Good advisors strive to provide value to their clients in many ways. One often-overlooked way involves what may be one of the larger assets an older client has–a life insurance policy worth more than its cash surrender value. A high percentage of life insurance policies are not held to maturity, since many clients drop or surrender their policies, or allow them to lapse, because the premiums become unaffordable. But allowing a client’s policy to do so without first getting a valuation in the life settlement market would constitute a lost opportunity for your client.

To help address this issue, there is an expanding number of companies whose only business is purchasing these policies through life settlements. This is not the viatical market–viaticals involve the purchase of policies of the terminally ill who usually have a life expectancy of less than two years. Life settlements normally involve the purchase of policies of people aged 65 or older who may have a life expectancy of up to 15 years.

To properly utilize life settlements, an advisor must be able to recognize situations in which policies may no longer be wanted or needed, or in which the settlement can be used to creatively solve other financial problems for the client. For example, the policy may have been purchased to fulfill a specific need or situation that no longer exists. The beneficiaries may no longer need the proceeds of a policy. Or a reduction in estate size or a change in tax laws may make the policy coverage unnecessary.

In one case, there were several policies within a trust, but the gifting allowances couldn’t cover the premiums on all the policies. So the trustee used a life settlement on one of the policies to pay premiums on the others.

In another case, an advisor was able to eliminate future premiums for a client. The client had a policy with an $8.7 million death benefit and slightly less than $1 million cash surrender value. A life settlement produced $2.6 million for the client, who used some of the proceeds to buy a single-premium policy and still had an additional $500,000 from the transaction to bank or invest elsewhere (for more examples, see Life Settlements Illustrated table at right).

There are many areas of business succession in which a key person is not going to be remaining with the company, such as when a business is sold or because of retirement. If there is a key-person insurance policy in place, that policy will no longer be necessary, but will still have a value to the key man or to the company. Here are two examples drawn from business succession situations that illustrate the potential value of life settlements.

In one case, a company was being sold, and an advisor obtained a settlement of $3.5 million on a key-person policy that had a face value of $10 million and a cash surrender value of $800,000. The proceeds helped to clinch the sale of the company: The owner was dissatisfied with the original offering price of the buyer, but the life settlement amount more than made up the difference.

In another case, an advisor failed to see the value in a key-person policy–a term policy with no cash value. After the acquisition was made (including the transfer of the policy), the new owners obtained a life settlement of several hundred thousand dollars for the policy. The advisor was then sued by the former owner, and the advisor’s E&O carrier settled the suit.

Key-person policies may also be replaced in family-owned businesses when the owner passes on the business to the next generation. A good example of this was when a 79-year-old retired owner passed on a business to his son, who was in his 40s. The policy on the father had high premiums due to his age. Since he was no longer the key man, the policy was sold and some of the proceeds used to purchase a key-man policy on the son. This led to lower premiums–and extra cash–for the company.

The Right Time and Place

When is a life settlement appropriate? It may be appropriate for many policy types:

  • Term
  • Universal life
  • Whole life
  • Group
  • Survivorship, or second to die
  • Key man

Each type of policy can influence the offer in its own way. Age is another variable. Some purchasing companies will look at policies with insureds aged 65 or older, while others will only consider those for an insured over age 70. In either case, an offer is more likely when the insured’s health suggests there will be less than a 15-year life expec- tancy; stronger cases are usually made when life expectancy is less than 10 years.

How does the process work? There are two distinct types of companies in the industry: providers and brokers. Providers purchase the policies, while brokers take the policies to market. Brokers work with many providers, and a broker may have exclusive access to a specific provider. Knowing which provider to approach with a given case can be critical. Since many policies can be quite complex, some brokers may be able to attract offers through their expert knowledge of the components of the policy and ways to restructure it.

Caution is called for in taking a policy to market, as some cases wind up being shopped to the same provider through multiple sources. With each layer of sources, another layer of commission may be introduced; fees and commissions vary with each settlement.

The process of obtaining a life settlement is not complicated. First, the advisor (or policyholder) completes an application, which includes policy information and medical and policy information release forms. No physical exams are required. Various illustrations of the policy and verification of coverage are obtained from the insurance company that underwrote the original policy. Any fees to obtain the information needed to complete a package are usually paid for by the broker, resulting in no cost to the client or advisor.

The package is then sent to providers for bids. When a bid is made, however, there is no obligation to accept. When a bid is accepted, the funds used to purchase the policy are held in an escrow account until the transfer of ownership and beneficiary is completed. The purchasing company takes over the premium payments, and the client is paid a lump sum.

The lump sum payments obtained from a life settlement may be used in any way the client chooses. There are tax considerations, of course. In general, the proceeds are tax free up to basis, then taxed as ordinary income from the basis up to the cash surrender value, and then taxed as capital gains beyond the cash surrender value, but a professional tax advisor should always be consulted.

While the process may be simple, make sure you are compliant with state regulations and laws governing the transactions. Some companies in the field–especially brokers–have compliance departments that will work with financial advisors.

The Value of Education

While this may all sound great, educating clients about life settlements is imperative. Advisors can identify which client fits the profile and send information to the client on how the process works and how he can obtain a policy valuation. Some brokers (including myself) will provide these educational materials in various formats to advisors free of charge.

When a valuation or offer is obtained on the policy, the tax consequences should also be explored in deciding which option best suits the client’s needs. A life settlement may not always be the best option. However, failing to present the option and to obtain a valuation of the policy could result in a loss for the client, and for the advisor.

Valerie Greenberg and Associates is a life settlement broker based in Michigan that assists clients, financial professionals, and advisory firms to effectively market life settlements and to obtain offers on policies. Greenberg may be reached at 248-548-1086, or at valgreenberg@hotmail.com.