For advisors with senior clients, it’s a familiar storyline: An insurance portfolio review exposes a client’s life insurance policy as under-performing, unnecessary or unaffordable. Alan W. Pratt, CEP, CAP, has been around the insurance business long enough to recall when the only two options in those situations was to surrender the policy for pennies on the dollar or let it lapse altogether, with virtually nothing to show for years of premium payments.
Pratt knew there had to be a better alternative, and after six or seven years, he found one. An advisor whose client base consists largely of people 65 and older who own at least one — and in many cases, multiple — life insurance policies, Pratt, president of Pratt Legacy Advisors in Bellevue, Wash., says the emergence of life settlement as a third option for disposing of life insurance policies has been a boon for his clients and his practice.
“It’s good to have [life settlement] when you need it,” says Pratt, who specializes in life insurance portfolio management, estate planning and charitable giving strategies for high-net-worth seniors. “Life insurance has real value in the open market. If you’re an advisor who manages portfolios of insurance, life settlement is a very valuable management tool.”
A policy sold in the secondary market often can fetch three, four, even five times its surrender value for the seller. Generally speaking, the value of a policy is directly linked to the life expectancy and health of the insured: The greater the likelihood of collecting a policy’s death benefit, the more attractive that policy is to providers (purchasers). While universal life policies dominate trading in the secondary market, there’s also demand for convertible term, conventional term and whole life policies. The typical policy sold via life settlement carries a face value of $250,000 or more, usually with at least $1 million in death benefit. While policies for which the insured has a life expectancy of 10 to 12 years are most appealing to providers, there’s now a market for policies held by people with a life expectancy of 15 to 20 years.
Liquidity generated by the transaction can be put to a variety of uses that stand to enrich not only the client who sold the policy but the agent/producer who presides over that person’s insurance and or investment portfolio. Still, despite recent robust growth in the secondary market, life insurance experts say settlement remains an underutilized maneuver chiefly because large segments of the advisory community and the general public aren’t aware it’s an option.
“Most don’t know about the opportunity,” says Doug Head, executive director of the Life Insurance Settlement Association.
“There are thousands and thousands of people walking around out there with older policies that are strong candidates for life settlement,” says Pratt. “But nobody’s really telling policyholders.” Evidently, however, the secret is getting out. According to Head, the face value of policies changing hands via life settlement has increased from about $500 million in 2000 to almost $18 billion in 2007. During that time, the Life Insurance Settlement Association has seen its membership swell from 13 companies to 172. Meanwhile, there are other signs the secondary market is maturing. These days, according to Paul J. Moe, co-chair and CEO of Living Benefits Financial Services, a Minnesota life settlement firm, providers are almost exclusively institutional investors — hedge funds, pension funds and investment banks — while escrow for many transactions is handled by big-name institutions such as Wells Fargo and U.S. Bank. Most states now have laws to regulate the life settlement market. Michael Coben, senior vice president at Coventry First, a Pennsylvania-based firm specializing in life settlement transactions, notes that insurance carriers who once wanted no part of the secondary market have begun dabbling in it. Using the Tool All signs point to a broadening embrace of life settlement as a planning tool, says Coben. “Advisors and agents, I think, are much more receptive today to life settlement because they have seen the positive impact it can have with a client.”
Life settlement practitioners view it chiefly as a means to orchestrate:
- “Insurance refinance” to shed an underperforming or overpriced policy in the secondary market and use the proceeds to purchase a new, more efficiently priced and configured policy; or
- A life insurance “exit strategy” where a client who no longer needs a life insurance policy sells the contract to generate liquidity for other purposes, for example to purchase another instrument such as an annuity or to infuse a trust with liquidity.
Some of the best candidates for life settlement are clients with irrevocable life insurance trusts. As Moe points out, one of the fiduciary responsibilities of an ILIT trustee is to periodically obtain a present-day valuation of a life insurance contract held by the trust. Oftentimes the valuation reveals that the policy is outdated and can be replaced with one that more effectively accomplishes the goals of the trust, he says. “There are tens of thousands of ILITs in this country whose life insurance policies no longer serve their intended needs.”
Changes in federal estate tax law have made life settlement a viable option for trusts and individuals, notes Pratt. “You have many estates of $2 million, $3 million and $4 million that bought million-dollar policies for the purpose of covering estate tax liability. Ten years later, the [federal] estate tax exemption is quite a bit higher and the need for the policies is no longer there.” Changes in personal situation do happen — financial status, health status, divorce, death of a spouse, new liquidity needs — and that’s the time to re-examine a client’s personal life insurance portfolio, with an eye toward the life settlement option.
“Maybe a person’s need for life insurance has gone down. Maybe the cost of obtaining a life insurance contract comparable to the one they have has dropped,” says Pratt, “Then it’s a case of determining whether it makes sense to keep funding a contract given the changing circumstances.” The push by carriers to innovate with lower-priced policies has opened the door to insurance “refinancing” opportunities, he says. “A person can sell a policy [via life settlement] and even though they’re older, find a new policy with comparable value whose premiums are much lower — 30, 40, even 70 percent.” Likewise, the same premium can buy a person a much larger death benefit.
There is also a place for life settlement in a business context, where selling policies that are no longer needed — such as key-person policies — in the secondary market is much more lucrative than surrendering them.
Life settlement can be rewarding to producers as well. Not only do they stand to earn good will (and perhaps, referrals) from clients whom they have helped with a life settlement transaction, they can earn commissions by referring clients to a life settlement broker or provider. What’s more, an agent/producer stands to earn commissions when clients use proceeds from life settlement to purchase new insurance contracts, annuities and the like. “The income-producing potential is significant,” says Moe.
For advisors who know first-hand what life settlements can do for clients and their own practices, there’s no going back to the days when hold, surrender or let lapse were the only options. For them, says Pratt, the secondary market “is a wonderful place to be.” Be your own life settlement broker By Zohar Elhanani As the life settlement industry grows at an accelerating pace, an increasing number of life insurance producers are opting to transact directly with life settlement providers — companies which actively purchase life insurance policies in the secondary life insurance market.
Executing life settlement transactions through a specialized life settlement broker is beneficial for life insurance producers without the know-how or resources to transact directly with life settlement providers.Producers who do elect to work directly with life settlement providers may benefit from significant opportunities to execute more efficient transactions while raising the level of the total policy sale. In working directly with life settlement providers, producers can earn higher commissions compared to what they earn by working through a life settlements broker. These commissions, typically a percentage of the policy purchase price, are determined as part of the overall life settlement negotiation.
Furthermore, producers can provide optimal service for their clients by engaging in direct dialogue with a provider. Eliminating the need for an intermediary broker can achieve a greater degree of transparency, control and transaction efficiency in evaluating bids while expediting the overall life settlement transaction process.
While the idea of acting as your own broker might seem daunting, many producers have found that working directly with life settlement providers is surprisingly simple and well worth the additional effort. Many providers are pleased to cooperate directly with producers in making the bidding and sales process as smooth and straightforward as possible.
Producers, in turn, must do their part in compiling the documentation needed for a life settlement application package. Such materials include: the life insurance policy; the policy illustration as generated by the insurance carrier; a medical release form signed by the insured; updated medical records; and life expectancy reports. Life expectancy reports provide an analysis of the client’s medical history and actuarial life expectancy determination, as prepared by one of a handful of specialized firms.
In addition to compiling important information, producers must fulfill their fiduciary obligation to their client, the policy owner, by shopping the market for the highest offer and quality of service from experienced providers. Fortunately this is a manageable task for most producers, as the universe of established provider firms is relatively small. Key criteria for provider selection Producers need to exercise their best judgment and diligence in selecting the qualified liife settlement providers. Prior to releasing any information to potential firms for bidding, preliminary research needs to be conducted by following tried-and-true guidelines. Determine your client’s eligibility with the firm Save time and minimize your client’s exposure by inquiring about the provider’s policy purchasing parameters before providing them with your client’s life settlement application. Some firms are exclusively interested in policies that fall within specific age, policy size, applicable state jurisdiction and health guidelines. It is wise to withhold your client’s confidential information until you believe that his or her policy will meet the firm’s purchasing qualifications. Work with firms that represent institutional, not individual, funding Almost all life settlement providers are funded by institutional buyers, and for good reason. Institutional buyers clearly understand the asset that they are buying; they also have strong compliance practices and comprehensive legal documentation in place. Most importantly, institutions amass pools of policies and have no specific interest in the individuals involved.
It’s a good idea to ask for a copy of their policies, as well as for samples of their settlement agreements. A reputable firm should be more than willing to provide such documents. It is also recommended that you obtain references from other producers who have transacted business with any of the life settlement providers under consideration. The bidding and sales process After selecting qualified providers, producers should establish the structure of the subsequent bidding and sales process in a straightforward manner.
A suggested approach is as follows: producers distribute policy information applications simultaneously to all life settlement providers under consideration, with a timetable for obtaining a bid and the auction end date and timeline. Producers should collect bids from life settlement providers in writing, typically by e-mail. Setting a deadline for bidding is advised, as it maintains an efficient, compliant process which fulfills the producer fiduciary obligation to the client and the providers’ operational need for timely delivery of bids. After closing the bidding process, producers should submit the offers to their clients for a final decision which is typically based on the overall bid consideration and provider quality of service and identity.
In the end, acting as your own life settlement broker can provide optimal service and reward for your clients as well as lucrative commissions in return for your hard work. Zohar Elhanani is chief operating officer with New York-based Legacy Benefits, LLC. How to better serve your clients and double your revenue using life settlements By Keith Singer, JD, CFP There are only three ways for senior market advisors to increase their revenue.
- Get more clients.
- Get better clients.
- Offer existing clients additional services or products.
I submit it is far easier to offer additional services to one’s existing clients than to prospect and acquire more clients. By offering senior clients your expertise in life settlements, you not only can significantly increase your revenue but, more importantly, can create tremendous value for your clients. A life settlement is the sale of an existing life insurance contract to a third party that will then pay the premiums and collect the death benefit at the insured’s death. The life settlement market is a multi-billion-dollar market in which many of the world’s largest financial institutions have jumped in with both feet. But not many advisors have become proficient at advising their clients on life settlements. An agent who takes the time to understand the appropriate applications of life settlements will acquire a significant advantage over the competition as well as significant increases in revenue.
We are all aware of how much money is controlled by the wirehouse brokers; however, as a general rule, none of those brokers is even allowed to discuss life settlements with their clients. If you encounter a prospective client who happens to have a close relationship with a wirehouse broker and that client is relying on the broker for financial advice, chances are that broker has never discussed life settlement options with the client.
Conventional wisdom has always dictated that life settlements were appropriate only when a client no longer wanted or needed an existing life insurance policy. Most advisors translate this narrowly to mean when a client can no longer afford a policy. But this narrow view is inaccurate. One of the best uses of a life settlement is when the client is planning on keeping a policy forever. In a great many instances, the client will receive a considerable financial benefit by selling a current policy and purchasing a new replacement policy. Utilizing this strategy, you can save the client two to three years of premiums or increase their net worth. Imagine that you bought a new car for $50,000 and a year later someone offered you $80,000 for it. You could sell it and go right back to the original auto dealership, buy a new car for $50,000 and pocket the difference. This is the exact scenario possible in the life insurance/life settlement market.
Life settlements should be used:
- When a client no longer wants or needs an existing life insurance policy.
- When a client still wants and needs an existing life insurance policy, is still insurable, and wishes to reduce the amount of premium they are paying each year.
- As a superior alternative to a 1035 exchange.
The clients must meet certain parameters for this strategy to work. Ideally they must be between the ages of 70 and 85; be in at least average health; and own either convertible term or universal life insurance.
For example, a prospective new client had several million dollars at a couple of major wire houses in addition to a $1,000,000 universal life insurance policy. He was very happy with his stock broker and happy with his life insurance policy. His premium was $35,000 per year and the policy had a $50,000 cash surrender value. The advisor had the policy appraised on the secondary life insurance market and received a high bid of $122,000 for the policy. The advisor explained to the client that he could sell his existing policy for $122,000 and purchase a new $1,000,000 policy with a lump sum premium of $50,000 and annual premium of $28,000. This would give the client the same $1,000,000 coverage for $7000 less per year and an additional $72,000 in the bank ($122,000 less $50,000 lump-sum dump-in).
What a great deal for the client as well as for the advisor who made over $50,000 on the transaction. You are not asking the client to pay for a new policy, you are asking the client to pay less for what he already has — plus the client gets money in the bank. It’s a total win-win for the client and the advisor.
Another example is a client who was almost 75 and owned a $1,000,000, 10-year term policy that cost $10,000 per year. The policy was 5 years old and convertible only until the client was 75. The advisor explained to the client that he needed to convert the policy to universal life, which would cost $40,000 per year. The client objected to increasing his premium by $30,000 per year; however, the advisor explained that by converting the policy it would become very valuable.
The client subsequently converted the policy and sold it for $200,000. The client then purchased a new $1,000,000 universal life policy for $40,000 premium per year. By selling the initial policy, however, he received a check equal to the next five years of premium. So, five years from now, instead of having an expiring non-convertible term policy, he will have an in-force universal life policy. The client essentially received the money to cover his premiums for the next five years. Previously he was paying $10,000 per year. So he actually saved $50,000 and now has the opportunity to keep the new policy until his death or sell it at some point in the future. This transaction was highly beneficial for the client as well as the agent. The agent received three commissions: one on the conversion of the original term policy ($40,000), another on the sale of the policy ($20,000), and one more on the purchase of the new policy ($40,000).
Can you see how lucrative these transactions can be? If your client is over 70 and has a life insurance policy they are happy with, they may be an ideal life settlement prospect. Let’s take the above illustration one step further. He can buy a $1,000,000 policy worth $200,000 in the secondary market for $40,000 per year of premium.
Now that I have your attention, let me explain how you can begin offering life settlements as one of your services. You can access the life insurance secondary market in two ways. You can go directly to one or several “life settlement providers” in order to get bids on your clients’ policies, but you will have to deal with numerous funding sources and their specific requirements. In addition, you will need a high level of expertise in negotiating the highest price for your client. Also note that compliance requires that you be licensed as a “life settlement broker” in each state in which you do business.
As an alternative, you can work with a licensed life settlement broker, who will negotiate on your behalf directly with licensed life settlement providers. If you use a life settlement broker, you are taking most of the work off your plate, which frees you to focus your efforts on normal business activities while the broker does all of the compliance work and legal work, as well as the negotiations for you.
I recommend that when you are conducting a new client interview, or an existing client review, to find out exactly how much life insurance your clients have. Then have those policies appraised by a licensed life settlement broker. It is crucial that you can identify when the use of life settlements are appropriate for your clients; if you don’t, chances are someone else will.
Don’t miss Keith Singer at Senior Market Advisor Expo, Aug. 20-22. Visit www.seniormarketexpo.com for more information. Keith Singer is the owner of Insured Returns LLC, a Life Insurance Settlement and Arbitrage firm in Boca Raton, Fla. He is a life qualifying member of MDRT. He can be reached at firstname.lastname@example.org. Taxation of life insurance policies in an evolving secondary marketplace Life insurance has traditionally been treated as a static asset. Historically, the only options available for an owner of a life insurance policy were to continue maintaining the policy with premium payments, restructure the policy, or allow the policy to lapse by surrendering it back to the issuing life insurance company. Recently, however, this traditional view has been altered with the emergence of an evolving secondary market for life insurance policies. Today, seniors are now able to sell in-force life insurance policies into a viable, competitive and active secondary marketplace maintained by institutional investors — the life settlements market.
The popularity of the life settlements market has grown rapidly as these transactions have proved enormously beneficial to seniors versus the historical option of allowing a policy to lapse or be surrendered. Through a life settlement, seniors (typically age 65 or older) are able to sell policies no longer needed, for which premiums have become burdensome or to realize an investment profit. The policies are sold at their “fair market value” for amounts substantially greater than policy cash surrender values, which FMV is determined by multiple factors such as the insured’s age, medical condition, policy performance factors and market interest rates. In a life settlement transaction, the purchaser takes the position of the policy owner, names itself the beneficiary and becomes responsible for future premium payments. By stepping into the shoes of the policy owner, the life settlement purchaser is able to acquire a valuable financial asset which has a certain payout under the life insurance contract.
As a result of this rapidly evolving secondary marketplace for life insurance, the taxation of life insurance transactions and computation of a life insurance policy tax basis has become increasingly important. Yet, the proper taxation of life settlement and premium finance transactions is not entirely clear and the Internal Revenue Code fails to provide a methodology for the proper tax-basis calculation when the policy is sold to a third party
The secondary market is offering to purchase life insurance policies from seniors for amounts often many times greater than both the cash surrender values of the policy, and the premiums paid. The result is new substantial tax revenues to federal and state governments. In 2007, Conning Research & Consulting, Inc. reported in its Strategic Study Series on the Life Settlement Market that transactions in 2006 approximated $6.1 billion, and that by 2016 the annual transactions could reach $140 billion. Clearly, the issue of taxable income and tax revenues is substantial.
In direct response to the growing life settlement industry, several innovative estate planning techniques such as premium financing have emerged. Even as premium finance transactions are being scrutinized by insurance carriers, life settlement firms, investors, regulators, legislators, and third-party sales of life insurance policies is becoming more common. The tax community needs to focus its attention on the unfolding questions concerning the proper computation of gain and tax basis for these sellers.
While taxation of death benefit payouts, policy lapse and policy surrender to carriers have been well settled, the IRS has yet to provide formal guidance on the subject of policy sales under life settlement. Existing case law suggests that a bifurcated approach for the sale proceeds of a life settlement is the proper tax treatment, even if the policy was premium financed. Under such an approach, gains recognized between the tax basis and the cash surrender value in the policy would be deemed ordinary income, and gains recognized above the cash surrender value (or, if the policy has no cash surrender value, above the tax basis of the policy) would be given capital gains treatment. In the matter of complete non-recourse premium finance, the transfer of a policy to a lender in discharge of the note constitutes gain and not COD income. Any gain recognized through the discharge of a non-recourse premium finance loan should be treated as ordinary taxable income as no part of the loan debt represents an increase in the market value of the policy.
IRS code is not clear on the proper tax-basis calculation for policies sold as life settlements in the secondary market. In its guidance, the IRS has provided conflicting views, having applied an approach similar to that mandated for policy surrenders and calculated basis by the aggregate of premiums paid. However, while not formally overruling this approach in private letter rulings, the IRS has argued for an approach where a policy’s basis is reduced by the cost of insurance. Under this approach, one who sells a policy or surrenders a policy in satisfaction of a premium finance loan would be accountable for taxation on the portion of the debt balance discharged that exceeds the aggregate of premiums paid reduced by the cost of insurance. Again, the IRS argument of reducing policy tax basis by the cost of insurance conceivably opens well-settled basis calculation methodologies of policies surrendered to carriers. It must be asked as to why would the reduction of a policy tax basis by the cost of insurance differ depending on the transaction used to exit the policy? Why should the tax basis of a life insurance policy be forcibly reduced by cost of insurance any more than the tax basis of real estate or equipment be forcibly reduced by depreciation that has not otherwise been expensed against taxable income?
There remain numerous unanswered questions concerning the taxation of life insurance policies within the evolving secondary insurance marketplace. Without question, this multi-billion dollar marketplace represents an important revenue source that continues to grow for federal and state governments. It is therefore vital that the IRS provide clarification through future tax regulations to ensure the resulting tax revenues are efficiently accessed at both the federal and state levels. This is a recap of a white paper, “Taxation of Life Insurance Polices In An Evolving Secondary Marketplace” published by Insurance Studies Institute, March 1, 2008. The full article can be found at www.InsuranceStudies.org/Research