Finding Alternative Sources of Liquidity in Times of Need

While the secondary market for annuities does not offer the immediacy of a stock exchange — it can take three to six weeks to complete a transaction — it does offer significant flexibility. That is, annuity owners can sell their entire annuity, all of their payments for a certain period of time, or just a portion of their payments for a certain period of time.

Here’s an example: A widow has an annuity paying $2,842 per month funded with a single premium immediate annuity for $600,000. She finds herself facing stiff college tuition bills for her two children. Rather than borrowing, her agent advises her to sell 10 years worth of payments for $244,844, enough to see her children through school without incurring any debt. And once her children are established, the widow can again begin receiving monthly payments of $2,842.

Some annuity buyers even found ways to enlarge the market by purchasing not just the guaranteed payment stream as in the case above, but also the non-guaranteed ones. These are the payments that continue after the guarantee period but cease upon the annuitant’s death.

From annuities to life settlements
Buying these payments represented an important advance, since it introduced the notion of annuity payments with mortality risk. It’s important to note that most of the annuities purchased in the secondary market are ultimately bundled and sold as bonds to institutional investors. Therefore, the kinds of annuities that that are purchased on the front end of the secondary market are strongly connected to the kind of assets that institutional investors want to own on the back end. Thus, a demand for payments with a mortality risk connected to them was one of the forces that gave rise to the development of a secondary market for life insurance policies, which are known as life settlement transactions.

The notion of life settlement transactions is not new. What are new are life settlements for smaller policies, with face values of less than $1 million, which has much more applicability for many more clients. For instance, a 72-year-old man with a $500,000 universal life policy recently sold it for $150,000 in cash.

The decision to purchase life insurance is often made very, very carefully; the decision to sell life insurance should also be made with equal care. In many instances, keeping the policy is the right option. But if your client’s circumstances have changed since they bought the policy, such as through the death of a spouse, the beneficiaries have outgrown the need for the proceeds, or your clients simply need the money now, a life settlement transaction is worth considering.

Even term policies with no cash value can have value in the secondary market. A client who took out a $250,000 term life insurance policy in 1984 found it was becoming more and more expensive to maintain. In 2008, the total cost of his premiums would be $7,800. Meanwhile, his credit card balances were going up and up, as were his utility and fuel bills. The client said, “It got to the point where my wife and I had to consider what had more value to us: freeing up cash that we could use today, or cash in the future, after I died.”

By converting his term life policy into a whole life policy, the client was able to immediately sell it for $14,000 in cash. The financial benefits of the transaction were magnified by the fact that not only did the client receive cash, he also got out from under $7,800 in annual premium expenses for a total impact of $22,000 in the first year.

Overall, the absence of liquidity in many assets owes its origins to the way in which the products are marketed. That is, annuities, life insurance, and legal settlements are positioned in such a way that their owners view them as sacrosanct — once purchased or accepted they can never be sold again. Increasingly, this is no longer true. However, what’s important for advisors to help clients recognize is that assets are just that, assets, to be used for the benefit of their owners and not their issuers.

John Zepeda is a senior sales representative for J.G. Wentworth. He can be reached at 866-386-3102.