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Here are 4 reasons why you should reconsider life settlements

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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.

As to policy types, current assumption universal life is best, followed by guaranteed UL and variable universal life. The real surprise for many seniors and their professional advisers is convertible term policies, which can be converted to permanent insurance and sold on the secondary market like other life policies. Less suitable for buyers are whole life policies because the contracts’ premium payments are not flexible. Hersch: To what extent are life insurers and other partners helping or hindering life settlements?

Weinberg: This is a hard question to answer. Depending on the carrier, I’ve experienced some instances in which a carrier dragged its feet in issuing verification of coverage, a key document needed to transact a life settlement. This can delay the closing of the transaction.

A second issue is carrier resistance in authorizing policy-splits. When the policy being sold is large — say, over $10 million in face amount — it may be prudent to split the contract into two policies, each carrying half the original death benefit, making the sales price and future premium payments more palatable to buyers.

I once tried to split a $15 million policy into two $7.5 million contracts, but the insurer denied the request, presumably because of its opposition to life settlements. We ultimately managed to sell the policy, but we got less money than could have been achieved through a policy split.

On the flip side, our life settlement broker, ValMark Securities, is very skilled at navigating the bidding process. They know how to manage the documentation, package the sale and get life settlement providers to bid against each other so as to maximize the sales price.

Obtaining the best price for the client is an art, not just a mechanical auction process. In one remarkable case, my contact at ValMark, Pam Bancsi, managed to get a buyer to bid against itself — boosting the offer to $2 million from $1.6 million. This was a case where no bids had been received for the policy at auction; and I still don’t quite know how she managed to do this. So having a good life settlement broker is crucial. Hersch: How would you assess the current legislative and regulatory environment for life settlements?

Weinberg: Since the STOLI [stranger-owned life insurance] market crashed, many states have tightened restrictions on life settlements in general. That’s certainly true in California, where we do business; my home state of Colorado is less strict. Most states, including Colorado, require a rescission period, during which policy owners can change their minds about selling their policies, even after a deal has been concluded.

Irrespective of the jurisdiction, the best practice — one that we and ValMark Securities follow — is to treat life settlements as securities. Among other things, that means disclosing all key elements of a transaction, including all offers received from the buyers and all compensation paid to the agent and broker.

When I meet with clients, I give them a page showing every offer we received in the policy auction. I also provide a schedule of our compensation, which is capped and uniform. Hersch: How do you anticipate the market will evolve in the years ahead?

Weinberg: I’m very optimistic about new business opportunities, most notably in an area where we haven’t seen as much activity: sales of life insurance policies held in trust. One trust officer recently told me he thinks that trustees now have a fiduciary duty to analyze whether a life settlement is appropriate in lieu of a policy lapse or surrender, and perhaps even to replace a policy that isn’t performing satisfactorily.

If this trust officer’s view gains currency, the market could expand significantly. In any case, I think life settlement sales will be very good this year, and we’re looking forward to a substantial increase in our revenue from them.