Too Much Insurance, Not Enough Cash?
by Shane Dez

Astunning 89.5% of universal life policies never result in death claims, aaccording to a study by Millman & Robertson. Many of those policies belonged to people who let them lapse because they could no longer afford to pay the premium or the policy served very little or no purpose anymore.
In 2002, life insurance policy owners received close to $336 million in life settlement out of an estimated 1.5 billion dollars face coverage amount with collective cash surrender value of only $93.4 million, according to a 2003 Report by the Wharton School of University of Pennsylvania. That is $242.6 million dollars in excess value that would have been forfeited to the insurance companies.

An Overlooked Asset

A life insurance policy is considered personal property, like a car, stocks, or bonds. Therefore, it can be bought and sold in accordance with applicable laws. Surrendering a life policy to the insurance company is always an option. But settling the policy in the secondary market allows the policy owner to choose among a number of buyers so that the policy is sold for its fair market value, rather than being underpaid by the insurance company. How limited would a homeowner’s options be if they could only sell the house to the original seller?

Life Settlement Defined

A life settlement is the sale of an unneeded or unwanted life insurance policy for a cash payment, which is greater than the policy’s surrender value, but less than the policy’s death benefit. Life settlements typically cater to people over 65.

For a term life policy owner (notably a convertible term life), a life settlement provides immediate cash and liquidity that otherwise would only be available to the beneficiary after the insured’s death. For a whole life, universal life, or variable universal life policy owner, a life settlement pays the fair market value of the policy that is much more than the surrender value, more often than not.

Factors involved in the amount of settlement are the insured’s age and life expectancy, the policy cash value (if non-term), and the required premium payments to keep the policy enforced minus any outstanding loans against the policy. Once sold, all rights and obligations of the policy are transferred to a third party as required by applicable laws. Premium payments become the new policy owner’s responsibility. Upon the insured’s death, benefits are payable to the new owner.
Life settlement laws and regulations have been developed since 1992 by The National Association of Insurance Commissioners. Since then, many states have adopted comprehensive insurance rules for life settlements and settlement providers, providing regulatory protection for policyholders.

Why a Life Settlement?

Due to its positive financial impact, financial planners have a responsibility to explore, explain, and unlock the financial benefits of life settlement to clients and prospects, when applicable. In fact, banks and trust companies believe, when evaluating trust’s assets, there is a potential liability if they do not make life settlement options available to their clients. Most recently, The Insurance Marketplace Standard Association (IMSA) adopted suitability rules that clearly apply to recommending life settlement over policy surrender as a better option to cash in on unneeded or unwanted life insurance policies.

Suitability

In reviewing clients’ portfolio, we should pay close attention to their present situation to determine whether the need for life insurance has become less important or non-existent; in which case life settlement is the solution that the client could need instead of the life insurance.
Take the following examples: Your client is experiencing a decline in health due to a medical condition. He sells his policy for less or settles the policy for more to pay for his medical expenses and his grown children are no longer financially dependent on him. Continuing to maintain a poorly performing life insurance policy may not make as much sense as using its liquidity to help fund a long-term care plan. In this way, the life insurance policy can become a real asset.

Once suitability is determined, the proceeds from settlement can be used for living benefits, such as a long-term care, an immediate income annuity, or any other financial products. If the client is insurable, but over-insured, life settlement could be a perfect vehicle to fully pay for a life insurance with a lesser-needed face amount.

Why Sell A Life Insurance Policy?

To determine suitability, it is important to understand why a client should consider selling a policy. A life settlement is appropriate if the policyholder is considering letting a policy lapse, they now need very little or no life insurance, the insured has outlived the beneficiary, or the premium payment has become a financial burden. There are many other circumstances in which a life insurance policy may no longer be needed. Here are some of those circumstances:
• The policy was purchased to protect the insured’s family, but children are all grown and well on their own so the family protection is no longer an issue.
• The policy was purchased for estate and tax planning purpose, but the policy owner has very little or no estate tax exposure, due to increasing estate tax credits or exemptions, sold or depreciated properties, charitable gifts and donations, or poor investment performance resulting in declining liquid assets, just to name a few.
• The policy owner can no longer afford the premium and is forced to let the policy lapse or surrender.
• The insured’s medical condition is chipping away at their savings. Consequently, there is more concern about sparing or improving the insured’s life than leaving money for the beneficiary.
• The policy was purchased to finance a cross purchase or buy/sell agreement between business partners. But, the business partnership has changed, the underlying business has been sold or dissolved, or the company has gone into bankruptcy.
• A business purchased a key person life insurance policy, but the executive has retired, is no longer employed by the company, or has been forced to resign due to a medical condition.
Even though institutions have poured billions of dollars into life settlements and the potential market has greatly expanded, the life settlement market is still in its infancy. Several institutions have been watching their peers and evaluating the right time to enter the market.
This will create greater efficiency and competition. As a result, the life settlement industry will be able to provide service to eligible policyholders more efficiently.
Considering the zero cost of applying for life settlement valuation, the enormous benefits to qualified policyholders are thought provoking, not to mention the untapped rewards to financial planners in exchange for invaluable services they can offer to their clients.
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Shane Dez is a Certified Estate Advisor and the president/ CEO of Shane Dez & Associates, a network of benefits & financial planning serving Individuals and Small Businesses in Orange County since 1983. He has helped hundreds of clients with comprehensive financial, tax and estate planning using insurance products. For more information, call 949-250-8999 or e-mail shanedez@shanedez.com.