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.