Utilizing the ‘highly negotiable asset’ of life insurance
by Kelli Conroy
Kelli A. Conroy is a Brokerage Manager at First American Insurance Underwriters, Inc., Needham, Mass. She can be reached at 800-444-8715 or kconroy@faiu.com.Almost overnight, life settlements have moved from the periphery of the life insurance business to center stage. To make the point, you will find nearly 22 million entries if you Google those two words.
Countless consumers have quickly come to recognize that their life insurance policies can be highly negotiable assets and life settlements can be the key to unlocking their value. At the same time, producers have become far more comfortable with the life settlement process and now view it as an opportunity to broaden their practice. Here is one example:
A 72-year old male owned a $2 million UL policy with $247,000 cash surrender value. At this point, his financial objectives were changing and he was now interested in purchasing real estate assets.
As a result, he decided to reduce the amount of life insurance and purchased a new policy with a $500,000 death benefit, recognizing that he would also need a survivorship policy as his estate grew taking into account that his heirs would have liquidity issues due to the amount of real estate in his portfolio.
Instead of surrendering his $2 million policy or doing a 1035 exchange into a new policy, he decided to see what the settlement market had to offer. Even with the recent changes in life expectancy tables and lenders being more conservative with our current economic situation, he received a total offer of $430,000, which netted him $407,000.
The client was pleased with the offer and the producer, who recognized the benefit of a life settlement solution, is enjoying multiple sales: a new $500,000 UL policy with an $11,000 commission, a settlement fee of $18,000, and the possibility of a survivorship policy sale in the future.
The most common question producers ask is how to recognize when a life settlement is appropriate. Here are six situations that will serve as a guide.
An alternative to policy surrender
There are circumstances when the policyholder no longer needs the coverage. Changes in people’s lives can easily alter, reduce or eliminate their need for existing insurance.
A life settlement makes it possible to maximize the value of the existing insurance by selling it in the settlement market.
It’s worth noting that quite often, if the policy has cash value, the market value can be higher than surrendering the policy for only its cash surrender value.
A divorce is a case in point. When there’s no longer a need to protect a spouse’s income or there’s no appropriate alternate beneficiary, a life settlement is a beneficial alternative to allowing a policy to lapse.
Here is an example:
Because of a divorce, the client, a 64-year old male with a $1.5 million 15-year term life policy, no longer needed the full death benefit. Working with his advisor, he decided to convert just enough of the policy, $400,000 of the death benefit, so he could continue paying the same premium.
The remaining $1.1 million term conversion was put up for sale. The total offer was $213,000 with $154,000 going to the client and the remainder split between the agent and the settlement broker. The agent made three sales: a $400,000 term conversion with a $9,000 commission, a $1.1 million term conversion with a $28,000 commission and a settlement fee of $40,000. In addition, the producer created a renewal income stream for himself.
Should the insured outlive the beneficiaries, putting the policy up for sale in the settlement market may be a way to recoup the premiums paid and perhaps more. There are also situations where the owner of a policy can no longer afford to pay the premiums. What was once a sound and essential asset can often turn into an unneeded expense or even a burdensome liability.
Producers should be alert to other liquidity needs, such as situations where there may be a long-term illness, interest in funding a grandchild’s education or dealing with a bankruptcy.
There can also be the need to ease the burden of living in difficult economic times. The proceeds of the sale of a life policy can be used to fund an annuity that will produce an income stream, and may still have some accumulation value left for their heirs upon death.
Life settlement as a 1035 alternative
A client may need to purchase a new policy with a larger death benefit or may currently have a policy that is under performing. In such situations, it is worthwhile comparing the market value of the policy with the cash surrender, 1035 value, which would be available to help reduce future premiums or purchase an additional death benefit. This can result in multiple sales for a producer, including the sale of the current policy, and, perhaps, funding an annuity to then pay the premiums for a new life policy. Also, the agent of record would continue to receive renewals on the policy sold.
Conversion period on a term policy expiring
Within two years of a term conversion expiration date, a producer should engage the policy owner in a discussion of available options. Converting and selling the policy may be an appropriate scenario that could result in multiple sales, including the sale of the current policy, converting the current term policy, and, perhaps funding an annuity that could pay the premiums for a new life or long term care policy.
Estate Planning
Many times, there is a need for either more life insurance or for a more appropriate type of coverage, particularly as a client accumulates wealth. Selling an existing policy to help fund the right type and amount of insurance is a solution that can help clients reach their financial goals.
There are a number of possibilities, such as helping to finance the purchase of an insurance product that better suits a client’s current circumstances, i.e., long term care insurance, annuities and survivorship policies.
A change in a family situation is another opportunity, particularly as children leave the nest, adults retire or the mortgage is paid off. A survivorship policy may be the solution for minimizing estate taxes so the accumulated wealth can be left to heirs intact. There are times when life insurance is no longer necessary, but protecting assets through the purchase of long term care insurance can be a priority. The proceeds from the sale of a policy can help fund this type of product, either directly or through an immediate annuity that will pay the premium.
In a number of instances, a family’s estate has been diminished by the downturn in the stock market, which may affect the amount of life insurance needed for estate tax planning purposes.
As estate tax laws continue to be a moving target, many clients need to make adjustments to their life insurance portfolios. Purchasing additional death benefit with the use of proceeds from the sale of an existing policy or simply just settling an existing policy can help protect, expand and support a client’s financial fitness.
Sale of a business and a key person termination
As an alternative from allowing life policies to lapse or cash surrendering, life settlement may be a beneficial option.
There are situations in many businesses where the liquidation of corporate owned life insurance is appropriate such as policies on key employees who have retired or who are no longer employed by the company. Life settlement can be a way to recoup premium payments and perhaps additional monies.
This can also apply when a company can no longer afford the premiums for life policies for employees involved in buy-sell agreements or for those who have left the company.
Times change and life policies may be valuable company assets, particularly in difficult economic circumstances.
Life settlement to meet extended care needs
It is not unusual today when policyholders require additional liquidity for current living expenses more than they need the death benefit for the family.
For example, the sale of a life insurance policy could provide cash for uncovered medical expenses or in-home care for a client who has been diagnosed with a life threatening illness.
In addition, there are policyholders who may qualify for an impaired risk annuity that could help increase their cash flow from the settlement.
Just because life settlement has become popular as a way to leverage financial assets, it is not the solution for every situation. If the reason for purchasing a life insurance policy in the first place was to provide liquidity upon the insured’s death and that has not changed, then it is only appropriate that the policy remain in force.
That said, life settlements offer options for those with changing situations and needs that may not otherwise have been available. This is why it is critical that producers arrange annual policy reviews with clients to identify life situation changes that may impact an insurance program. Since the average client does not know that a life policy can be sold, this is an opportunity to explore the need for a life settlement. Both client and producer can benefit.
