Advisors Need To Be Informed About The Life Settlement Option

In the 21st century, no one disputes the economic value of working men and women. A primary purpose of life insurance is to protect families and businesses against lost economic value due to premature death. In addition, permanent life insurance is an extremely valuable and flexible financial asset that has a wide variety of uses in estate and business planning, regardless of when the insured dies.

Nevertheless, some policy owners discontinue insurance policies for a variety of reasons including: (1) a change in economics–either the policy owner can no longer afford the policy or income replacement coverage is no longer required; (2) a key employee has retired, so key person insurance is no longer needed; (3) a change from first-to-die protection to second-to-die coverage for estate planning purposes and, (4) lifetime purchase of a co-owner’s business interest eliminates the need for buy-sell insurance.

If the purpose for which the insurance was purchased no longer exists, or if the owner of the life insurance policy merely wants to discontinue premium payments, various contractual options are provided in the policy. For term insurance, the contract simply lapses or terminates. For a cash value policy, the contractual options include: (1) surrender the policy to the insurance company for its cash value; (2) exercise the extended term option to maintain the original death benefit for fixed period of time (3) exercise the paid-up insurance option to maintain a reduced death benefit to age 100 or lifetime, and (4) exercise an annuity settlement option by exchanging the cash value for a monthly income that would be guaranteed for a certain number of years or for the lifetime of the annuitant, with the guarantees based on the claims paying ability of the issuing company.

To the mix of contractual guarantees listed above, a non-contractual alternative may exist for some policies: the life settlement. Sophisticated investors, including hedge funds, may offer to buy an eligible policy and take over the premium payments in exchange for receiving the eventual death benefit. The target market for these investors are insured people over age 65 with relatively large policies, where the insured has suffered a negative health event since the policy was first issued. In order to qualify for a life settlement, the insured must submit current medical information for evaluation. The investors take advantage of what the insurance companies by law cannot do-determine policy values based on the insured’s current health status.

Life settlements are contractually the same as viatical settlements (viaticals), the original term used for policies being bought and sold in the 1980s and 90s when AIDS was epidemic and its victims needed money quickly for medical expenses. Viaticals typically involved individuals who had life expectancies of 2 years or less and the policies generally were small face amounts. A number of regulatory issues associated with viaticals, including widespread instances of investor fraud, arose.