Life Settlements – Don't surrender your policy
People who need some of the benefits of the life insurance
policy before they die, or who have life insurance policies
that for whatever reason will otherwise lapse, should consider
selling their life insurance policy by way of a “life
settlement”. This allows people to get cash out of
their life insurance policy, in an amount in excess of the
policy’s cash value (if any), while they are still
alive.
A life settlement is the sale of an insurance policy, for
more than the insurance policy’s cash value, to an
investor who keeps the policy alive until the person on whose
life the policy is on dies. Often, life settlements involve
insurance policies that are failing because they lack sufficient
cash value to pay the annual insurance costs, and the policy
would have expired anyhow. Sometimes they are term life insurance
policies where the policy owner for whatever reason cannot
make the necessary premium payments, or desires not to anymore.
Essentially, the buyer purchases the policy (giving the selling
owner immediate cash) and then resuscitates it or keeps it
alive until somebody dies, and then policy finally pays out
to the buyer who presumably will get his money back plus
some investment yield.
Life settlements can be real saviors for people whose life
insurance policies will expire if the status quo is maintained,
and who cannot (or are unwilling) to put additional cash
into the policy to keep it alive. Instead of the policy eventually
becoming worthless, or being limited to the policy’s
existing and perhaps low cash value, they instead get a nice,
current cash settlement in excess of the policy’s cash
value. As we will discuss below, insurance companies hate
the life settlement industry because it means fewer policies
that lapse before the death benefit it paid, thereby reducing
the life insurance companies’ profitability that traditionally
anticipates high lapse rates. Insurance companies would instead
prefer (greatly prefer) that the policy owners simply surrendered
their policies for the cash value of the policies, thus creating
a windfall for them since the amounts paid during the life
of the policy for “death benefits” turned out
to be free money to the insurance companies.
A life settlement means that the current policy owner will
receive money for selling their policy, and the policy owner
is not required to put up any cash or make any kind of investment.
The current policy owner receives, very simply, a large lump
sum of cash for selling the policy, and thereafter had no
further financial obligations.
Why Policies Fail or Become Unneeded
Life insurance policies can “fail” – or
just no longer be needed -- for many reasons, including:
-
The owner has borrowed too much of the cash value of
the policy for it to be self-sustaining. This usually
happens with retirees who have ended up using the policy
as a source of retirement funds, or who have had some
unexpected event occur that required them to draw down
the cash value of the policy.
-
If the investment performance of a variable policy
was very bad in the early years, the policy will not
perform as predicted. Those who bought variable policies
from 1999 through 2001 can probably relate to this.
-
Too many unscrupulous life insurance agents have put
their clients into policies that, in retrospect, were
doomed from the start considering the clients’ situation
and cash needs.
-
Another type of “failure” is that for whatever
reason, the life insurance is no longer needed. The intended
beneficiary may have died or been disinherited, or for
estate tax planning reasons it no longer makes sense
for the policy to pay out as planned, such as that the
estate no longer needs insurance for liquidity.
-
A company’s key executive could retire, thus ending
the company’s need to maintain insurance on his
life.
· A business could fail, be dissolved, or go public, thus eliminating
the need for Buy-Sell Arrangement backed with insurance.
-
An individual policy is being replaced with survivorship
insurance.
-
A better insurance or financial product for particular
circumstances has become available, but for whatever
reason the existing policy cannot efficiently be “rolled” into
it.
-
The policy is no longer affordable, or the owners need
relief from the monthly premium expenses.
-
The owners need cash now, such as for a medical emergency
or to assist a child or grandchild, or they need cash
to supplement their retirement income. Also, the owners
want a higher cash payout than the cash surrender value.
Not the Same as Viaticals
Although very similar, life settlements are not the same
as viatical settlements, which typically involve the sale
of a life insurance contract for somebody who is terminally
ill, such as a cancer patient or somebody with AIDS. The
idea behind a viatical settlement is that, although the insurance
policy is well-funded, the person can’t get the benefits
of the policy now – when they need it – and so
they sell their policy to somebody for an immediate cash
payment that they may need for medical care, etc.
Typically, viatical settlements are made when the person
on whose life the policy is on has some sort of terminal
illness, and a life expectancy of less than two years. If
that person’s life expectancy is greater than two years,
then a life settlement is made instead. The difference is
that the buyer of a viatical settlement has a much, much
greater chance of being paid the full policy proceeds in
the short term, and thus have greater comfort that their
ship will come in soon. For this reason, buyers are willing
to pay much more for viatical settlements than for life settlements,
since there is no expectations of an immediate payout with
the latter and the buyer may be forced to wait some years
or decades – and having to additionally fund the policy
in the meantime – until the policy pays out.
As investments, viatical settlements have gotten a bad
name for two reasons: (1) there have been many scams involving
viatical settlements where promoters organized “pools” and
raised and embezzled moneys, and never attempted to buy any
real policies; and (2) many viatical settlements were made
on HIV/AIDS patients who, with the help of new drugs, subsequently
recovered and lived for years and decades after their viatical
settlement was made (to the deep chagrin of the buyers of
those settlements).
Little Risk to Seller
Back to life settlements, there is little risk from the
owner’s perspective in selling their insurance policy
if the policy would otherwise fail. Usually, these are cash-in-hand
transactions, and there is little risk of the persons losing
money on such a deal, assuming that the current value of
the insurance contract has been calculated fairly.
Types of Qualifying Policies
Nearly all life insurance policies will qualify for life
settlements, including term, universal life, variable life,
and whole life policies. Sometimes, even group life policies
can be settled. Whether it makes sense for a buyer to purchase
such a particular policy is a completely different issue.
Some of the factors to be taken into account by buyers are:
-
Is the issuing insurance company rated at least B+
or better?
-
Does the policy allow for an absolute assignment or
change of ownership?
-
How much cash will be required to resuscitate the policy?
-
Is the policy at least 2 years old?
-
Is the policy non-contestable, and are there unfavorable
policy exclusions?
-
What is the face value of the policy? (Policies with
a face amount under $100,000 are often not worth the
time to most brokers, but you never know).
-
Who is the insured and what is their health and life
expectancy?
-
Has there been a change in health (if nothing else,
due to aging) since the policy was issued? (Note that
good health is not an automatic disqualifier, depending
on age).
-
Can copies of medical records on the insured be obtained?
No Medical Exams Required
Except in the rarest of occasions, there is no need for
the insured to undergo any additional medical examination.
Usually, the buyer can make a determination of the policy’s
value based only on the insured’s general health condition
and age, then measured against their life expectancy estimates.
Usually, a prospective buyer will ask the insured to sign
some medical release forms and an application, so that they
can pull all the past medical files and make a determination
how long the insured is expected to live based on actuarial
tables. The buyer will be required to keep the information
confidential, and the buyer will first have to come to the
insured for their written release to give the information
to anybody.
After the policy has been sold, the buyer will have the
right to occasionally check with the insured’s doctor
to determine whether you are still alive. Some buyers will
set up a system where they send the owner a postcard every
six months or so, for the insured to sign and return.
Partial Settlements
In some cases, it is not necessary that the full policy
be sold. Instead, you can transfer to a buyer only part of
a policy.
Transferring the Policy – Payment – Escrow Agents
Although each buyer is different, most transfers of policy
involve the use of an escrow agent. You deposit your policy
and the buyer deposits the purchase amount with escrow agent,
and then when all the necessary paperwork is completed giving
your rights to the policy to the buyer, the escrow agent
releases the money.
For this reason, it is important to both parties that a
quality escrow agent (often a reputable bank or law firm)
be used.
Miscellaneous
Most states have provisions allowing you to rescind the
contract and get your policy back within a certain number
of days, usually 15 days or so. Of course, you have to give
the money back to get the policy back.
Tax Implications
The tax treatment of life settlements and viaticals can
be very tricky, and can be some combination of income and
capital gains (or, nothing at all in a given case). Often,
how the sale is structured can help to dictate what the tax
effects will or will not be. For this reason, it is critically
important that the existing owner of the policy consult with
a financial planner to determine the tax effects.
Potential Downsides
It is critically important to consult with a financial
planner about other aspects of life settlements as well,
including:
-
Do you need the insurance?
-
Can or should the insurance be replaced, and what will
the premiums be?
-
Will you lose any conversion rights or other benefits
under your existing policy?
-
Will receiving a large lump sum of cash affect in a
negative way your ability to receive supplemental social
security income or certain publish health benefits such
as Medicaid?
-
Will you lose any asset protection of the cash value
if it is currently being protected by creditors under
your state’s exemption laws?
Life Settlement Scams
Where there are, unfortunately, scams in this area is that
scam artists seek investors for “pools” or “partners” to
invest in life settlements. Often, the scam artists will
show the investor that they can make big returns investing
in life settlements, and obtain the investor’s money,
but then they never actually purchase any insurance contracts.
Instead, they simply pocket the money, using a portion of
it to pay “returns” to previous investors in
a pyramid scheme sort of way. A big problem is that the life
settlement industry, as is the viaticals contract industry,
very loosely regulated and it is difficult if not impossible
for a person desiring to invest with a broker of such contracts
whether the broker is legitimate or not.
Sometimes, an investor will persuade an older person to
buy a life insurance policy specifically for the purpose
of selling it into the life settlements market. Such a policy
is known as “wet paper” and may not be sellable
at a profit for some time, or the insurance company may suspect
collusion and cancel the policy.
Sometimes, sellers and the buyer will intentionally misrepresent
the insured’s health as poor, in an attempt to drive
up the policy value (since a subsequent buyer would think
the person is soon to expire and thus the policy will pay
off soon). This is known as “cleansheeting” and
is basically a scam on subsequent buyers.
Insurance Company Scams
Actually, the greatest scam in this area doesn’t
involve insured, owners, or buyers, but involves the insurance
companies themselves, since they don’t want these transactions
to take place. The reason is that insurance companies typically
rely on a certain percentage of policies lapsing for profitability.
In other words, insurance companies expect that X% of people
will, for whatever reasons, not keep their policies up and
therefore they will expire. To the extent that this happens,
whatever the insurance company has collected so far is pure
and glorious profit to the insurance company.
Insurance companies would instead prefer (greatly prefer)
that the policy owners simply allowed their policies to lapse.
If that doesn’t happen, the insurance companies want
the policies they have issued surrendered back to them for
the cash value of the policies, thus creating a windfall
for them since the amounts paid during the life of the policy
for “death benefits” turned out to be free money
to the insurance companies.
For these reasons, many insurance companies are downright
hostile to life settlements, and do not allow their agents
to promote them to their clients. The insurance companies
say something like “getting rid of the policy means
that the original insurance goals were not furthered” or
something to that effect, totally ignoring, of course, that
the insurance company itself relies for profitability on
a certain percentage of policies lapsing or being surrendered
for cash value. Thus, insurance companies will urge the surrender
of the policy even though policy surrender might not yield
anywhere near the cash that a life settlement would. And
therein lies the very subtle fraud of the insurance companies
on their policyholders.
Not all insurance companies are complicit in this fraud,
and an increasing number of insurance companies are starting
to encourage their policyholders to consider the possible
benefits of life settlements in some circumstances, after
a very thorough analysis of the consequences in a given case
of course.
No Costs to Inquire
Typically, prospective buyers of life insurance policies
do not charge fees to review a particular policy to see whether
it might qualify for a life settlement. Beware those buyers
who do charge significant up-front fees as it might be an
advance fee scam.
Source: AP
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