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A Key Settlement Consideration: Can Clients Get Replacement Coverage?

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Among the most often discussed benefits a life settlement can provide is the opportunity to shed an older, underperforming policy and replace it with newer life insurance designed to meet current needs. In fact, many life settlements spring from a desire to update a policy while maximizing the value of the older one, according to one industry executive.

Frank Gencarelli, executive vice president of Hartford-based Phoenix Life Solutions, says that in conversations he’s had with brokers and agents, he’s heard that as many as 40% of settlements are undertaken following an insurance review for a client. Rather than simply doing a 1035 exchange, he says, agents are now “investigating the economic value” of a policy in order to determine if a better option exists.

Perhaps the most significant concern for agents, according to Norman Hood of Illinois-based, is ensuring that a client can get the replacement coverage they are seeking.

Among the most important things to consider in seeking replacement coverage, however, he says, is the “capacity issue.”

A life insurance company, Hood says, is not going to provide unlimited coverage to any individual, and policyholders should consider if and how they will get the newer life insurance policy.

“If people reached the limit on how much coverage they can buy,” a replacement policy may be impossible to obtain, he says.

John Skar, managing director and chief actuary of Legacy Funding, and a former chief actuary for MassMutual, agrees that in planning replacement coverage, the “main concern that comes to mind is how much you qualify for.”

Generally, he says, coverage limits for individuals are “based on your financial position” and how much coverage you can afford. “Each person has a sort of finite limit” in terms of insurance coverage, he says, and a policy sold on the secondary market “is still considered part of that.”

There is no general rule of thumb that can provide an estimate of coverage limits, Gencarelli says. Limits will generally be in “kind of a cluster” for most companies, he says, but that does not exclude the prospects of companies making very different determinations from one another.

“It varies by company,” he says. “Every company has its ‘blood pressure limits’” for preferred status and coverage.

One element that can affect the amount of coverage a company will allow, he says, is the size of the company, and the amount of reinsurance it has and the threshold at which that reinsurance kicks in. As a result, he says, “there may be a stark difference between a small company and a big company,” in terms of how much coverage they will allow an individual.

Skar says agents should also consider changes in the clients themselves, and whether that could affect their ability to obtain new coverage or the pricing of a replacement policy.

“You may have become uninsurable in that time,” he says. “You still have to go through the normal underwriting process.”

Hood says such questions should be answered before the settlement process goes too far, and that agents should look beyond simply the policy itself before advocating a move to the secondary market.

“There are a fair number of people who have no business doing a life settlement, even though they qualify,” he says, adding that many of these people are made aware of the benefits of a policy by an insurance agent, or may just be seeing others in their communities or social circles receiving high prices for their policies.

Among those who should be most careful, according to Hood, are couples. Many older couples are concerned with outliving their savings, particularly during tough economic times, he notes. However, in seeking to sell a policy, at times “they may forget that if they die, the spouse may need that income,” he adds. “In reality they may be better off with it.”

Once the decision has been made to sell a policy, and obtain new coverage, Hood says what remains is largely a question of timing.

“They would need to be approved for coverage before they proceed with the life settlement,” he says, to ensure that not only will the client be able to obtain coverage, but that it will be in place before the older policy changes hands.

Gencarelli echoes the sentiment that the largest immediate danger to a client would be if the transactions were mistimed and a gap were created between the sale of the old policy and the new one taking effect. “I don’t know that you can get hurt necessarily, other than a gap in coverage issue,” he says.


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