Life settlements have been in the market for over 30 years. What once was an unregulated financial transaction designed to help AIDS victims not covered by insurance pay for health care, has evolved into a well regulated, mainstream financial option for seniors. In 2018, there was $3.8 billion of life settlements transacted for life insurance policy death benefits that would have otherwise been lapsed or surrendered by the owners.
Americans own more than 150 million life insurance policies, but over $650 billion of death benefits are abandoned by the owners every year. Of that amount, seniors own $230 billion of death benefit that on an annual basis could potentially qualify for a life settlement. $3.8 billion of life settlements transacted last year indicates this is a healthy, growing market. Yet, in comparison to the amount of policies let go every year, and the high amount owned by seniors, you can see that the room for growth in this market is almost limitless!
More policy owners are becoming aware of life settlements every day thanks to TV commercials, positive news articles, and the growth of advisors incorporating life settlements into their practices. In fact, life settlements have become such a well-known option for policy owners that, if you are not talking to your clients about this option, someone else is.
Studies show that nine out of 10 life insurance policies are in danger of being lapsed or surrendered by the owner. But, according to the National Association of Insurance Commissioners (NAIC), the value that a policy owner can receive through a life settlement can be significantly higher. A Life Settlement Evaluation will quickly determine if your client would qualify to settle their policy while it is still in force and what percentage of the face value that they could receive as a payout for their policy.
But what should advisors know about life settlements beyond the basics, and what should they know about how the life settlement market functions?
Five Key Life Settlement facts you should know:
- Surrender Value vs Settlement Value—Life settlement industry averages over the years show that life settlement market value can be five times to 10 times greater than surrender value, and certainly a smarter option than to lapse a life insurance policy after years of premium payments. The range for a life settlement can be as low as 10 percent of the face value, and can climb as high as 60 percent or greater of the face value.
- Reverse Underwriting—Qualifying for a life settlement is the opposite of qualifying to purchase insurance. In this case, the older and more impaired the life of the insured is, the higher percentage of the death benefit the policy owner will receive in “present-day value.” A person who would qualify to buy a life or LTCI policy would be too young and/or healthy to qualify for a life settlement, and a person who would qualify for a settlement would be an automatic decline to buy any type of life/health insurance. The typical age range for a life settlement is 75-89, but younger or older applicants can qualify based on the severity of their health related impairments.
- New Value from Old Asset—Life insurance policies are legally recognized as assets of the policy owner, with the right to sell their policy for its market value. Once a policy is sold, the owner will receive a lump sum that can be used in a variety of ways to meet the unique financial needs of seniors and/or those suffering from health and long term care needs. The minimum policy size to qualify for a life settlement is $100,000 of face value (and there is no upper limit for policy size).
- Tax Advantages—Life settlements provide specific tax advantages for policy owners. If a policy owner is diagnosed as chronic or terminal, the proceeds from a life settlement are tax-exempt. If a life settlement is done for a policy owner not chronic or terminal, the proceeds received are taxed at capital gain for any amount received above the basis in the policy (basis=premiums paid). Policy owners rarely need to pay taxes for life settlements.
- Fiduciary Responsibility—A life insurance policy is legally recognized as an asset like a home or stocks. The owners of these assets need to be informed of their options to maximize their value, and the same is true of a life insurance policy. Advisors need to understand this option and educate their clients or risk possible legal ramifications. There are settled lawsuits on the books brought by policy owners against advisors for failing to inform them of their life settlement option. Life settlement evaluations are a smart defense for advisors against potential future problems from clients who abandon a life insurance policy.
What Is the Life Settlement Evaluation Process?
Step One—Information: Submit policy owner information and a current, in-force illustration.
Step Two—Analysis: Policy owner information is reviewed for age, gender, state of residence, and prevailing health impairments impacting remaining life expectancy (the typical qualifying range is 2-10 years). The policy illustration will be reviewed to analyze the policy economics for the remaining time the new policy owner would keep the policy in force.
Step Three—Results: Longevity/settlement experts present a policy valuation analysis detailing what the owner could expect to receive as a percentage of the death benefit for their policy. A formal purchase and sale agreement is executed if the policy owner agrees to the valuation offer. The typical time it takes from Step One—opening the case, to Step Three—closing the purchase and sale of the policy, is 60-90 days.
Advisor Life Settlement Checklist
- What type of licensed entity is the organization: Provider or Broker?
- Are you working direct with the buyer, or are you working with a broker between you and the buyer?
- Does the settlement entity have contracting documents and state filed disclosure forms to appoint an advisor under their license and E&O?
- Will the entity cover the costs of, and order, all medical records, life expectancy reports and do all the settlement work for the submitting agent?
- If an advisor is going to co-broker with a licensed life settlement broker, have they been properly informed about state regulatory laws that the advisor (and any up-line participating in remuneration) must possess a life settlement broker’s license, specific life settlement E&O coverage, and meet consumer disclosure and annual state filing requirements?
- Does the settlement entity require any kind of exclusive, prohibiting the advisors from talking to other settlement entities about a case at any time?
- Does the settlement entity take a commission out of the gross offer to pay themselves, or is it a no-load settlement with advisors fees paid separately from the offer?
- If a brokerage commission is taken, how does the advisor independently verify from the buyer how much the actual gross offer is, and how is the co-brokerage commission divided between the settlement broker, the advisor and any up-line?
- Is the compensation for a settlement based on the face amount of the policy, or is it taken as a percentage out of the gross offer?
- If a term conversion, does all of the conversion compensation get paid to the advisor and the up-line?
Life settlements play an important role in financial planning for seniors. A policy owner is always better off to get the highest value for their asset, than to potentially lapse or surrender for far less. There are a number of advantages for seniors who utilize a life settlement, including: Favorable pricing for higher age and more impairments, property ownership rights and protections, tax advantages, and fiduciary considerations.
But, for advisors seeking to access the life settlement market, it’s important they conduct due diligence before working with a settlement entity. Advisors should understand the key differences between: Working with a life settlement broker or under direct appointment with a buyer; co-brokerage licensing requirements and E&O coverage; no-load settlements vs commissions taken out of the offer; and disclosure vs non-disclosure compensation rules. These are among the factors that can be completely opposite from each other based on if advisors co-broker a life settlement versus acting as an appointed agent of a life settlement buyer.
