Life Settlements Guide

Life Insurance Settlements Defined

Life insurance settlement is the term used to describe the sale of a life insurance policy covering the life of one or more individuals with an “ascertainable and limited” life expectancy. The policy owner is paid a lump sum in cash in exchange for transferring the rights of ownership of the policy to the buyer. The amount paid to the seller is calculated based on the specific life expectancy of the underlying insured and may be stated as a percentage of the policy’s face amount.

There are two basic types of life insurance settlement transactions. One type involves policies covering individuals who have terminal or chronic illnesses or conditions — a “viatical settlement”. The other type of transaction involves policies insuring individuals over the age of 65 whose health may have declined since the policy was purchased, but not to the point that the primary medical conditions involved are described as being life threatening or which prevent the insured from performing primary activities of daily living (ADL). This second type is known as a “life settlement”. Other terms used to describe life insurance settlements are senior settlements, viatical life settlements and life insurance settlements. For purposes of this document, the generic term “life settlement” is used to describe both types of transactions described above.

The Life Settlement Marketplace

According to life insurance industry statistics, approximately $ 1.5 Trillion of life insurance lapses or is surrendered annually in the US. The most comprehensive and widely known study of the life settlement marketplace, released by Conning & Company in 1999, indicated that of the more than $ 490 Billion of life insurance in force and insuring the lives of Americans over the age of 65, nearly $ 160 Billion of this insurance may qualify for settlement in the next several years. While exact figures as to the total face value of settlements purchased in the past decade are hard to come by, industry estimates indicate the total volume of policies purchased over the coming decade will grow 5 to 8 fold. (This study has since been updated several times. For more information see www.conning.com) What this means is that the potential for success as a provider of life insurance settlement services has never been greater.

The marketplace in which life insurance settlements occur is driven, in large part, by the same forces driving all financial services businesses, namely demographics. In general, the aging of the US population and the gradual shift from asset accumulation to asset management and eventually asset consumption has resulted in an increasing interest in alternatives to more traditional planning processes. This in turn has sparked a growing interest in life insurance settlements as a means of extracting additional value from an asset normally thought of as being “dormant”.

The typical settlement transaction involves a policy bearing a face value of $1.5 to 2 Million. The typical insured is aged 74 years or more, and is considered to be a “wealthy” or “high net worth” individual. These characteristics indicate that policy owners who offer their policies for sale in the secondary market are doing so within the context of a more comprehensive financial planning process. Therefore, it makes sense to consider the life insurance settlement process as both a means to uncovering other client needs and as an end in itself. In short, as policy owners’ financial circumstances change, opportunities to identify and present the settlement option as a viable planning concept will continue to arise. Advisors who offer this service in a professional manner, with the backing and support of an experienced, reputable and well-financed settlement firm will be well positioned to capitalize on this significant potential.

The Basis for Selling a Life Insurance Policy

Prior to the creation of the life settlement transaction, policy owners whose financial circumstances had changed found that policies purchased in the past neither met their current needs nor were they easily altered to achieve current objectives. Therefore, agents, accountants, planners and other advisors were often limited in their ability to offer their clients alternative strategies to using previously purchased coverage to address new financial goals. The default recommendation in most of these cases was to either lapse or surrender the policy. A lack of options also restricted the policy owner to dealing only with the issuing insurance company with regard to the disposition of the policy. This situation describes what is known as a monopsony, in that only one buyer, the insurance company, was available to offer the seller, the policy owner, any value for their policy. Since life insurance is a form of private property, life settlement companies serve as a free market alternative to this condition and thereby offer policy owners an alternative outlet for the sale of their private property. Rather than simply allowing a policy to expire worthless or surrendering it to the issuing company, life settlement firms are able to assist consumers in their effort to maximize the value of an otherwise dormant asset. It is also important to note that in the current market environment, policy sellers make the decision to sell based not on a need for the money paid to them, as was the case in the early “viatical” market. Rather, the typical seller today has concluded that they no longer want or need the coverage the policy provides and they prefer to apply the proceeds of the sale and the premiums they will no longer have to pay to other financial objectives.

The uses for the proceeds of a settlement transaction are as varied as the changing needs and wants of consumers. However, the conditions under which a settlement opportunity is most likely to make sense are fairly easy to identify. The following is a partial listing of the situations in which policy owners may find that the settlement option represents a meaningful alternative to lapse or surrender:

The policy owner has decided they no longer need the coverage and they inform their advisor of their intention to surrender or lapse the policy.
The policy was purchased by a business to fund a buy-sell arrangement should one of the partners or shareholders die prematurely. A change in ownership might make the current policy obsolete.
The business is being sold and the need for coverage protecting the previous owner(s) is no longer relevant.
A key employee in the business leaves the firm and coverage purchased to insure that person is no longer needed.
The business fails and a resulting bankruptcy requires that assets be liquidated. Life insurance covering owners or key employee may have value in such a liquidation.
Premiums for a particular policy have become burdensome and the policy owner would prefer to redirect the cash flow to address other financial concerns.
An examination of the policy owner’s financial affairs indicates that a survivorship policy is preferable to individually-owned coverage. It may be possible to sell the individually-owned policy and use the proceeds to pay all or a portion of the premiums for the new survivorship policy.
The insured person has outlived their beneficiaries such that there is no longer a need for the policy.
The beneficiary may no longer need the financial protection provided by the policy.
The policy owner intends to make a gift of life insurance to a nonprofit organization. However, the nonprofit would prefer to receive cash. The policy owner can maximize the value of the gift and provide cash to the charity through the settlement process.
Policies which were sold under the assumption that after a limited number of premium payments the policy would “self-fund” have proven not to be supportable and new premiums are due to keep the coverage in force. As a result, the policy owner decides the coverage is no longer desirable.
Changes in tax law have made a previously implemented estate plan less effective and thus life insurance purchased as part of the old plan’s structure no longer makes sense.
Policies which can be included in an estate tax calculation must be removed from the owner’s estate immediately. Such policies can be sold and the proceeds transferred outside the estate by making gifts to trusts, charitable organizations or individuals.
Changes in the policy owner’s net worth result in the elimination of the need to pay sizable estate taxes. Thus, the policies purchased to provide excess cash are no longer necessary.
The grantor of an irrevocable life insurance trust decides not to continue making the annual gifts necessary for the trust to continue premium payments. The policy owned by the trust may be sold and the proceeds used for other purposes.
The policy owner needs cash for some other purpose and sells a policy to meet the objective.
A nonprofit organization owns a policy insuring the life of a board member, key donor, or other benefactor but the donor no longer wants to contribute funds to pay premiums. Rather than lose the value of the policy entirely, the charity may sell the policy and use the cash proceeds for other purposes.

It is important to note the underlying theme in all of these examples: change. When the policy owner’s circumstances change, the settlement option may come into play. Of course, there must also have been a meaningful decline in the health of the underlying insured and other underwriting considerations must be addressed. However, it is change — changes in needs, changes in objectives, changes in cash flow, changes in estate plans, changes in health, and changes in life — that cause previously purchased life insurance policies to be lapsed, surrendered, exchanged or sold. By staying in touch with and constantly reminding policy owners about the settlement option, intermediaries will be better positioned to identify, contact, present and close settlement cases for the benefit of the clients they serve.

Benefits to the Settlement Professional

Like any innovative idea, life settlements represent a unique value to the true financial professional. The ability to confidently provide a service that results in policy owners receiving a lump sum of cash in exchange for an asset they might otherwise have discarded or ignored can be extremely powerful. In addition, it is common for the qualified professional to develop a significant stream of referrals from other advisors in their marketplace as they become known as the source for competent, effective advice in their area. Offering settlement services can go a long way in positioning the settlement associate as an expert who can be trusted to act in a quick, confidential and highly ethical fashion to uncover the hidden value of the client’s dormant life insurance assets.

In addition to these qualitative benefits which enhance the marketplace’s perception of intermediaries as expert professionals authorized by a leading settlement company, the financial benefits of offering settlements can be both numerous and substantial. Settlement transactions produce their own commission revenue stream and, by their very nature, settlement transactions unlock other opportunities as well. Here are just a few ways in which settlements can add revenue to an advisory practice:

Intermediaries who originate settlements are paid very generous commissions.
Advisors earn commissions generated by the use of settlement proceeds to purchase new financial products and services products.
“Trail” commissions for new liquid assets placed under management are paid from the sale of investment products purchased with settlement proceeds.
Residual or renewal commissions continue to be paid on settled policies as these policies remain in force for as long as the insured lives.
Persistency bonuses may be paid, as settled policies do not lapse.
Many settlement transactions involve the placement of other types of insurance which generate commission revenue.

Settlement cases often develop as a result of a more involved planning process. Qualified settlement professionals are often well positioned to serve as advisors in assisting the client in managing other financial decisions and the assets they involve.

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