Volume 2, Issue 7
The Wealth Advisor
Life Settlements: Understanding the Opportunity for Your Clients
This month’s issue of The Wealth Advisor addresses a topic that many professionals do not understand fully, life settlements. For the right clients, a life settlement offers a significant advantage over the alternatives – and one that the client and the planning team should at least consider.
Life Settlements – The Basics
A life settlement is a product for seniors (generally over the age of 70) who are seeking an economically sensible exit strategy from unwanted life insurance policies. A life settlement transaction involves the sale of an existing life insurance policy, typically valued at $250,000 or more, to an institutional investor (known as a “provider”) in exchange for a lump-sum payment greater than the cash surrender value, but less than the death benefit. The institutional buyer becomes the new owner of the policy, assumes responsibility for premium payments, and collects the death benefit upon the insured’s death.
Planning Tip: Where the owner/insured no longer needs or desires a life insurance policy, a life settlement can generate significantly more income than a policy surrender. As long as the life settlement payment does not exceed “basis” or the premiums paid for the policy, the payment will not be subject to income tax.
Based on industry statistics, the average life settlement candidate is a 78 year-old male who owns a universal life insurance policy valued at $1.8 million, and the average lump sum payment typically ranges from 3 to 5 times the cash surrender value. In addition to universal life insurance policies, most other types of life insurance policies may qualify for a life settlement, including variable universal life (VUL); term policies (if convertible); whole life; survivorship; and group policies (if portable and convertible).
Planning Tip: Life settlement offers from providers can vary widely. To obtain the highest possible value for a client’s life insurance policy, advisors should seek the services of an experienced settlement broker who can shop the market and obtain multiple offers from providers authorized to do business in the state in which the policy ownership resides. A listing of settlement brokers operating in the secondary market is available online at: www.lisaassociation.org.
Life Settlements for VUL Policies Are Securities Transactions
Those elements of Notice 06-38 directly impacting the handling of VUL life settlement transactions concern:
Some broker-dealers have taken the position that although they will not proactively promote or advertise the product, they are putting procedures in place to make the option available to their registered reps in situations where a life settlement may be the most suitable solution for the client.
Planning Tip: Following the issuance of NASD Notice 06-38, many independent broker-dealers began screening life settlement brokers and establishing preferred vendor relationships to service this business from their registered reps. Financial advisors should check with the broker-dealer home office regarding the procedures for transacting a VUL life settlement and any preferred vendor relationships.
Life Settlements for Trust-Owned Life Insurance
This statistic is important because life settlement industry statistics indicate that approximately 40 percent of life insurance policies sold in the secondary market involve trust-owned life insurance policies. For financial and legal professionals acting as trustees or fiduciaries for trust-owned life insurance policies, or for any professional whose clients have trust-owned life insurance, conducting periodic reviews of policy performance is highly recommended.
For example, policies purchased with the expectation that policy values or dividends would be available to pay future premiums may now require additional premium payments to maintain coverage. In some cases, the trust makers may choose a life settlement for the underperforming policy and then use the proceeds from the life settlement toward replacement coverage with a better-performing product.
Planning Tip: All wealth planning professionals whose clients have trust-owned life insurance should consider engaging an insurance professional with expertise in conducting regular policy reviews. Life insurance policies are complex financial instruments, and once a trustee discovers that a trust-owned life insurance policy is at risk, they will want to discuss all possible options with the insurance professional and the insured.
Common Uses for Life Settlements
Planning Tip: Life settlements are often preferable to the client accepting a low cash surrender value or surrendering the policy.
Consider working with an experienced insurance professional to conduct periodic reviews of your clients’ life insurance policies, and if suitable, recommend a life settlement.
Sellers Johnson Law • 1 Research Court, Suite 450 • Rockville, Maryland 20850 • (240) 988-5530