Life settlements are growing in popularity, even as financial advisors and insurance brokers are reluctant to discuss these transactions with their clients. That reluctance, however, is problematic — particularly if you are in a fiduciary role. Because life settlements can generate substantially more cash for the policyholder than a surrender or lapse of the insurance, not presenting the life settlement as an option could constitute a breach of fiduciary duty.
A 2014 lawsuit, Larry Grill, et al. v. Lincoln National Life Insurance Co., hinged on this very concept. The plaintiffs claimed fraudulent concealment and financial abuse of an elder, because their broker failed to inform them that they could sell their insurance in a life settlement. The couple had purchased $7 million in life coverage and, despite 10 years of sizable premium payments, the policy was not generating sufficient investment returns to cover their cost-of-insurance charges. When the Grills asked their broker for options, the broker advised that they could pay more in premiums or reduce their coverage. They subsequently surrendered more than $5 million of their life insurance. After learning that they could have sold their policy in a life settlement for cash, the couple filed suit.
Though the case was eventually settled, the courts did confirm that failure to disclose the life settlement option could result in financial harm to both policyholders and beneficiaries.
What does all this mean for you? If you are a fiduciary advisor, it’s critical to understand how life settlements work and be able to recognize the situations where one may be fruitful for your client.
1. Clients can benefit from understanding the value of their life insurance asset.
Fiduciary duty doesn’t require you to educate every one of your clients about the secondary life insurance market. But in situations where clients are already considering a reduction or restructure of their life insurance, the life settlement conversation is warranted.
Clients who are over-insured, burdened by high premium payments, or facing a liquidity shortfall may view the cancellation of their life insurance, particularly high-dollar policies, as a quick source of financial relief. If they surrender the policy back to the insurer, they will receive the policy’s cash surrender value. They’ll also no longer be responsible for the premium payments. Those are both good things for someone who’s struggling financially.
The thing is, a life settlement also accomplishes those outcomes — while generating more cash for the policyholder in the process. A typical selling price in a life settlement would be 20% to 30% of the policy’s face value, though some policies are worth up to 60% of face value.
Here are some questions to consider. Would your client benefit from knowing the market value of his or her life insurance? Is that value an important reference point for making an informed decision about surrendering the policy or keeping it in force? Does your client have excess life insurance? Is your client looking for financial restructure strategies due to solvency concerns? If any one answer is yes, then it may be time to discuss life settlements with that client.
2. Life settlements aren’t right for everyone.
A life settlement can unlock wealth in the right situation, but it’s not a cure-all financial strategy. For one, not every life insurance policy is marketable. Investors prefer permanent or convertible term policies valued at $50,000 or more, and insureds who are at least 65 years of age. Younger policyholders who are terminally or chronically ill may, however, qualify for a viatical settlement instead.
Secondly, the life settlement does transfer the policy’s death benefit to someone else. For that reason, the client who feels strongly about using the death benefit as an inheritance or gift to surviving loved ones is not a candidate for a life settlement.
And finally, a life settlement may produce unwanted financial implications in some situations. A portion of the proceeds will likely be taxable, for example. As well, the value in that life insurance may be protected from creditors before the sale — but that protection ends when the client receives the cash proceeds once the transaction closes. The influx of cash may also affect the client’s eligibility for needs-based programs like Medicaid. For those reasons, your client should invite legal and tax advisors to the conversation before any decisions about life settlements are made.
3. Fiduciary duty of brokers vs. providers.
The main players in a life settlement transaction are the selling policyholder and the buyer, also known as the life settlement provider. Providers can purchase life insurance directly, but they also work through life settlement brokers.
The distinction between a broker, like Suncrest Benefits, and provider is important to you and to your client. Here’s why. The broker has fiduciary duty to the client, but the provider does not. The provider is buying the insurance on behalf of an investor and is bound to that investor to pay the lowest price possible. The broker’s role, however, is to capture the highest selling price. He or she delivers on that goal by setting up a bidding auction among potential buyers. The competitive nature of the auction naturally puts upward pressure on that selling price. A broker might manage three rounds of bidding, for example, negotiating along the way to push those offers higher.
Sellers do pay brokers a commission from the proceeds. Even so, the brokered sale often produces a higher net payout than a direct sale because they can generate a higher selling price.
4. Life settlements are a viable financial strategy.
The life settlement is a legal, regulated transaction that can provide much-needed cash flow for seniors. It’s a viable financial strategy and, in some situations, the most lucrative approach for someone who no longer needs or wants their life insurance. The financial advisor who understands life settlements and can present them when appropriate is prepared to fulfill the fiduciary standard and also help clients reach their financial goals. On the other hand, the advisor who avoids the topic, even as a client considers surrendering life insurance, may be in direct violation of that fiduciary duty.