In 2013, the top 15 life settlement providers paid more than $362 million for unwanted life insurance policies valued at over $2.2 billion. These amounts, according to The Deal Pipeline, were up by 29 percent and 17 percent, respectively, from the prior year. Though revised industry statistics aren’t yet in, anecdotal data suggests the results for 2014 and 2015 will match or exceed these numbers. And a growing number of advisors — many of whom were once averse to engaging in these transactions — are taking notice.
“The life settlement market is so hot now, it’s unbelievable,” says Michael Weinberg, president of The Weinberg Group, Inc. “This space is just exploding.”
“Business this year up is up by 15 to 20 percent, and this is on top of a 25 percent gain in sales last year,” adds Robin Weinberger, director of national accounts at Life Insurance Settlements Inc. “Policies that wouldn’t have been considered two or three years ago now are receiving bid offers.”
What’s fueling the market’s rise? In a word: money.
As the U.S. economy has picked up steam in recent years, institutional investors that dropped out of the market during the 2007-2009 downtown — hedge funds, pension funds, endowment funds, insurance companies, commercial trusts and other large entities that trade securities — have reentered the space. Upshot: There are lot more dollars available to buy unwanted life insurance policies on the secondary market.
The capital inflow is evident in the Jan. 20 announcement by one provider, Abacus Life Settlements, which secured more than $250 million to purchase policies in 2015.
There’s no shortage of insurance contracts that could be sold for cash — if only more policyholders knew about the option. At the 5th Annual Institutional Investor Life Settlement Conference of the Life Insurance Settlement Association’s (LISA) in February, Welcome Funds Founder and CEO John Welcom said seniors age 65 and older forfeit $112 billion in benefits annually by lapsing or surrendering their life insurance policies. That equates to some 250,000 policies or a combined face value of more than $57 billion.
Market-watchers are betting that fewer policyholders will opt for these alternatives in coming years. The influx of capital has prompted more bidding wars among potential buyers, yielding more money for the sellers. For buyers, contracts are more attractive than in past years, in part because of life settlement providers’ greater savviness in valuing policies based on the four key variables used to price products: the death benefit, cost of future premiums, the target discount rate and life expectancy. The settlement amount is pegged to the net present value of a policy’s future payout, less loans, future premiums and commissions, calculated at a return on investment that the funder needs to obtain.
“As life expectancies have increased in accuracy, the rate of return that buyers will accept has declined,” says Weinberger. “And buyers are prepared to pay more for lower, more accurate returns.”
Also fueling the market are low interest rates at which buyers can borrow money to buy policies and make future premium payments. Add to that life settlements’ appeal as a “non-correlating asset” (i.e., one that doesn’t fluctuate in tandem with stock market gyrations). Given prevailing ROIs on the product — 15 to 17 percent — the vehicle can make for a very attractive investment.
The sums that buyers are doling out for secondary market policies are yielding not only top-dollar for sellers, but also for advisors who broker the transactions. Weinberg says he recently concluded a sale providing $100,000 in compensation. He’s working on another case that promises to bring in an additional $600,000 — and many times that amount for his client. To be sure, these sums derive from sales of policies with significant face amounts, the largest of which can run to eight figures. For Weinberg, the sweet spot is between $500,000 and $5 million.
Given his target market (high net worth clients), face amounts below $500,000 generally yield too little in compensation to make handling a case worthwhile. Policies topping $10 million might face resistance, either from prospective buyers unwilling to pay the premiums, or from insurers, as in cases when their approval is needed to make a purchase more palatable.
That happened when Weinberg sought to split a $15 million policy into two $7.5 million contracts, each to be sold separately. The life insurer denied the request, presumably because of its opposition to life settlements. The policy ultimately was sold, but the owner received less on the transaction than could have been achieved through a policy-split.
How much is enough?
Sale proceeds have to be considered when deciding on the merits of a life settlement relative to the alternatives. These generally include (1) surrendering the contract (assuming a permanent life policy) and receiving back the accumulated cash value; (2) allowing the policy to lapse; or (3) using the cash value to buy a paid-up policy carrying a lower face amount.
The last may be the preferred when the insured desires to the keep the policy (e.g., because of a continuing income replacement or estate planning need), but the original premiums are too costly to maintain. Option 2 may be advisable when, for example, the insurance is still needed, but the accumulated cash value will be sufficient to cover the premiums for a desired period.
As to option 1, the decision to sell will hinge on whether more can be secured from a settlement than by surrendering the policy. Often this is the case — the proceeds will usually be an amount less than the death benefit and greater than the cash value on surrender — but this is not always so.
The reason: taxes. In 2009, the IRS issued Revenue Ruling 2009-13, which increased the proportion of sale proceeds subject to capital gains tax. In an example provided by The Weinberg Group, a policy that sells for $80,000 and has an adjusted basis of $64,000 would yield after-tax proceeds of $72,000 after the ruling, versus $74,000 before the ruling. This amount, less the broker’s commission, could yield a net distribution inferior to that of the cash surrender value, making the life settlement a poor choice. However, changes to the tax code increasingly favor life settlements, a trend that’s evident on the question of estate taxes.
A report released in March by market research Conning shows that ownership of cash value life insurance among the top 10 percent of U.S. households (as measured by net worth) fell to 34 percent in 2013 from 61 percent in 1989. The study attributes the decline to periodic increases in the estate tax exemption (now $5.43 million per individual, up from $625,000 in 1989), indicating that paying estate taxes motivated purchases of life insurance for many of the high net worth.
“A lot of life insurance policies bought in past years to cover estate tax may no longer be needed,” says Peter Katz, a life settlement broker and co-director of national accounts at Life Insurance Settlements Inc.
Assuming also that the policyholder is no longer able or willing to pay the premiums, and that alternatives have been explored and rejected, then a life settlement may be advisable — or at least a partial one. Policyholders can also retain a portion of the original death benefit and sell the balance for the cash. Weinberger and Katz caution, however, that this option entails risk to the seller. Should the buyer become insolvent and fail to keep the policy in force, the retained death benefit will be lost.
Money in hand
Whether for all or part of the death benefit, settlement proceeds can be used to fund a host of needs, the provisioning of a supplementary nest egg being just one. A growing number of seniors are using distributions to cover long-term expenses — even while maintaining eligibility for long-term care services under the federal government’s Medicaid program.
John Darer, president of 4structures.com LLC, recently teamed up with Life Care Funding, which offers a program to convert a life insurance policy into a long-term care Assurance Benefit plan. Using a special needs trust, the plan is exempt from IRS rules that disqualify certain financial assets (life insurance policies included) for Medicaid eligibility. Seniors electing these plans preserve a portion of a policy’s death benefit during a qualified “spend-down period,” protecting the asset from Medicaid Recovery action against their estates. Chief benefit: The plan lets enrollees use non-Medicaid dollars, and thereby secure access to top-flight long-term care options by remaining “private-pay” patients during the spend down period.
“[Under the plan], individuals can use from 30 to 60 percent of proceeds from a policy sale to fund qualified long-term care services on a tax-free basis,” says Darer. “So a $1 million policy might provide a pot of cash totaling $300,000 to $600,000, which is significant. The plan provides a lot of financial leverage.”
Darer expects that life settlement-funded long-term plans will become a growing part of his practice, which specializes in structured settlements: legal settlements paid as an annuity to compensate injury victims, including those requiring long-term care. In cases of physical injury compliant with IRC Section 104(a)(2), settlement damages are excluded from income tax.
Life settlements are also complementary to the practice of The Breus Group, which consults with universities, charities, brokerage firms and accounting firms on estate tax and non-cash related donations of fine art and other collectibles, plus insurance-related financial instruments. Among the list: charitable gifts of life settlement proceeds.
Alan Breus, the firm’s managing partner, says he periodically receives requests from fellow professionals to appraise policies. These include term contracts that can be converted to permanent insurance to secure a life settlement, or some variant thereof.
Typically, Breus interfaces with colleges and universities that are seeking life insurance-funded planned gifts from their alumni. When policyholders desiring to make such gifts can no longer cover the premiums, Breus will appraise their insurance and seek an outside buyer. (The educational institutions, he says, won’t take possession of the policies.) The deal concluded, the college receives an immediate cash donation; the seller claims a charitable deduction on federal and state tax returns; and the buyer secures the death benefit at the insured’s passing. Or least that’s how the process is supposed to work. When an insured’s health declines precipitously, life expectancy dips in tandem, boosting the value of a policy to a potential buyer — sometimes by three or four times that of an initial appraisal. In some cases, says Breus, policy owners have set aside their charitable inclinations, keeping the proceeds of a settlement for the benefit of heirs.
Breus has encountered another sticking point: insurers who won’t provide contacts of senior-age policyholders who bought life insurance from him years ago. That’s because their carriers’ fear the clients’ policies will be sold.
“When I call carriers and ask for a list of my older clients, the request is now turned down,” says Breus. “In years past, this wasn’t a problem.”
Why are insurers so staunchly opposed to life settlements? As industry-watchers are quick to note, the market has matured in recent years. Gone are the much-publicized abuses involving stranger-owned life insurance: investor-initiated policies bought for individuals in order to sell them on the secondary market.
Life settlements are now regulated in 42 states; some would contend they’re overregulated in certain jurisdictions (see Producer’s Corner column on p. xx). Truth be told, institutional investors who hold contracts in blind trusts to assure client confidentiality — not nefarious characters intent on killing policyholders after buying their life insurance — dominate the space.
When pressed, insurers say that life settlements threaten their business model. That model presumes that a certain percentage of in-force policies will lapse or be surrendered. To the extent that life settlement providers distort the model by buying polices then, insurers contend, they may be forced to boost premiums, making the products less attractive.
Life settlement proponents label this argument nonsense.
“The number of policies that both qualify to be settled and are owned by people who are prepared to sell constitute such a small percentage of insurers’ in-force business that it’s not worth the time to argue that life settlements are a bad thing,” says Weinberger.
Adds Katz: “Compared to the estimated $20 trillion of life insurance on the books, the life settlement market now totals only $2 to $3 billion. Even if the business grows by 10 times — and it won’t do that — it will still be only 1/10 of one percent of total face amount in force. So the pricing issue is negligible.”
Getting the word out
Less trivial is the level of ignorance, both among consumers and industry stakeholders, about life settlements as an option. Breus says he’s regularly greeted by “astonished looks” when broaching the topic with senior-age clients.
Trust officers who manage their estate assets are often no better informed. Many of them, he says, violate a fiduciary duty to appraise the value of trusts under their care every three years. Or when they do, they value clients’ investment accounts, but not their life insurance policies.
“They don’t realize the policies have untapped value,” says Breus. “When you mention life settlement, they look at you with no degree of understanding.”
Unfamiliarity with (or a disinterest in) the secondary market is prevalent, too, among other professionals engaged in estate planning. For the market to grow, life settlement brokers have to raise awareness not only among prospective clients, but also their advisors.
“The best marketing brokers can do is to let it be known to advisors — accountants, attorneys, trust officers, financial planners and other centers of influence — that life settlements are available,” says Katz. “If they have clients who are retiring, going out of business or in financial difficulties, then that’s the way to expand their practices.”
Challenges aside, life settlement brokers say the space has a ways to go before reaching its potential.
“Over time, I expect that more buyers and will enter the life settlement market, increasing the level of business activity and the size of offers,” says Katz. “The market’s rebound will continue.”
But by how much, and for how long? Proponents of the business foresee the sector following an upward trajectory, with demand fueled by growing public awareness about life settlements, a continuing inflow of capital, increasing sophistication among potential buyers and sellers, and an ever-tightening regulatory regime.
Other factors — life insurers’ continuing resistance to the transactions, an unforeseen economic downturn or a STOLI-like scandal that makes headlines — could also depress sales. This much is certain, however: The industry’s many stakeholders — advisors included — will be following the market’s fortunes with keen interest.