Understanding Life Settlements
Frequently Asked Questions
A Life Settlement is a way to gain cash without incurring debt or disposing of more valuable assets and can be a practical funding source for retirement and continued care living. Many American seniors—typically those 70 years of age or older—are discovering that the life insurance policies that they bought many years ago no longer meets their needs. Some reasons to sell a life insurance policy are:
- A policyholder may want to reduce or eliminate coverage to lower premium costs
- The policyholder has outlived the beneficiary
- The policyholder has lost a spouse or divorced
- Disposed of a business or retired from an insured executive position
- Change in estate or tax situation
- Children or other heirs may be more mature and financially independent
- There is a need to raise cash to pay for immediate medical and/or living expenses
- Gifting a policy for philanthropy and having a tax deduction for fair market value
I would like a free no obligation evaluation of my life insurance policy.
Answer - A life settlement is a financial transaction in which a policy owner possessing an unwanted or unnecessary life insurance policy sells the policy, to investors (generally financially stable investment institutions) who will pay the policyholder more than 3-5 times the cash surrender value that would be offered by the insurance company.
The proceeds are given to the owner (usually in a lump-sum payment of cash) and used as they wish for retirement, charitable giving, medical costs, vacations, investments, travel, etc….Other benefits include relief from the payment of premiums or a vehicle to replace underfunded or inappropriate plans of insurance.
The purchaser of the policy continues to pay the insurance premiums and becomes the new beneficiary of the policy collecting the death benefit.
Answer – The fundamental benefit of a life settlement is that it provides the policyholder with the most proceeds from a life insurance policy that is no longer needed or wanted. Allowing people to respond more comfortably to their changing needs, the following are opportunities in which a life settlement may prove to be a valuable tool:
Change in insurance needs:
- Premium payments have become unaffordable and - absent a life settlement - would have to allow the policy to lapse
- A cheaper or differenct type of life sinsurance policy is more appropriate
- A Term life policy is nearing the end of its guaranteed level term period. Whereas a policyholder may otherwise allow the current policy to lapse (without receiving any value), their agent could bring value by converting the term policy to a permanent product (if available). The the new insurance policy could qualify for a life settlement .
- A survivorship policy is preferable to a single life policy
Change in life circumstances:
- There is a need to raise cash for immediate medical and living expenses
- Do not want to incur debt
- Do not want to dispose of other asets
A spouse has died:
- The primary beneficiary named in the insurance policy predeceases the insured
- The surviving spouse can no longer afford premiums
Policy owner is divorced:
- The beneficiary was the spouse but is now in different circumstances
- A policy may need to be sold as part of a divorce agreement
Change in beneficiaries:
- Heirs are financially independent and no longer have a need for proceeds
- Beneficiaries are no longer in the life of the policyholder through death or divorce
Change in estate planning needs:
- Changes in estate tax laws have made a previously taxable estate now exempt from estate taxes
- Reductions in the size of the policy owner’s estate have decreased so that the current policy is no longer appropriate
Change in business circumstances:
- A business was disposed
- A previous key executive is now retired making coverage no longer necessary.
- A corporate buy-sell agreement was established and one of the partners has either died, sold their shares or left the company - eliminating the need for the policy
- Opportunities for Charitable, Academic, and other Organizations
Answer - A life settlement can provide significantly more money thana cash surrender value or letting a policy lapse. But there are potential drawbacks that must also be considered.
- Proceeds can be taxed
- Life settlement proceeds may be subject to creditor claims
- The cash proceeds could affect the policyholder's eligibility for social services benefits such as Medicaid, the Supplemental Nutrition Assistance Program (food stamps), or other programs
- The policy remains in force, which could restrict the policyholder's ability to obtain more coverage
- Numerous people have access to personal medical information to estimate length of life
- The sale of the policy could be voided if later shown that the insured was not mentally competent
Almost all the financial benefits afforded by the policy to the policy holder and beneficiaries are eliminated. These can include:
• Forfeiture of the payment of the tax-free death benefit
• Inability to receive accelerated death benefits
• Inability to make policy loans or make withdrawals from the policy’s account value
• Giving up policyholder dividends
Answer - Whle there are a few buyers that will offer a bid on policies as small as $100,000 in death benefits, some investors consider policies f$250,000.00 policies while most prefer policies above $1 million.
- Universal Life policies have predictable interest rates and are overwhelmingly favored by the industry
- Term policies must be convertible into universal life policies otherwise they are not eligible
- Whole Life policies often don't price well, unless the life expectacny is very short (the premium structure is fixed and dividends are les predictable)
Others may qualify…
Answer - There are certain requirements that investors or life settlement providers look for when evaluating a policy for possible purchase. These include:
• Insured is 65 years of age or older if healthy or any age if terminally ill
• Life Insurance policy should have a minimum Face Value of $100,000
• Must be a decline in health status since the policy was issued by the insurer
• Policyholder must have a life expectancy of 2 to 20 years to qualify
• Life insurance policy must be beyond contestability period (The policyholder must have owned the life insurance policy for at least two years).
Answer - Life settlement investments are generally not considered suitable for individual investors. Normally, life insurance policies are purchased by financially stable qualified institutional buyers (also known as funders or purchasers) possessing large amounts of capital. These buyers have experienced case managers and investment analysts who expediently act to ensure that the privacy and confidentiality are maintained from start to finish.
Generally, life settlement providers can purchase a freely portable, unencumbered policy from any type of non-restricted owning entity such as an individual, trust, partnership, corporation, charity, etc. The buyers need to be certain they are buying an asset in which they will be able to collect 100% of the death benefit.
Answer - Policy amounts and investors differ, making it impossible to set a standard amount. One can generally expect to get a significant percentage of the policy’s value — well in excess of the surrender value. However, professional advisors should perform an economic analysis to help determine whether or not a particular life settlement makes good financial sense.
Factors such as type of policy, age and general health of the policy holder are considered when valuing a life insurance policy for settlement consideration. The life settlement value is in today’s dollars, given projected premium costs, life expectancy and death benefit. Policies without loans typically price better than those with large loans.
The actual price the policyholder receives is essentially what an institutional investor is willing to pay – net all taxes, commissions, and other expenses. Policyholders should use a broker that thoroughly investigates the market to find the absolute best net offer.
Answer - The process involves a series of steps and multiple parties monitored by both state and regulatory agencies primarily for consumer protection and industry standardization. While the process can typically take three to six months to close, the policyholder should consider the amount of premiums that will need to be paid during this time.
1. The Consumer recognizes the need (individual, business, estate, charitable) or has been financially advised that obtaining a life settlement is in the best interests of the policy holder providing the minimum requirement are met:
2. A life settlement intermediary, an insurance agent, a financial adviser, or life settlement broker begins the process by obtaining preliminary information from the policy owner/insured to determine if the policy does indeed qualify for initial consideration as a life settlement. Basic information includes:
• Insured’s age, gender, medical condition, tobacco use (no medical exam required)
• Policy type, amount, issue date, premiums as a percentage of face value, policy loans, and Cash Surrender Value
3. If acknowledged as a candidate, the intermediary coordinates actions with the professional advisor, client, and a licensed life settlement broker in obtaining further information such as:
• In-force illustrations
• Medical records
• Life expectancy reports
• Signed application
Law requires that any entities involved in the Life Settlement industry carry the necessary licenses to protect the safety of the insured, the policyowner, and the financial professionals advising the client.
4. Information is received and reviewed by a reputable broker underwriter, who may need more information to be obtained from insurance carriers, medical records, etc. Certain brokers have in-house medical directors whose expertise in identifying pertinent information help to expedite the life insurance valuation.
5. After underwriting is completed, the case and all documentation is presented by the broker (working on behalf of the policy owner) to multiple well capitalized institutional buyers (known as providers) representing third party underwriting sources in the secondary market.
6. If the policy is considered valuable to investors, the Broker will negotiate with prospective buyers for two to three rounds to obtain the highest possible settlement offer for the policy.
7. A non-binding offer is presented to the policy owner for acceptance or refusal. The policyholder whould carefully consider and compare the terms and conoditions of the contract and the quality of the provider and investor firm, along with the bid price. The highest price may not be the best offer. The Policyholder is not obligated to accept any offer and should not have to pay any fees or expenses incurred if choosing not to proceed. If refused, the process ends at this point.
8. If the offer is accepted, the broker may then obrtain other supporting documents to close the deal. Once everything is is order, the policyholder signs and notarizes a package of closing documents. The policy's ownership will be transferred to the buyer and a new beneficiary will receive the death benefits. The buyer places all funds into escrow and contracts, closing documents, and change forms (owner and beneficiary) will be sent to the advisor for completion by the seller.
9. Once all documents are in order, closing takes place (policy holder need not be present) and the escrow agent releases funds to the policy holder. Payment is received after the insurance carrier transfers ownerhip to the buyer, which could take seven to 30 days.
10. Policy holder has a rescission period, after payment is received whereby the policy holder who changes his mind can cancel the transaction, retain the policy and return funds.
11. After rescission period the policy transfer becomes binding. Ownership transfers to the financial institution.
12. After the deal closes, the provider firm or a life settlement servicing company may contact the seller, doctor family member, or advisor to get status of the insured.. Some state laws limit these calls to once a quarter or once a year until one to two years preceding the estimated life expectancy where contact can be monthly.
Answer - Life settlement proceeds may be taxable, but the rules are complex and a tax accountant should be consulted. When thinking about the tax consequences of life settlements, it is important to think of the variety of policy owners and the important issues that are likely to surface:
3. For-profit entities
4. Executors of estates
5. Tax-exempt entities such as a 401(a) trust or 501(c) organization.
It is important that you consult with competent financial advisors, attorneys and/or CPA’s for professional advice of income tax consequences of the proposed settlement before the transaction closes. On May 1, 2009, the IRS issued Revenue Ruling 2009-13, which defines an individual policy owner’s tax liability on the proceeds from the sale of a life insurance policy in a life settlement transaction. The policyholder should ask the tax advisor about this ruling.
Answer - Life settlements are complex legal and financial transactions. Compliance regulations continually change, further complicating matters. Professional assistance is necessary not only to navigate this world, but also to maximize the policy’s value in the marketplace and to locate an appropriate buyer quickly.
The broker has the fiduciary responsibility to the policy owner and will negotiate the sale between the buyer and the policy owner, acting purely in the best interests of the policy owner.The policyholder should resist the temptation to engage multiple brokers to seek bids at the same time. Providers will likely discover that the policy is being shopped by several brokers and may refuse to do the due dilligence and analysis needed to submit a competitive bid out of fear that they are working with a broker that does not truly represent the seller.
The policyholder or insurance agent can also approach providers directly to avoid broker fees. However, contacting only one or two companies will not likely get the best price. Out of pocket expenses will include paying for life expectancy and medical reports. The policy owner should make sure that their agent is experienced in life settlement transactions when bypassing a broker.
The life settlement intermediary will work as a liaison between policy holder, the insured (if different), the professional advisors, and seasoned licensed brokers. The Life Settlement Intermediary carefully screens reputable brokers for:
• Financial soundness
• Years of experience in the settlement life insurance business
• Professional designations and trade association memberships
• Quality of recordkeeping procedures and the means by which the broker maintains the privacy of health and personal financial information
• How the broker investigates the financial soundness of prospective buyers
• Experience and working relationships with as many institutionally-funded buyers as possible
• Requests multiple first round bids to encourage competitive bids to raise prices
• Knowledge of buyers favoring certain kinds of life insurance policies and which ones would be interested in making competitive offers
• Transparency in sharing full information on each bid upon receipt
The broker will negotiate with the funding sources to achieve the highest value on behalf of the policy owner. The agent or intermediary, acting as liaison between the broker and the policy holder, will present the best offer to the policy holder and if accepted make certain that the process comes to timely and favorable conclusion.
Answer - If you still need this life insurance, but can no longer afford premiums, there are several options to explore:
• Borrow against the cash value of your life insurance policy
• Have someone else pay the premiums
• Obtain a reduced death benefit policy
• Have the cash value in policy pay premiums
• Learn about a policy rescue program from your insurer
• Cash out the policy based on the available cash surrender value
• Check with the life insurance company to find out if the policy can be converted to a paid-up policy or if the death benefit can be reduced in order to lower the amount of your premium payments
• Use the life insurance policy as collateral to secure a loan
• Utilize an accelerated death benefit
Always seek the advice of a financial planning professional before making any final decisions.
Fees for medical records, policy illustrations, life expectancy reports and other needed documenations are the responsibility of either the broker or provider (funding source). There are no fees required on the part of the insured. All commissions paid to the brokers(s) come directly from the providers (funding source).