventually went under so the buy-sell agreement and its life insurance policy are now irrelevant and no longer needed.
- A couple with no kids purchased a policy while they were married. After a number of years, they divorce and the individual that owns the policy post-divorce no longer has a need for it.
A mature secondary market for existing life insurance policies to be bought and sold can greatly benefit the consumer in each of these common cases. The biggest benefit is taking something that was perceived to be illiquid and of limited value, and turning it into a liquid asset that may have an even greater value in the hands of an investor than the original policy owner.
Most consumers do not know that they can sell their life insurance policy - so it comes as a pretty big shock when you tell your clients that they could realize thousands of dollars for it (over and above any existing cash value). To add to the upfront additional cash that can be realized from the sale of the policy, another large benefit of the transaction is eliminating the ongoing premium expense of keeping the policy in-force. Life insurance is expensive to maintain and often becomes more expensive the older the insured becomes – a common feature of Universal life insurance (particularly policies that have previously been underfunded).
Life Settlement Brokers And Life Settlement Providers
There is no central life settlement exchange where policies are traded. Like real estate, life insurance is sold ‘over-the-counter’ in private transactions between sellers and buyers, often facilitated by two types of life settlement companies. There are life settlement brokers which facilitate a life settlement transaction of the policies between the seller of a policy and a buyer, and life settlement providers are companies that buy policies (via a broker or directly from the policyowner), either to hold themselves, resell to an institutional investor that buys life settlement investments, or even engage in a life settlements securitization process to repackage across multiple institutions investing in life settlements.
Life Settlement Brokers
Life settlement brokers represent the individuals who are selling an existing life insurance policy to a life settlement buyer (usually an institutional investor). When partnering with a life settlement intermediary, that professional will solicit offers for the policy from life settlement providers who will buy the policy (discussed below). The current landscape of traditional life settlement brokers is a fragmented market of small brokerages.
If your client is pursuing a life settlement, it is recommended that you work through a broker instead of contacting buyers directly. Similar to real estate, brokers can help your client realize a more competitive value. It’s also possible to sell a policy without a broker by contacting a provider directly. The benefit is that the client will save money on the broker’s commission fee; however, unless the advisor knows many of the life settlement providers and can generate a competitive bidding process by themselves, the financial advisor risks not getting their client the best deal.
Notably, the process of working with a life settlement broker to obtain quotes for the sale of a policy is typically free and non-binding to the client. The life settlements provider gives a binding quote (binding on the provider to pay the quoted price) for a period of time, and the client can choose whether to proceed. If the client executes the sale that the broker facilitated, the broker is paid an execution commission on the completed transaction.
Here are some examples of reputable life settlement brokers:
- Ovid Life Settlements: www.ovidlife.com
- Welcome Funds: www.welcomefunds.com
- Ashar Group: www.ashargroup.com
- Policy Options Life Settlements: www.quicklifesettlements.com
There are several key considerations when selecting a life settlements broker to partner with you and your clients pursue a life settlement transaction.
Transactional Fee – The life settlement industry has a dark past of brokerages charging abnormally large transaction fees before the industry was regulated. Today fees should be disclosed up front and are now capped based on the state’s regulation. Some companies may charge a contingency commission that is dependent on the size of the life settlement offer obtained. The maximum fee arrangement is 30% of the settlement value, but some brokers may charge less than that. Make sure to ask for more information on this if you’re obtaining a quote or doing due diligence on a life settlements broker.
Transparency and Accountability – Use your best judgement to make sure that your life settlement broker will do the best job possible for your client. A good broker should be soliciting life settlement bids in an objective manner, from multiple providers, seeking the highest bid for your client. In the past, life settlement brokers have engaged in the bid process in a manner that would benefit themselves more than their clients. An example of this would be recommending that the client accept the first offer so the transaction closes quickly (and so the broker gets paid quickly) instead of waiting to negotiate with more buyers for competing bids.
Licensing – Confirm that the life settlement broker is fully licensed in the appropriate state. If the broker is not licensed in the appropriate state, then that life settlement company may have to contract out to another life settlement broker who is licensed.
Privacy – Make sure that the life settlement broker protects your client’s information and only sends your client’s files to only the parties necessary to produce offers – usually only life settlement providers and life expectancy underwriters (discussed in the life expectancy section). These files will include confidential health and insurance records. There is no reason for a broker to send your client’s information to anyone else who is not involved in this process.
Life Settlement Providers
Life settlement providers are companies that are licensed to purchase many life insurance policies on behalf of large institutional investors. Sometimes a provider themselves may also be an investor. All reputable life settlement investors utilize life settlement providers for origination.
Life settlement providers have expertise in evaluating the investment quality of a life insurance policy, and make bids for policies based on the policy characteristics, the insured’s life expectancy and the interest rate environment.
Once acquired, the life settlement provider often resells those life insurance policies, or sells fractional interests in them, to a group of investors. Sometimes a group of investors or other financing entity will provide the capital the life settlement provider uses to purchase life insurance policies from consumers.
Here are some of the larger life settlement providers:
- Coventry Life Settlements: www.coventry.com
- Life Equity LLC: www.lifeequity.com
- GWG Life Settlements: www.gwglife.com
- Magna Life Settlements: www.magnalifesettlements.com
Notably, while advisors and their clients might engage with a life settlements provider directly to facilitate the sale of a policy (and thereby save money by eliminating the brokerage fees), the provider will function solely to purchase the policy themselves (or not), and would not obtain competing quotes from other potential buyers/investors (as that is the job of the life settlement broker).
Concerns About Life Insurance Settlements
There are a number of concerns regarding the life settlement business, and over the past several years the life settlement industry has received negative press for a variety of reasons.
The first major concern about life settlements is the size of the commission the brokers take. In the industry’s earlier days, there were many unethical brokers who used an opaque market to take advantage of desperate consumers. These individuals charged unreasonable commissions to sell their policy – as high as 50% of the settlement amount – and did not properly disclose this fact to the consumer. As a result, the life settlement industry’s reputation was tainted. Since then, lawmakers have passed more regulation to protect consumers from such acts – including placing a cap on the commission rate at 30% of the life settlement value (though some brokers already accept commissions as low as 15%) and requiring upfront disclosure. Make sure to shop around and ask for their rates – any legitimate life settlement intermediary broker will provide this to you in advance of an engagement.
The final main concern is that the transaction inherently feels uncomfortable because a third party stands to gain financially when the insured passes away. This is entirely understandable. That said, policies are generally bundled together along with hundreds of other policies and are sold as a package – or sometimes even fractions of packages – to large institutional funds. The investor is diversified against the risk of any single policy’s financial impact, which in turn also means the investor has very little to gain from the death of any particular insured individual. Furthermore, there has never been a reported instance of foul play or harm in a life settlement case (although it is still advisable to work with professionals and sell to a diversified institutional investor, and not an individual investor, to minimize the concern). Finally, it’s worth noting that the economics of a life settlement are really quite similar to that of an annuity (where the company on the other side of the transaction “profits” when the annuitant dies sooner rather than later), where again there are no institutions that issue annuities acting to hasten the demise of an insured.
Thus, while there are a number of valid concerns, in practice the evolution of professional life settlements companies have helped to mitigate or minimize most of the issues. In fact, arguably the real downside of a life settlement to a consumer is simply that the intended beneficiaries of the policy will no longer receive the policy benefits upon the passing of the insured. This leads us to whom a life settlement is right for.
Who Qualifies for Life Settlement?
Candidacy for a life settlement depends on several factors. The most important aspects are age, policy size and policy type. Qualification is based on a buyer’s willingness to pay for the policy and how much economic value is in the policy.
Ideal candidates for life settlements are seniors, age 65 and older. Age is an important factor because the insured’s life expectancy is the most important variable in calculating a life settlement offer. In general, the shorter someone’s life expectancy, the more valuable the life settlement offer will be. Thus, older individuals who naturally have shorter life expectancies tend to have more valuable policies of greater interest to investors; similarly, individuals who are younger than 65 but have a serious illness (and therefore reduced life expectancy) may also have policies that qualify for sale.
The policy that is being sold generally must have a death benefit of at least $100,000. This is because buyers have a fixed due diligence cost structure for each policy, and usually don’t want to purchase smaller policies where they cannot generate a sufficient investor profit after their own expenses. As the industry continues to mature, we expect buyers to become more amenable to purchasing smaller policies.
Policies must also have been owned by the insured for a minimum number of years. The exact required number of years varies on a state by state basis. For instance in California, it is two years. This is to prevent individuals from taking out a policy for the sole reason of selling it. Exceptions can be made to this minimum ownership period rule if there has been a material change in the insured’s life, such as divorce, retirement, death of a spouse, etc. Again these exceptions vary on a state by state basis.
Finally, the policy must be a whole life, universal life, or a term life policy that is convertible into one of those types of permanent policies. Standard term policies and premium financed policies generally do not qualify for life settlements, because of the additional risk to the investor. Group life insurance policies can also qualify, if they are permanent or convertible term policies (and are actually transferable in the first place).
When Would You Consider Selling Your Life Insurance Policy?
Most of the situations where a policyowner would consider selling a life insurance policy will fall into one of the three following categories: (1) the insured can no longer afford the cost of life insurance. (2) the insured needs additional liquidity for some other expense. (3) the insured no longer needs the coverage of life insurance.
- Unaffordable Premiums. Premiums can become unaffordable for two reasons. Either the financial situation of the insured changes and they cannot afford premiums they expected to pay. Or, the premium cost escalated as the insured aged – a common feature of universal life insurance policies.
- Needs Liquidity. A common expense is a large and/or ongoing medical cost. Another example is if the insured’s retirement account is underfunded or if the insured wants to help pay for a grandchild’s college education. The insured may also decide that they want to purchase a vacation house or upgrade their retirement living standard.
- Unneeded Coverage. If the policy beneficiary is the insured’s children, the children may now have become financially independent and no longer need the safety net. If the policy beneficiary was the insured’s spouse, that insured may have passed before the insured, rendering the policy’s purpose of coverage unnecessary. Notably, though, if the policy death benefit is unneeded but is otherwise affordable to maintain, the policyowner might consider keeping it for the same reason the investor would want to buy it: the policy still has material economic value to keep paying the premiums and hold until death.
What Affects the Terms Of The Life Settlement Contract Offer
The average policy sale in the life settlement industry results in a cash settlement of 20%-25% of the policy death benefit. For example, if you had a $1,000,000 policy and you were a candidate for policy sale, you would receive on average $200,000-$250,000. That said, each offer received is completely case specific. Later we will provide a specific example of how a life settlement offer estimate can be calculated. In general, the following factors will determine your offer:
The larger the policy benefit, the more valuable the life insurance settlement will be. In general, the minimum policy size eligible for a life settlement is $100,000. As the life settlement industry continues to develop, smaller policies may become eligible to sell.
Age & Life Expectancy
The older the insured is, the more valuable the life insurance settlement will be. Similarly, the lower the life expectancy (i.e., the worse the health of the insured), the more valuable the settlement will be. The reason for this is because the buyer will be able to realize the death benefit sooner and will be required to pay out fewer premium payments.
The lower the annual premium cost, the more valuable the life insurance settlement will be. This is because the cost to maintain the policy and keep it in-force is lower for the investor.
Market Rate of Return/Discount Rate
The rate at which the investor can raise capital affects their targeted investment returns, which affects what they can pay for policies. In the current low interest rate environment, investors will be willing to pay more than normal for a policy because they can tolerate lower returns. Or viewed differently, investors make larger offers when there is a lower discount rate to estimate the present value of a future anticipated death benefit.
A policy’s cash value can potentially be used (depending on the type of policy) to pay the ongoing premium expenses. Therefore, a high cash value generally equates to a higher life insurance settlement offer. However, this is not a linear relationship and high cash value has diminishing effect on increasing the settlement offer. This is due to the fact that the yield on the cash will likely be lower than the expected return and discount rate of the investor, which results in an indirect drag on the relative value of a large cash value. A more detailed explanation is provided below.
Sample Life Settlement Calculation
The calculation of the value of a life settlement transaction is essentially a discounted cash flow analysis. Let’s consider an example of an individual who has a life expectancy of 10 years. The individual owns a whole life insurance policy with an annual premium of $4,000 and a death benefit is $100,000. Let’s also assume that the discount rate used is 8%. We can create a discounted cash flow analysis to establish the value of the policy.
This shows that the expected value is $19,479. In this example, the present value of the death benefit exceeded the present value of the premium payments – i.e., the sum total of each year’s discounted cash inflows/outflows is positive – and so the policy is sellable. This is not always the case. For instance, let’s change the example such that the individual has a life expectancy of 15 years.
A greater life expectancy adds additional premium payments, and also reduces the NPV of the death benefit (because it’s discounted over a larger number of years waiting for the payout to occur). In this case, the policy would not be sellable because the present value of premium payments exceeds the present value of the death benefit.
(These life settlement calculations were simply created using standard Excel spreadsheet formulas. You can click here to download the life settlement calculator spreadsheet used for these examples.)
Estimating Life Expectancy For A Life Insurance Settlement
It’s clear by the previous example how big of a difference life expectancy can make. Just an additional 5 years turned what was a highly positive transaction into a negative one. Therefore, it’s worth discussing how life expectancy is determined.
The primary factors of life expectancy are age and health. Life settlement buyers often utilize a life expectancy underwriter to provide this estimate. The two most common underwriters are AVS Underwriting and 21st Services. Using various mortality tables and the insured’s medical records, these underwriters will produce a life expectancy for investors. Although their proprietary life expectancy models are not available for public use, advisors can explore life expectancy questions with their own clients, and there are a few online tools available to estimate life expectancy:
Cash Value and Life Insurance Settlements
You may have noticed by the examples above that we implicitly assumed zero cash value. So you may be wondering how a policy’s cash value affects the life settlement offer. For most policies, cash value can be used to pay premiums, which reduces the premium/cash flow obligations of the investor, and enhances the economic value of the policy for the buyer and seller. For instance, the analysis below shows an updated estimate of the economic value of the policy, where $4,500 of cash value is available to cover all of the first year premium and part of the second year’s as well.
Notably, the earlier policy with a $4,000/year premium and no cash value was worth $19,479, but this policy with a $4,500 cash value is worth $23,611, an increase of "only" $4,132. In other words, when the policy has any material cash value, the policyowner actually ends out getting less than 100 cents on the dollar for that cash value! The reason a policy with a large cash value may actually be less appealing to investors is because the investors do not want to “buy cash” – especially if it is illiquid cash that can’t be used for many years. It means the investor must "buy" the cash and sit on its low return, which decreases the prospective value of the policy for the investor. In addition, high cash value presents investors with other risks as well, such as interest rate risk given their costs of capital. As a result, investors are likely to discount the cash value more aggressively (i.e., to make a relatively less generous offer if it must include buying out existing cash value on top of the policy death benefit) than a policy with little or no cash value.
Furthermore, remember that the cash value also represents a “hurdle” threshold for the life settlement provider to reach. If your client can get more money by just outright surrendering the policy, then there is no reason to go through a life settlement. Thus, again, policies with less cash value – and a policyowner who doesn’t want to make ongoing premium payments – tend to be the better candidates for creating value in a life settlement transaction.
In some rare cases where a policy has a high cash value, the policy owner could take out a withdrawal of the cash value (particularly with a universal life policy) before undergoing a life settlement. This will decrease the death benefit, but potentially make the policy sellable. However, this is a complex transaction and you should engage with a life settlement broker to help you analyze this option.
And of course, remember that surrendering and selling your policy and are taxable events (and taking significant withdrawals can be as well) and that you should compare the after-tax implications of both options when evaluating a decision.
Taxation of Life Settlements
(Michael's Note: Since original publication, this section has been updated for the Tax Cuts and Jobs Act of 2017, which overrode the previous guidance on the taxation of life settlements under IRS Revenue Ruling 2009-13.)
The sale of a life insurance policy is a taxable event and the characterization of gains is determined under the guidelines set out in IRS Revenue Ruling 2009-13 by the Tax Cuts and Jobs Act (TCJA) of 2017. We provide a general explanation of the process here, but sellers of life insurance policies should seek advice from their tax advisor based on their own particular circumstances.
Let’s examine the IRS ruling’s look at an example under the current tax law as a way to illustrate how life settlements are taxed. Here is a summary of the facts:
- Cash surrender value of $78,000
- Total premiums paid of $64,000
- Cost of insurance of $10,000 (no longer applicable to the calculation since TCJA)
- The policy has been owned for 8 years, has had no withdrawals, and has had no loans
- The individual is not terminally or chronically ill
- The policy is sold for $80,000 in a life settlement transaction
Prior to TCJA, the cost basis as determined in IRS Ruling 2009-13 would have been the premiums paid reduced by the insurance company's record of the internal cost-of-insurance charges ($64,000 - $10,000 = $54,000 in this example). However, TCJA repealed this interpretation, and instead the cost basis is simply the total premiums paid ($64,000).
In the example, the IRS states that the amount of the proceeds that exceed the cost basis is taxable. In this case, the cost basis is premiums paid, reduced by ongoing internal cost-of-insurance charges that were paid internally from the policy’s cash value along the way.
Thus, in this example:
Life Settlement Proceeds: $80,000
(Minus) Paid Premiums less Cost of Insurance: $64,000 $54,000 ($64,000 - $10,000)
Gains (taxable income): $16,000
Of the taxable income, the portion that is the policy’s internal “profit” (the excess of the available cash surrender value over premiums paid) is taxed as ordinary income. The remaining gain – the excess of the life settlement value over the cash surrender value, plus the addition gain triggered by subtracting out internal cost-of-insurance charges – is treated as a gain on property interest and is taxed at capital gains rates.
In this example, the internal “profit” is $78,000 (cash surrender value) - $64,000 (premiums paid) = $14,000. Therefore $14,000 is taxed as ordinary income (the same that would have been ordinary income had the policy simply been surrendered for its cash surrender value), and the other $2,000 $12,000 (including $10,000 of prior cost-of-insurance charges and $2,000 of ‘excess’ value over the cash surrender value) is taxed as long term capital gains.
To determine whether it would be better from an economic standpoint for the policy owner to sell or surrender the life insurance policy, the net proceeds that remain from a life settlement after taxes must be compared to the after-tax proceeds an individual would obtain from surrendering the policy.
Again, this example only covers the basics of how taxation for life settlements work. You or your client should contact a tax advisor for advice when evaluating a life settlement.
What Role Does a Financial Advisor Play In A Life Insurance Settlement
The financial advisor is critical to many parts of the life insurance settlement process - all of which revolve around the advisor looking out for the best interest of their client. The first step is to evaluate whether or not a life settlement is appropriate for the individual. The advisor should also take into account alternatives for the client. For instance, if the client needs money for a large expense, the advisor might evaluate the pros/cons of taking out a personal loan or simply outright surrendering the policy. Alternatively, if it is determined that the policy has real economic value to keep, the advisor and client should consider whether it makes more sense to simply keep the policy to benefit directly from the long-term value of the death benefit, rather than sell as a life settlement (since by definition, if it’s valuable to a buyer to purchase, it’s valuable to the seller to keep it!).
If the advisor judges that a life settlement is the right approach, particularly when the client cannot afford/manage the ongoing cash flow obligations or otherwise needs the policy value liquidated today, the advisor should help identify a life settlement brokerage partner to guide the client through the transaction. The advisor must use their best judgement in evaluating all of the previous-mentioned qualities and variables of a life settlement brokerage. The key is to find a partner that you feel you can trust.
Once a brokerage partner has been identified, the financial advisor wants to make sure that the client understands everything that is happening. The fact is that life settlements can be somewhat complex. There are many documents to sign, and the industry has yet to become standardized to the level you might see when applying for a mortgage or some other large financial transaction.
Make sure your client understands the privacy implications of releasing medical records and insurance information to the life settlement broker. Make sure they understand the financial impact and tax implications. Help the client evaluate the offers they receive on the policy. Compare that to the potential value they could realize if they just surrendered the policy or took a loan out on the policy (both affected by the cash value of the policy).
If the policy beneficiaries still need coverage, help the client think through if the upfront cash payment is really worth losing the coverage. Throughout this process, the financial advisor can help be a channel of information from the broker and the provider but also a source of comfort and familiarity.
After the transaction, the financial advisor should help ensure that the funds from the sale are used appropriately. For instance, one of the more exciting opportunities is that freed up cash can be reinvested into other assets. This is especially important because clients are generally not used to having a large lump sum of money become suddenly available. Finally, the financial advisor should work with the client’s tax advisor to ensure that the proper taxes are paid for the transaction.
Life Settlement Contract Process Snapshot
Here is a final, high level summary of the steps in the life settlement transaction:
- Decision— the financial advisor works with the client to evaluate the appropriateness of a life insurance settlement and considers all the alternatives. If the client agrees and wants to proceed, the advisor helps the client identify a trusted life settlement broker. Upon retaining a broker, the broker will evaluate the case and also make suggestions on whether to proceed with the transaction.
- Information gathering—the life settlement broker obtains information about the life insurance policy and the state of the insured’s health. The medical records of the insured are gathered. Then, the broker engages an independent life expectancy underwriter to estimate the life expectancy of insured.
- Application—an application for the sale of the life insurance policy is completed and sent to various life settlement companies to solicit offers for the policy.
- Review, Analysis and Offer—once they have all the data, the life settlement providers calculate the value of the life insurance policy and decide whether to make an offer to buy to the life insurance policy from the policy owner. If the life settlement provider’s analysis of the policy indicates that an offer should be made to buy it, the provider makes a formal life settlement contract offer.
- Receipt and Evaluation of Offers—the broker will present all received offers to the client and the advisor with an objective explanation of each offer and make sure that everyone understands them. The advisor and the client will usually have 30 days to consider the offers,and if the client accepts an offer, the life settlement broker communicates the offer’s acceptance to the appropriate life settlement provider.
- Completion and return of closing package—the provider sends a life settlement contract “closing” package, containing the documents necessary to formalize the policy owner’s acceptance of the life settlement exchange offer and to request that the life insurance issuer transfer ownership of the policy to the life settlement provider. The life settlement broker makes sure the financial advisor and the client understand the forms before the client signs and returns them to the life settlement provider.
- Submission of the transfer-of-ownership forms and escrow of funds—when the life insurance provider receives the completed life settlement contract documents in the closing package, it makes a formal request to the life insurance company for the transfer of the policy’s ownership. At the same time, the funds to be paid for the life insurance policy are given to an escrow agent for safekeeping pending the actual transfer of the policy’s ownership to the life settlement provider.
- Acknowledgement of the transfer-of-ownership and release of the escrowed funds— when the transfer of the policy’s ownership is completed and recorded by the insurance company, the insurer sends confirmation to the client and the life settlement provider (the new policy owner). The confirmation is forwarded to the escrow agent, who then releases the funds in payment for the life insurance policy.
The bottom line is that for clients who otherwise plan to surrender their life insurance anyway, either because they simply don’t want it, don’t need it, or if they cannot afford to keep it, life insurance settlements can be an appealing financial alternative to consider to maximize the value when walking away from the policy.
Please note that this guide is NOT intended as financial, legal, investment, accounting or tax advice, and is for informational purposes only.