Leveraging policies for cash to offset planning shortfalls
by Wm. Scott PageMr. Page is CEO of LifeGuide Partners, LLC and policyappraisal.com, providing education and perspective to seniors, their loved ones, and advisors, as they consider retirement options and research untapped financial strategies. Visit www.policyappraisal.com.
In late 2021, the term “inflation” started creeping into the national consciousness. By the spring of 2022, consumers throughout the United States saw prices rise for many everyday household expenditures. Soon, interest rates were increased to counter-balance inflation, and by the end of the year, consumers, particularly seniors, were seeing extremely dark economic clouds on the horizon.
The life settlement market has been in a sharp state of inflation reaction for most of the year, and rising interest rates have also changed perspectives. Here are some of the issues that have impacted the life settlement industry in 2022 and a look ahead to the coming year.
Life Settlements Counter Inflation
Premium payments may become onerous as costs rise, particularly for those operating with a fixed-income mentality. Budgets are tightening, and many seniors are not seeing their money go as far as it once did – and they’re looking for some relief. A life settlement may provide the answer. Because inflation has the potential to chew away at retirement nest eggs (in both the short and long term), we are telling clients with whole and universal life policies that now is a great time to perform a policy appraisal as part of an overall assessment of coverage.
For example, a senior client with a $1 million universal life policy may be blowing through $6,000 – $7,000 per month to keep it in force. Given rising costs, they are likely looking at those payments and seeking flexibility. A senior client with a $1 million policy could often expect a cash payout from a life settlement of about $250,000. They would go from paying a hefty premium to having an additional $250,000 to invest. Options abound for the payout and the roughly $80,000 annual premium payment that they will no longer be sent directly to the insurance company.
Use the Proceeds to Pay Expenses or Reallocate
Placing the settlement proceeds under management is an attractive option for all parties. It enables the client to spread some risk and increase upside opportunities, as many seniors are still looking at the broader stock market for growth. Adding in the premium payments or some portion may be the perfect addition to the overall financial plan. It’s easy for an advisor to illustrate how placing money under management may be a better option when compared to a prior need for a death benefit. In addition, placing “future” premium payments into assets under management has other benefits for the client and the advisor. In this scenario, the agent recommends increasing their total assets under management, hardening the overall financial plan, and earning an excellent referral fee from the life settlement transaction.
Purchase an annuity or other product: While it may not make sense for a client to acquire replacement coverage after a life settlement, an annuity might be a great fit. A single premium variable annuity could help them diversify and offer some guaranteed income down the road. The flexibility provided by eliminating the life insurance policy premium payment might be just what a client needs – in the short and long term. In this scenario, the agent not only offers a solid solution for their clients, but they also earn a “double-dip” referral fee for the life settlement transaction and a commission for the annuity product.
Free up cash for the family or themselves: While our instinct as advisors is to put the payout from a life settlement to work, sometimes it might make sense for clients to gift it, place it in a trust, or spend it. For senior clients worried about their children and grandchildren, a settlement payout may be used to fund a trust or simply as a gift to struggling relatives. Also, many seniors stopped traveling and seeing family during the pandemic, so they may want to make up for the lost time by traveling and enjoying their golden years more than they have in the past. Again, while we always recommend good financial moves, we also don’t want to forget why our clients have been following our advice and saving money with us for years – so they can enjoy the fruits of their labor.
Possible Recession Would Disproportionately Impact Seniors
A recession, which many suggest is likely, will disproportionately negatively impact seniors. We recently reviewed the historical implications of the last “Great Recession” in 2007 on seniors and other demographic groups, and found that households headed by adults aged 55-64 experienced a decline in median wealth of about $72,000 during the last recession. We reviewed several studies of that period and found that seniors are at higher risk because much of their wealth is held in stock market holdings and other savings, which they use to generate current and future income. While younger adults have most of their wealth in their homes, seniors depend more on the market.
Seniors had more wealth and, therefore, had more to lose during the last recession. However, the numbers don’t lie because seniors also have less time to catch up. In addition, about 30% of current money managers were not active in the workforce during the last recession. Skepticism exists as to whether or not the current crop of money managers, many under the age of 35, understand the implications of a recession and are adequately preparing their clients for a downturn.
Rising Interest Rates to Impact Offers
The secondary market for life insurance policies typically marches to the beat of its own drum. Offers are computed based on the appraised value of the policy, and external economic factors rarely come into play. However, dramatic interest rate increases are expected to impact policy offers in 2023.
Over the past 20 years, we have only seen one central economic scenario that dramatically changed the life settlement market: the Great Recession. Many providers relied on institutional lines of credit, using borrowed money to purchase policies. Interest rate fluctuations were rarely an issue. During the recession, institutions did not raise rates, instead opting to pull lines of credit completely. And for a short time, the life settlement market collapsed like other parts of the economy.
How much offers will change has yet to be determined, but the high single digits are not out of the question. For more significant policies, this could mean tens of thousands of dollars. We won’t know for sure until things start to shake out at the beginning of the year, but we see a change is coming.
With rising interest rates, borrowing costs go up, and we fully expect that life settlement offers will be a lagging indicator. The good news is that many companies that fund life settlement transactions remain bullish on the market, despite the rising rates.
Life settlements will likely rise in popularity if the economy makes a downturn. Agents and advisors should discuss the option with clients sooner than later. For clients who need to learn about the secondary market for life insurance, a policy appraisal offers an opportunity to educate them and bring forward a previously unknown option.