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March 20, 2015 at 05:36 AM
There’s substantial capital flowing into the life settlement “secondary market” for life insurance policies. This results in major benefits for clients and money to be made by agents in brokering sales of these policies to institutional buyers. These are among the more intriguing insights into the life settlement market shared by Michael D. Weinberg, JD, AEP.
President of The Weinberg Group, Inc., based in Denver, Weinberg recently took questions from LifeHealthPro Senior Editor Warren S. Hersch. The interview focused on trends impacting the rebounding life settlement market and how advisors can successfully build a practice in this space. The following are excerpts.
Hersch: To what degree are life settlements now a part of your practice? What’s your assessment of the current state of the market?
Weinberg (pictured with grandsons at right): First, the life settlement market is very hot now, in part because of all the institutional investor money flowing into this market. For example, that’s reflected in the recent announcement by one life settlement provider, Abacus Life Settlements, which earlier this year said it secured more than $250 million to purchase policies in 2015.
Second, there is now more competition among the buyers, which is good for the sellers. Buyers are able to offer higher prices because the investment returns they now expect — ranging between 15 and 17 percent — have declined from previous levels. When the expected buyer return is lower, the price a buyer is willing to pay is conversely higher.
Third, also contributing to the market’s growth are low interest rates at which buyers can borrow money to buy policies and make future premium payments.
And, fourth, there’s also the fact that life settlements are a very good non-correlating asset that is attractive to buyers, meaning they don’t fluctuate in tandem with stock market gyrations. When you factor in the expected 15 to 17 percent returns expected by buyers, life insurance can be a very good investment for them, to say the least.
The life settlement business, which has become a significant part of my practice, is looking very good. A case I just concluded will produce compensation of over $100,000 for us and almost $700,000 for the client after taxes and our compensation. (By the way, surrender would have netted our client less than $250,000.) We have another case pending that will yield a brokerage fee of $600,000 — and many times this amount for the client.
As you can see, not only do we earn good money from life settlements, but for our clients — seniors who are selling their policies — the net proceeds received from a sale are frequently substantially greater than the proceeds received if the policy were surrendered. So these transactions can be highly beneficial for everyone involved: sellers, buyers, and we agents and brokers. Hersch: What factors do you consider when deciding whether a life settlement is appropriate relative to alternative options? Which policies lend themselves best to a life settlement?
Weinberg: After sales price, the key variable in transactions is after-tax sales proceeds. Under IRS Revenue Ruling 2009-13, you arrive at this figure by subtracting from the gross sales proceeds: (1) the tax on the ordinary income portion of the sales price (equal to the excess, if any, of cash value over premiums paid); and 2) the tax on the transaction’s capital gains portion (equal to the total gain from the sale less the ordinary income portion). The capital gains portion and resulting capital gains tax are higher than they were before the ruling because the costs of insurance (COIs) are now factored into the tax calculation and reduce the policy’s adjusted basis used to calculate the gain from the sale. (Note that the gain from the sale may also be subject to the 3.8 percent Medicare tax.) 
These tax calculations are complex, and I’ve found that many professional advisers (and even life settlement brokers) do not understand how the tax rules changed in 2009. We bring added value to the transaction by explaining the tax effects to the client and advisers (although of course we are careful to point out that we don’t practice law or give tax advice).
Next, you subtract from the after-tax sales proceeds the broker’s compensation to arrive at the net sales proceeds payable to the seller. Lastly, you compare this net sales value with the policy’s after-tax cash surrender value. If the net sales proceeds are the greater of the two, then — assuming there is no longer a need for the insurance and/or the policyholder is no longer able or willing to pay the premiums, and all reasonable options for retaining the policy have been explored — a life settlement may be a suitable option.
