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June 25, 2006 at 04:00 PM
Professionals who work with older-aged clients face challenges not typically encountered in other markets.
Developments in the secondary life insurance market–also known as the life settlement market–could result in such professionals facing increased liability from a number of heretofore benign transactions. Policy exchanges are a good example.
Every professional worth his or her salt knows that Section 1035 of the Internal Revenue Code protects clients from paying tax on gain in their life policy when they exchange for another policy. Such exchanges make sense for many reasons, including the ability to access new policy features, to reduce or eliminate premium outlays, to purchase additional coverage and/or move to a carrier with stronger ratings. Due diligence is key to effectuating any exchange, however, and every exchange must be tested to determine whether it is suitable and in the client’s best interest.
What is important here is that, because of developments in the life settlement market, the due diligence bar has been raised for producers, advisors and trustees.
Before today’s active settlement market developed, older aged clients would typically have one option if they wanted to change policies. That was a Section 1035 exchange.
Now that the secondary market is active and competitive, however, professionals who think with Section 1035 blinders on do so at their own peril.
If the client is age 65 or older and has experienced a change in health since the policy was originally issued, the efficacy of a life settlement transaction clearly needs to be factored into the 1035 exchange due diligence process.
The following example illustrates the tensions that exist. Assume a life insurance trust owns a $3.8 million face policy on an 80-year-old male. The policy has $475,000 of cash surrender value, and the client needs an additional $500,000 of coverage to fully cover his estate planning needs. Consider the following proposals:
o Producer X, a broker working through her brokerage general agency, negotiated an offer from a new carrier for a $4.3 million policy. Producer X’s BGA also negotiated a $1.2 million life settlement on the old policy and used those proceeds to pay up the new policy on a guaranteed basis.
