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Life Settlements: A Legitimate Financial Planning Tool


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  • 1. August – September 2005 Life Settlements: A Legitimate Financial Planning Tool Rick Gardner Rick Gardner discusses situations in which life settlements of existing insurance policies may be an appropriate planning tool for your client. As oversight of these settlements increases, they may provide value in certain situations where your client’s other options may be limited. A s financial planning professionals, it is our an accelerated death benefit or would negotiate a responsibility to introduce all applicable tools transaction with an individual to purchase the policy into the planning process for our clients. A from the ill client. tool that has been often maligned and overlooked During the earlier days of the AIDS epidemic, when is life settlements. Quite simply, a life settlement a large number of people needed cash to provide is the sale of an existing life insurance policy to a for their care, an industry emerged in which viatical third party. This serves a client’s financial needs by brokers would purchase life insurance policies for as reducing or eliminating premiums, providing cash little as possible and then sell them to funders. These for needs such as long-term care, or acting as a tool funders were primarily private individuals, aligned for charitable giving. with finance companies or insurance brokerage firms. But, as a 2001 CONSUMER REPORTS1 article stated: Background of Life Settlements The industry has been dogged by problems—and In 1911, Chief Justice Oliver Wendell Holmes stated thorny ethical issues. Insufficient consumer pro- that a life insurance policy is a capital asset similar to tection has left viators (the people who cash in a home, car, stocks or bonds. Traditionally, the value their policies) with inadequate payments and of the policy was fulfilled when the policy owner investors stung after promised returns up to as passed away. However, there were instances where much as 30 percent or more fail to pan out. the policy owner could receive value during his Fraud has been so common a problem that the lifetime. Originally, it was the insurance agent who North American Securities Administrators Asso- was approached by a terminally ill client, seeking ciation, a group of state investment cops, named cash for his life insurance policies. The agent would viaticals one of the top ten investment scams of either approach an insurance company to secure 1999, along with telemarketing schemes and get-rich-quick seminars. Thirty-three of the 73 viatical companies Consumer Reports found Rick Gardner is a Principal in LifeStyle Insurances Services, operating in 2000 had been in trouble with Inc. and is the Co-Founder, along with Anthony Ridd, of the Life Settlements division of the agency. Rick is a nation- regulators in the past two years. Among their ally recognized leader in the growth and positioning of Life problems: failure to register with securities or Settlements as an integral funding tool for retirement. You may insurance authorities, misuse of investor funds, contact Rick at (800) 493-2056 or misstatements about the medical condition © 2005 R. Gardner JOURNAL OF PRACTICAL ESTATE PLANNING 35
  • 2. Life Settlements: A Legitimate Planning Tool of patients, and a fraudulent practice called those needs. According to a 2002 Wharton School of “cleansheeting.” Under that scheme, viatical Business study, it is now estimated that the potential companies solicit patients with life-threatening life settlement market could reach $100 billion.5 chronic or terminal conditions to lie about their Life settlements are becoming recognized by plan- health and apply for life insurance policies, ning professionals as a viable financial planning tool which are then resold to investors. and professionals and consumers alike are seeking more information. There are numerous reasons why While viatical settlements provided some assis- a client may want to consider selling an insurance tance to thousands of AIDS patients, these settlements policy, including, but not necessarily limited to the may no longer represent a good investment for those following reasons: purchasing the policies. The development of new Insurance needs have changed. treatments for HIV and AIDS has removed this group Premiums have become unaffordable or incon- of policyholders from that category of patients con- sistent with current needs. sidered to have a terminal medical condition. Estate planning goals have changed. As early as 1993, the National Association of In- Cash is needed to fund a different life insurance surance Commissioners (NAIC) developed a model policy, annuity or investment. law to provide standards and guidelines. The revised A change in business owners or key persons has model, introduced in 2001, reflects the emergence occurred. of life settlements for use with clients who are of Funds are needed for long-term health care. advanced age and in declining health, as a viable Funds are needed as a source of cash for chari- tool for financial planning. In 2004, NAIC presented table giving. an NAIC framework to the House Financial Services Committee (HFSC) and Chairman Mike Oxley for Life Insurance Needs Have modernizing the regulatory structure, including additional protections against fraud. The NAIC con- Changed tinues to work with HFSC to “implement national Policies that were purchased to protect a young fam- regulatory standards that will achieve the highest ily in the case of the premature death of the insured levels of marketplace safety and efficiency, while or to fund college educations may no longer be ap- maintaining a competitive marketplace with the propriate as a client matures. Clients may divorce strong consumer protections that are the hallmark and remarry then change their estates accordingly. of state regulation.“2 Clients may even outlive the beneficiaries of their life Many states have adopted some version of the insurance. These policies, with escalating premiums, statute or have developed regulations of their own.3 can become a financial burden on the client or an In January 2004, A.M. Best Co. issued its first ratings inappropriate use of his money. It is clear that in many on securities collateralized by life settlements.4 Their situations, the needs of the client/insured change and involvement and scrutiny of this important tool is the old policies may have outlived their usefulness. welcome and helps financial planning professionals By selling the old policy, the client receives cash to as a reliable source for ascertaining which compa- purchase a more affordable policy to cover current nies not only meet but exceed the state and industry needs and has additional cash for other insurance, requirements. investments or other uses. A typical scenario might be a 76-year-old widower Life Settlements As a who owns a whole life policy with a face amount of $8 million and a $795,000 cash surrender value. Legitimate Financial He has outlived his wife, and he has provided for his Planning Tool children and grandchildren through trusts. The Life Settlement professional negotiates a settlement of The U.S. Census Bureau estimates that there will $2.3 million, giving him $1.5 million over the cash be 50 million people age 65 and older by 2010 value. The insured will have to weigh the benefits of (15 percent of the population). A large segment of a life settlement against using other assets to cover his this group owns life insurance purchased for earlier current needs and preserving the $8 million policy life-stage milestones and is no longer necessary for for his beneficiaries. 36
  • 3. August – September 2005 Your clients rely upon you for advice in estate long-term care, which averages $70,080 a year in planning, trust administration or financial planning. the United States.8 A Life Settlement can provide the They may no longer need the life insurance they money needed to purchase a long-term care insur- are carrying. The option of a life settlement presents ance policy or one of the specialized life insurance another opportunity that should be discussed with or annuity products with long-term care benefits. your clients. It is also important to be cognizant of The U.S. government’s Medicare Web site expressly the fact that the needs for life insurance can change stipulates that life settlements are an opportunity for in businesses, as well. funding long-term care and offers a concise overview of requirements and limits for consumers and finan- Business Succession cial planners alike.9 One of the major myths is that wealthy clients Businesses have changing needs for life insur- have no need for long-term care protection because ance—the insured leaves the company or retires, they could easily self-fund the costs. However, with the company has a change in ownership, or the the costs of care escalating at an average of five company can no longer afford the premiums. Tak- percent compounded per year, with no cap in sight, ing advantage of key person insurance that has been transferring the risk of that possibility to insurance or purchased on an executive who is no longer going annuities, provides a sound stop-gap measure against to stay with the company is a unique opportunity serious erosion or depletion of assets. For clients who for a life settlement. A case in point: One particular want to leave a legacy for family members or help a advisor did not see the value of a client’s key person philanthropic cause, a life settlement is an excellent insurance policy because it was a term policy with way to ensure the safety of assets. no cash value. However, when the company was sold, the policy was transferred as an asset. The new Charitable Giving owners understood the policy’s value and sold it in the life settlement market for several hundred thou- Among wealthy insureds, a major beneficiary of life sand dollars.6 insurance policies is the nonprofit sector. Tradition- Another example of using a life settlement creative- ally, policies were donated to the charity with the ly is in the sale of a business. Consider the following premiums to be paid by the organization. Many example: A company owned key person policies with policies that have been donated have been allowed several million dollars in total face value. The cash to lapse because the organization cannot afford to surrender value was approximately $800,000. The continue payment of the premiums and/or maintain company’s advisor was able to obtain a life settle- the administrative review procedures of such policies. ment of $3.5 million—$2.7 million greater than the If the donor is in agreement, the policy could be sold cash value of $800,000. The extra amount received to generate immediate revenue for the organization. from the life settlement made up for the difference “If they knew Life Settlements were an option, perhaps between the company’s asking price and what it development officers would reconsider the practice actually netted in the sale.7 of letting policies lapse,” commented one philan- While it is important to be aware of the opportuni- thropic consultant whose clients include numerous ties that may arise in the business market, chances foundations, universities and organizations. “Most de- are, financial planning professionals will be called velopment staff are not aware of Life Settlements, but upon more often to help clients with life settle- I believe having knowledge of this new wealth man- ments in personal estate planning scenarios. One agement tool could help them make better decisions need becomes obvious if the client has an accident as it relates to managing their donated life insurance or develops a chronic illness—the need to pay for policies and donor acceptance programs.”10 long-term care. An even better way to handle charitable giving is for the policyowner to sell the policy, contribute the pro- Need for Long-Term Care ceeds to the charity and, perhaps, take a higher write-off than he would have if he had donated the policy. Protection Without some form of coverage, the client could This was the case with the donor of a $750,000 possibly deplete most or all assets on the cost of policy. The surrender value of the policy was JOURNAL OF PRACTICAL ESTATE PLANNING 37
  • 4. Life Settlements: A Legitimate Planning Tool approximately $142,000. However, the sale of Values-Based Case Studies the policy brought approximately $225,000, giving the donor an additional $83,000 chari- According to, there are other table donation, which the charity was able to benefits to candidates inquiring about Life Settle- use immediately.11 ments. “Clients who qualify for life settlements can see what the highest purchase offer is. If they choose Profile of a Life Settlement to accept the payment, they have added pure bot- tom-line dollars to their asset base.”14 Client As stated on the Medicare Web site: To be eligible Case Study #1 for a Life Settlement, you can’t be ill and must be A 79-year-old female approached her financial plan- over age 70 (for females) or over age 74 (for males). ner, worried about her ability to continue to pay her In some situations, if your life expectancy is 12 years annual premiums of $250,000 on her $7 million or less, a life settlement can be done at a younger face value Universal Life policy. She purchased the age.12 Those with serious health issues and a shorter policy to pay all estate taxes and leave a substantial life expectancy will receive higher settlement of- legacy to her children. She thought her only option fers. The lower the cost to the purchaser to carry was to lapse the policy and take the cash value of the policy and the more imminent the payment, $17,000. The financial planner realized that by ne- the higher the negotiated settlement amount will gotiating a life settlement on the existing policy she likely be. would be able to receive enough cash from the old According to a 2003 study by Conning Research & policy to invest in a new policy at a substantially Consulting and reported in NATIONAL UNDERWRITER: lower premium. In fact, the settlement offer was for $1.2 million and the new term life policy, for Males account for most of the settlement busi- the same $7 million face amount, has an annual ness (73 percent to 27 percent female). This premium of $119,000. Using the life settlement split roughly matches the historical experience allowed the client to continue to fulfill the desire with policy sales, although recent experience to leave a substantial legacy to her children at a far indicates the female share of new life insurance more affordable cost. sales is closer to one-third. Less than 1 percent of the life insurance purchases involved insureds Case Study #2 with a life expectancy of less than two years. (21 A male client, aged 82, had a Universal Life policy with percent had a life expectancy of 2-5 years, 53 a face amount of $1 million, which he purchased to percent a life expectancy of 6-10 years, and 25 cover estate taxes. The client experienced a substantial percent a life expectancy of 11 or more years). reduction in estate value and no longer needed the This is, in part, due to living benefit provisions, policy to pay the taxes. The cash value on the policy whereby insurers make a portion of the death was $112,000. By utilizing the life settlement option, benefit available to insureds with a terminal con- the client received $257,000, twice the cash surrender dition. Of all the policies purchased, 95 percent value for his policy. The value-add of the life settlement and 5 percent are permanent and term policies, in this case was the higher return on the investment he respectively.13 had made into the policy than he would have received by merely taking the cash surrender value. The funding companies purchasing life insurance policies also review the following criteria to deter- Case Study #3 mine the purchasing price of the policy: At age 75, a male client purchased a 10-year Type of Policy: Whole Life, Variable and Univer- $200,000 convertible term policy with his newly di- sal Life, Joint and Survivor Life, Adjustable Life, vorced daughter as the beneficiary, so that she would Term and Group policies (if convertible) have financial support for herself and her children, if Policy face value he were to die. In the seventh year of the policy, the Percentage of Cash Value to Death Benefit daughter remarried and there was no longer any need Percentage of Loans to Death Benefit for the insurance. The financial planner suggested a Percentage of Premium to Death Benefit life settlement as a way of recouping the money the 38
  • 5. August – September 2005 client had invested into the policy. At the end of the Regulations on life settlement companies vary from conversion period, the policy was sold for $27,000. state to state. Check your state’s regulations. Without the life settlement, the policy would have Some states require licensing; others do not. had no cash value at all. Check to be sure the life settlement broker is licensed through the state Department of Insur- Case #4 ance, if required. A 78-year-old male client asked his financial Though the life settlement industry is relatively planner for a way to replace his existing nonguar- new, it is still important to find out how long the anteed Universal Life policy with a guaranteed broker has been in business. policy. The original policy had a $12 million face Equally as important is to check the reputation of value and a cash surrender value of $177,000. By the company. One simple way to do this is to ask using a life settlement, the client received $2 mil- for a list of referrals from the broker. In addition, lion and was able to purchase a new guaranteed obtain this information if possible: $12 policy with reduced annual premiums from Are life settlements a core competency? $500,000 to $410,000. The life settlement not Is detailed information about the company only helped him achieve his goal, it saved him available? one year of premiums because of the premium Are the senior executives of the company reduction. recognized as leaders in the industry? While the value proposition for using life settle- Does the company have an anti-fraud ments is evident, it is important for the client policy considering a life settlement to know that there are Reputable brokers conduct business with providers tax consequences to this transaction. who are doing business with A.M. Best-Rated Issuers. Receiving an Issuer Credit Rating (ICR) from A.M. Best Life Settlements and Taxation is a rigorous process and has applied high standards to the life settlement industry.16 Life Settlements have three areas of taxation con- sideration. First, total premiums paid by the policy In Conclusion owner are nontaxable and are the owner’s cost basis. If the cash surrender value is greater than the total Last but not least, it is important to choose a life settle- premium paid, the difference would be treated as ment broker who shows a steadfast commitment to ordinary income. Settlement proceeds that are in doing what is best for your client. A good broker will excess of cash surrender value may be treated as diligently seek out and negotiate the highest offer. A long-term capital gains. broker who has direct contracts with many funding companies has a much better opportunity to obtain Choosing a Life Settlement the best offer. Due diligence on your part includes asking how many funding companies the broker has Professional a direct contract with and how many of those will be It is critical to seek out a reputable life settlement used in the process of obtaining an offer. broker. The broker is the liaison between financial The U.S. Census Bureau estimates there will planning professionals and their clients, and life be 50 million people age 65 or older by 2010. settlement funding companies. The exponential That is 15 percent of the population. A significant growth of this industry has spawned a plethora of number will be able to benefit from life settle- individuals and companies proposing to negotiate ments. As financial planning professionals, it is life settlements on a client’s behalf. The following is our responsibility to make sure that this solution a condensed list of qualifications to be considered is considered and explored to determine if it is in when choosing a life settlement broker15: the best interest of our clients. ENDNOTES 1 ture: The NAIC Framework for a National 3 Betting on Death, www.ConsumerReports. State By State, Viatical and Life Settlement org, Feb. 2001. System of State-Based Regulation, www. Association of America, 2 Modernizing the Insurance Regulatory Struc- States. JOURNAL OF PRACTICAL ESTATE PLANNING 39
  • 6. Life Settlements: A Legitimate Planning Tool ENDNOTES 4 Nursing Home and Home Health Care Cost Popular with Agents and Insureds, NATIONAL Life Settlement Securitization, A.M. BEST, Oct. 18, 2004, at 1–15. Survey, Sept. 2004. UNDERWRITER, Feb. 7, 2005, at 71–73. 5 9 14 Neil A. Doherty and Hal J. Singer, The Ben- New Value NOW in Old Policies …, avail- efits of a Secondary Market for Life Insurance LifeSettlements. able online at www.elderlifeplanning. 10 Policies, REAL PROPERTY, PROBATE AND TRUST J., Chronicle Survey, Foundation Assets Re- com/lifesettlement.htm. 15 Fall 2003. cover, CHRONICLE OF PHILANTHROPY, Mar. 2, Eric Lund, Putting the Sizzle in Life Settle- 6 2004. ments, CALIFORNIA BROKER, Dec. 2004, at David Port, Settling for More, SENIOR MARKET 11 ADVISOR, Feb. 2005, 89–102. Supra note 6. 25–26. 7 12 16 Id. Supra note 9. Supra note 4. 8 13 MetLife Mature Market Institute, 2004 Warren S. Hersch, Life Settlements More This article is reprinted with the publisher’s permission from the JOURNAL OF PRACTICAL ESTATE PLANNING, a bi-monthly journal published by CCH INCORPORATED. Copying or distribution without the publisher’s permission is prohibited. To subscribe to the JOURNAL OF PRACTICAL ESTATE PLANNING or other CCH Journals please call 800-449-8114 or visit All views expressed in the articles and columns are those of the author and not necessarily those of CCH INCORPORATED or any other person. 40