Jeff Hallman

In a first-of-its-kind announcement on the topic of life settlements, the Financial Industry Regulatory Authority recently released a set of guidelines aimed at consumers that define the agency’s stance on selling unwanted life insurance policies in the secondary market.

As the regulatory body responsible for supervising the securities trading activities of broker-dealers, FINRA’s guidance is welcome news to many of us in the industry.

Although the regulation of traditional life settlement transactions (which comprise the bulk of policies sold in the secondary market) fall under the purview of the states, transactions involving variable life policies are considered securities and therefore come under FINRA’s watch.

Here’s our take on why FINRA’s announcement is noteworthy:

1. It affirmed the efficacy and legality of life settlements, thereby establishing greater confidence in the market for seniors looking to sell unwanted policies.
2. It advised policy sellers to “shop around” to get the best price and spotlighted the role of life settlement brokers who have a fiduciary duty to protect the policy seller’s best interests.
3. It addressed (albeit implicitly) any hesitancy on the part of broker-dealers that may still be in the process of shaping their best practices or compliance procedures for recommending the option to clients.

In short, we view FINRA’s action as yet another step forward in shaping the trajectory of a maturing marketplace that has been driven for more than 20 years by the financial needs of retired seniors.

Looking Back
During the early stages, participants in the secondary market consisted of (1) a handful of providers who served as policy acquisition agents for institutional investors; (2) dozens of experienced life settlement brokers who negotiated the highest offer for the policy seller; and, (3) thousands of life insurance agents who sourced the majority of policies sold in the marketplace.

Based on our experience as life settlement brokers dating back to the early 2000s, very few broker-dealers, CFPs, estate attorneys, CPAs and other fiduciary professionals embraced life settlements as a solution for their clients. Consequently, the bulk of all transactions originated with life insurance agents whose clients were dead-set on getting the most value for their unwanted policies.

To the early adopters in this emerging market, there was little doubt that selling an unwanted life insurance policy for five to six times its cash surrender value (versus lapse or surrender) was in the policy seller’s best interest. These early market participants never imagined that, twenty years later, the phrase “serving the client’s best interest” would be top-of-mind for financial professionals throughout the financial services industry.

Changing Attitudes/A Major Turning Point
The turning point for many financial professionals—especially fiduciaries and members of self-regulatory organizations such as FINRA, FPA, AICPA, etc.—began emerging in the aftermath of the 2008 financial crisis. Due to enactment of the Wall Street consumer protection reforms in 2010, the financial services industry gradually adopted a series of laws and regulations that became a game-changer for the industry.

Although the regulation of traditional life settlements was not directly impacted by the federal reforms, the new initiatives transformed the mind-set and the manner in which most financial and insurance professionals interacted with their clients.

One of the most significant consumer reforms occurred in 2020 with the enactment of SEC Reg. BI—known as “Regulation Best Interest.” The rule states that broker-dealers have a fiduciary obligation to recommend only products that are in their customers’ best interest. Since its enactment, financial professionals who fall under SEC’s watch have been on high alert to comply with its mandate.

Fiduciary Obligation of Life Settlement Brokers
We consider it noteworthy that SEC’s “best interest” rule closely parallels the state licensing requirement for life settlement brokers.

Life settlement brokers are mandated by most state regulations to represent the policy seller’s “best interests” and to fulfill their fiduciary duty by negotiating the highest possible offer. (It is important to note that life settlement providers (buyers) who purchase policies are not held to that same fiduciary standard.)

Considering the spirit of the consumer-focused reforms mentioned above, it’s possible that, in certain situations, financial professionals could face a potential liability risk for not disclosing the life settlement option as the best possible solution for the client—especially for policies about to lapse.

Fast Forward to 2023
Today, selling an unwanted policy is widely embraced by most financial professionals as a prudent strategy for unwanted policies.

Unlike 20 years ago when many fiduciary professionals viewed the secondary market with skepticism, we are now routinely transacting life settlement cases submitted from a combination of professional advisors, including insurance advisors, financial professionals, estate attorneys, CFPs, CPAs, broker-dealers, trustees and trust officers.

While the change in mind-set took several decades to shape, we believe the regulatory landscape that emerged has provided an even stronger foundation to serve the needs of senior consumers burdened by premium payments for unwanted policies.

Key Takeaways
As we enter the final quarter of 2023, it is clear that life settlements have earned a seat at the table as an effective wealth optimization strategy utilized by most financial professionals and fiduciaries.

While FINRA’s recently published guidelines were targeted to the consumer audience, we believe their reach is broad and will serve to elevate the confidence level of broker-dealers and other financial professionals who may have been hesitant to embrace the solution.

Finally, FINRA’s guidance helped spotlight the important role of life settlement brokers in selling a policy for the highest possible offer. After all, it’s their fiduciary duty to do so.

Administration of a family trust for ultra-wealthy clients is a complex undertaking. As such, the proper management of the trust requires the highest level of fiduciary competence.

While the trustee is legally responsible for overseeing the trust’s assets—including the performance of trust-owned life insurance policies—achieving the grantor’s objectives typically requires consultation with a team of professionals from a variety of financial disciplines.

This article details a life settlement case study that demonstrates how a trustee and a team of four other interdisciplinary professionals achieved a “quinfecta” of fiduciary best practices associated with selling an unwanted TOLI policy for the highest possible value.

Each member of the client’s advisory team—comprised of the trustee, CFP advisor, CPA, insurance specialist, and the life settlement broker—exercised his/her respective fiduciary obligation in a manner that resulted in an extraordinarily successful outcome for the grantor, the trustee, and the beneficiaries of the trust.

This case study provides an excellent instructional tool for financial professionals, estate planners, broker-dealers and other fiduciary professionals who want to raise their competency level regarding the life settlement market.

Trustee: Top of Fiduciary Food Chain
The trustee has the ultimate fiduciary oversight for managing the trust’s assets. Due to the complexity of the expertise required to fulfill his duties, the trustee typically consults with other professionals in the family’s circle of advisors and may outsource certain services. His goal is to assemble a team of multidisciplinary practitioners who utilize fiduciary best practices and who are committed to the highest standards of professional conduct. For them, serving the client’s best interests is not only the cardinal rule, but also good for business.

When the trustee’s duties involve decisions regarding trust-owned life insurance policies that are no longer needed or have become too costly to maintain, the trustee often engages the expertise of a highly competent and credentialed insurance professional. The insurance expert’s role is to identify solutions that are aligned with the grantor’s current wishes. In some instances, the options may involve recommending the sale of unwanted life insurance coverage in the secondary market for life insurance.

TOLI Policy: Exit Strategy Needed
This case involved a 91 year old male who had purchased two permanent life insurance policies (valued at $3 million and $2 million) more than 20 years ago. The purpose for the trust-owned policies was twofold: To reduce the size of the taxable estate, and to create sufficient liquidity for beneficiaries to pay estate taxes and estate administration expenses upon the grantor’s death.

Recently, the grantor decided he no longer wished to maintain the annual premiums totaling $217,381. The costly premiums were eroding the cash assets in the trust and the adult beneficiaries wanted to repurpose the money being spent on premiums to purchase new investments held in the trust.

Insurance Specialist: Fiduciary-Focused and Top in His Field
A critical step toward employing a series of fiduciary best practices began when the trustee and financial advisors (credentialed fiduciaries) agreed to work with an experienced life insurance specialist to conduct a thorough performance review of both policies.

The life insurance expert chosen for the undertaking specialized in comprehensive estate and life insurance planning solutions for high net worth and ultra-high net worth clients. This individual and his associates (combined) had earned the highest credentials in the life insurance field—Chartered Life Underwriter (CLU), Chartered Financial Consultant (ChFC), Certified Exit Planning Advisor (CEPA) and Certified Financial Planner (CFP). Maintaining such credentials requires the practitioner to demonstrate they are operating with the highest level of fiduciary commitment to the client.

The trustee (as per his duty), carefully documented the process while the insurance specialist undertook policy reviews for the two policies.

The outcome of the process revealed several unique challenges:

• Both policies would terminate prior to the insured’s average life expectancy. However, continuing to maintain both policies to maturity would require substantial increases in the premiums. Such a course of action would further erode the cash assets in the trust and would not be an acceptable solution.
• Another challenge that had to be overcome involved a split dollar arrangement for the $3 million policy wherein a $500,000 loan to the trust from the grantor’s LLC was used to fund the premiums for that policy. Therefore, irrespective of the course of action chosen by the advisory team, the policy loan would have to be repaid at some point, thereby further draining the trust’s cash assets.

After presenting all possible scenarios, the insurance expert noted that achieving the goals of the grantor and his beneficiaries could be accomplished by selling the $3 million policy and using a portion of the proceeds from the life settlement to pay off the $500,000 loan on the same policy.

Depending on the amount of the payout from the life settlement on the $3 million policy, their hope was that the proceeds from the sale of the policy would also provide a substantial amount of liquidity for purchasing new investments owned by the trust, per the goals of the adult beneficiaries.

During the course of their discussions, the trustee, financial advisors, insurance specialist and the CPA noted that the most successful outcome would hinge on selling the policy for the highest possible amount in the secondary market. They agreed it was essential to partner with an experienced life settlement broker who was highly skilled in negotiating with institutional investors in the secondary market, and who also was bound by a fiduciary duty to represent the policy seller’s best interests.

Life Settlement Broker’s Fiduciary Duty
Once a trustee decides to outsource the sale of an unwanted policy to an experienced life settlement professional (i.e. a life settlement broker or a life settlement provider), he does not check his fiduciary duties at the door.

Fulfilling the trustee’s duties requires proper vetting and choosing an experienced life settlement broker who is bound by a fiduciary duty to the policy sell. This means the life settlement specialist must be highly skilled at negotiating with multiple buyers in the secondary market to generate the highest possible payout for the seller’s policy.

As a licensed broker the life settlement company holds a fiduciary duty to represent the policy seller’s best interests in the secondary market, (F.S. Sec. 626.9911). In effect, it is the broker’s fiduciary duty per state law to engage in negotiations with multiple buyers until the highest possible settlement is reached for the seller’s policy.

After obtaining all pertinent documents and completing the underwriting process, the settlement team submitted the case to more than 25 institutional money sources and launched into the competitive bidding process. Competition to purchase the policy was rigorous. By the end of the auction process, a total of 15 offers had been submitted from multiple funding sources. The lowest offer submitted was $1,250,000, and once the bidding process had run its course, the highest bid came in at $1,515,000.

During every step of the competitive bidding process, the life settlement company communicated with the team’s insurance specialist and provided frequent updates and documentation regarding the bids received. Complete transparency is essential for a broker, including disclosing to the seller the amount of their commission on the sale.

It’s noteworthy to point out that had the trustee and the client’s team of advisors opted to accept the cash surrender value (CSV) for the $3 million policy instead of selling the policy, they would have received only $150,000—one-tenth of the highest life settlement offer.

Five Levels of Fiduciary Best Practices
As the life settlement transaction approached the final stage, the insurance specialist presented the results of the competitive bidding process to the trustee and other members of the advisory team.

During their discussions, the CFP advisor noted that the $1,515,000 proceeds from selling the $3 million policy would enable the trustee to achieve several objectives. First, it would minimize or eliminate the drain on the trust’s cash assets that were being used to make the annual premium payments. Secondly, after repaying the $500,000 loan and terminating the split dollar arrangement, the remaining $1 million from the settlement could be invested. The growth from the new investments would help support the required premiums for the $2 million dollar policy to remain in place.

The entire team (i.e. trustee, insurance specialist, CFP advisor and CPA), unanimously agreed to accept the offer for $1,515,000 and directed the life settlement company to finalize the transaction. In their view, selling the policy was clearly the most financially prudent course of action to achieve the goals of the trust and the beneficiaries.

In short, the combination of the $1.5 million settlement to repay the outstanding $500,000 loan to the grantor and keep the $l million in the trust going forward resulted in a win-win-win, (i.e. a win for the grantor, a win for the trustee, and a win for the trust beneficiaries).

Take Away
Given the complex planning needs of affluent clients, life settlements have emerged as a powerful wealth preservation tool for financial advisors, CPAs, estate planners, and family trustees who have a fiduciary obligation to the client when pursuing the most prudent exit strategy for an unwanted TOLI policy.

As noted above, this life settlement success story is a compelling instructional tool for estate planners and other fiduciary professionals who want to raise their competency level regarding the life settlement market. Specifically, this success story showcases the following best practices:

• Illustrates and underscores the high degree of professional expertise and the fiduciary commitment required involving the prudent disposition of unwanted trust-own life insurance.
• Demonstrates the necessity for a trustee to partner with other fiduciary-minded professionals to achieve the most favorable outcome when selling a trust-owned policy.
• Cautions trustees that their fiduciary duty extends to the choice they make in partnering with an experienced life settlement broker to represent the policy seller’s best interests.
• Reminds professional advisors that accepting a single offer from only one life settlement provider (funder) may run contrary to their fiduciary duty. Unlike brokers, life settlement providers are not required by law to represent the seller’s best interests, nor are they required to disclose their compensation. On the contrary, the provider has a duty to their funding sources to acquire policies at the deepest discount possible.
• Highlights the fact that when a fiduciary professional is presented with the option to: (a) allow the client’s unwanted policy to lapse; (b) accept a low cash surrender offer; or (c) partner with an experienced life settlement broker to sell the policy for a payout that is multiple times the CSV—the fiduciary’s choice becomes quite clear.

In short, a strong commitment to fiduciary duty and serving the best interests of your high net worth clients is always job one. And it’s also good for business.