Life settlement

A life settlement is a financial transaction in which a policyowner possessing an unneeded or unwanted life insurance policy sells the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.

Life settlements are an important development in that they have opened a secondary market for life insurance in which policyowners can access fair market value for their policies, rather than accepting the lower cash surrender value from the issuing life insurance company.

Generally speaking, life settlements are an option for high-net-worth policyowners age 65 or older. Independent estimates report that among this group, 20% of policies have a market value that exceeds the cash value offered by the carrier. And while many policyowners are unfamiliar with life settlements until a financial professional mentions the option to them, the concept has gained attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill Gradison, and numerous media sources including The Wall Street Journal, Time Magazine and The Economist. A growing number of experts now believe that informing clients about offering life settlements should fall under the fiduciary duty of a financial advisor.

How It Works

In a life settlement transaction, there is a chain leading from the seller of the policy to the end buyer of the policy (known as a life settlement provider.) Each link in the chain has a different responsibility in facilitating the transaction and ensuring that it runs smoothly, while outside vendors typically assist the provider with specialized functions.

Policy Sellers

Candidates for life settlements are policyowners over the age of 65 who no longer want or need a particular life insurance policy. Life settlement candidates generally have a life expectancy between 2 and 20 years. There are certain restrictions for their policies as well - policies must be valued at $100,000 or more, and depending on the life expectancy determination of the seller, any and all types of policies can be sold, ie; universal life, whole life, or convertible term contracts.

Investors / Risk takers

While the Life Settlements industry may appear to be good value to investors that are novices in insurance accounting these investments, in fact, typically represent extremely poor value for a number of reasons. Despite the industry being a number of years old there are absolutely no statistics available on how these investments have actually performed. This is because they are suppressed by Life Settlements originators whom are the only business participants of this marketplace to historically have made a profit. Those statistics that are available are usually miscalculated and devoid of meaning. In the 6 year history of the industry there has not been one risk taker that has profited from a buy and hold strategy. This stems primarily from the fact that most participants rely on extremely poor actuarial and medical underwriting consultancies whom grossly overestimate the value of Life Settlement policies. These overestimates are the result of misaligned interests, and incompetence.

Financial Advisors

Life settlements are complex financial transactions that are generally conducted on behalf of clients by experienced professional advisors. Some examples of advisors that are becoming increasingly involved in the life settlement arena are:

• Accountants/CPAs
• Attorneys
• Financial Planners/CFPs/ChFCs/CFCs
• Insurance Advisors
• Estate Planners/CEPs
• Certified Senior Advisors/CSAs
• Charitable Trust Officers

Providers

Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the client a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and also have in-house compliance departments to carefully review transactions. Most importantly, they are backed by institutional funds.

Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 35 states have regulations in place regarding the sale of life insurance policies to third parties.

Brokers

Life settlement brokers shop a policy to multiple providers in an attempt to seek the best offer, much as a real estate broker solicits multiple offers for one’s home. As a middleman, brokers add another layer to the transaction and can have the effect of increasing the overall cost of the transaction to the client. In situations where a broker is used, it is incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, and more. The decision to work with a broker is ultimately the client’s, since financial advisors can submit the client's case directly to the life settlement provider.

Other Involved Parties

• Underwriters - Provide life expectancy estimates on the insured for pricing purposes.

Steps in a Transaction

1. Policyowner consults with an advisor, decides to sell his or her policy.
2. Client & advisor submit policy for valuation. Client releases medical information.
3. If policy meets criteria for a life settlement, providers send offers.
4. Client and advisor review offers and client accepts their preferred offer.
5. Client and advisor complete the provider's closing package, and return essential documents.
6. Provider places cash payment in escrow and submits change of ownership forms to the insurance carrier.
7. Paperwork is verified and funds are transferred to the policy seller.

Life Settlement History

Although the secondary market for life insurance is relatively new, the market was more the 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.

The Policy as Transferable Property

The Supreme Court case of Grigbsy v. Russell (1911) established the policyowner’s right to transfer an insurance policy. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policyowner could transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policyowner.

This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:

• Name the policy beneficiary
• Change the beneficiary designation (unless subject to restrictions)
• Assign the policy as collateral for a loan
• Borrow against the policy
• Sell the policy to another party

A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Viatical Settlements Model Act defining guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policyowners who no longer needed a given policy. Strong demand for life settlements policies is driving a rapid market expansion that continues today.

Major Study Findings

One major study that showed some of the potential of the life settlement market was conducted by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance." ([1]) This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their underperforming life insurance policies, an opportunity that was not available to them just a few years before.

"We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton Study, pg 6

Another study, perhaps even more influential, was the Conning & Co. Research study "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements. Since 2003, more and more of these eligible senior clients have sold their policies and helped the market increase.

Other Life Settlement Fast Facts

• When a life settlement should be considered
  • Policy no longer needed
  • Investment projections have not materialized
  • Premiums too expensive
  • Medical/long term care required
  • Charitable/family gifting desired
  • Employment status changes
  • Business Uses - Key man, split-dollar, or buy-sell agreements
  • Irrevocable life insurance trusts (ILIT)
  • Bankruptcy

• Market data
  • Policyowners 65+ - 36 Million
  • Active Life Insurance Producers - 175,000
  • Life Settlement Brokers - 178
  • Life Settlement Providers - 34
  • Estimated Amount of life policies to be purchased by providers in 2005 - $10-15 billion

- From the Maple Life Financial Industry Outlook 2005

See also

• Viatical settlement

External links

• Life Settlement Directory
• Life Insurance Settlement Association (LISA)
• Life Settlement Insititute
• Viatical and Senior Settlements at Curlie