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may no longer represent a good investment for those following reasons: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.
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.
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
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 Elderlifeplanning.com, 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
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
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.
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, http://viatical.org/
Modernizing the Insurance Regulatory Struc- States.
JOURNAL OF PRACTICAL ESTATE PLANNING 39
Life Settlements: A Legitimate Planning Tool
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- www.medicare.gov/LongTermCare/static/ New Value NOW in Old Policies …, avail-
eﬁts of a Secondary Market for Life Insurance LifeSettlements. able online at www.elderlifeplanning.
Policies, REAL PROPERTY, PROBATE AND TRUST J., Chronicle Survey, Foundation Assets Re- com/lifesettlement.htm.
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
ADVISOR, Feb. 2005, 89–102. Supra note 6. 25–26.
7 12 16
Id. Supra note 9. Supra note 4.
MetLife Mature Market Institute, 2004 Warren S. Hersch, Life Settlements More
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