A New Life Insurance Option: Senior Life Settlement

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By Jerry Rhinehart, CIC, CLU, ChFC, RHU

In the mid-to-late 1980s, the use of a financial arrangement called a “viatical settlement” began to emerge. A good example of this arrangement follows: A terminally ill person would “sell” their in-force life insurance policy to a 3rd party for an amount that was greater than the cash surrender value, but less than the face amount. Medical underwriting would be performed on the insured and the shorter the insured’s life expectancy, the greater the payout. Generally, the insured’s life expectancy was somewhere between a few months to less than two years. In exchange for the payout, the 3rd party organization (or individual) would then become owner, premium payor, and beneficiary of the life insurance contract. These arrangements soon came under intense scrutiny by the various state insurance regulators, and still are today.

While viatical settlements (VS) are still in use today, they were the impetus and forerunner of what has become a new and growing market called Senior Life Settlement (SLS). It is also known in the industry as a Life Settlement. While similar in some respects to a VS, a SLS differs in a couple of important ways. First, the SLS is only for a person who is age 65 or older; and second, only for a person who is not terminally ill. And there are a couple of other details to know—most settlement companies (usually referred to as “providers”) will consider any contract and most arrangements.

Contracts: Term, even some group term contracts, whole life, universal life, and variable life. If the contract is a term, it must be convertible to permanent life insurance to be considered.

Arrangements: Individually owned, owned by a business or a trust, even those owned by a charity. Additionally, a life insurance contract will only be considered after it has been in force for at least two years.


Consider this Typical SLS Case

Paul, age 75, owns an $850,000 Whole Life policy that was purchased in 1975 when he owned his business. The annual premium is $7,200 and it has a current cash surrender value of $266,000. He has paid a total of $216,000 in premiums over the years.

His wife recently died, and he now feels he no longer needs this life insurance policy. Here is a brief snapshot of his health: he has some mild heart problems and sleep apnea, he is a diabetic, and he has a few other minor ailments. Additionally, he is beginning to have a problem paying the annual premium. He has another small paidup life insurance policy that will easily be enough to take care of his final expenses.

The agent who sold the $850,000 contract is no longer in the insurance industry. Paul tells Joan, his personal lines agent, that he is thinking about cashing in the policy and would appreciate her assistance with the paperwork. Joan tells Paul she recently read about the SLS concept and it might be an alternative to consider. Joan contacts a life insurance broker who has access to numerous “settlement companies.” The initial paperwork is completed, followed by some minimal medical underwriting. The underwriting consists mostly of the settlement broker corresponding with Paul’s physicians. After about six weeks, the broker notifies Joan that he has six firm offers. The best offer is a cash settlement of $355,000. Paul accepts the offer and signs the forms to make the settlement company the owner, beneficiary of the policy, and the party responsible for all future premiums. Upon Paul’s death the settlement company would receive the death benefit, free of any taxation.

Let’s examine Paul’s potential taxation on his $355,000 settlement check1:

  • The amount equal to the cumulative premiums he paid ($216,000) would be free of any federal or state income tax;
  • The next $50,000, the difference between the current cash value ($266,000) and the cumulative premiums ($216,000), would be subject to ordinary income tax;
  • The remaining $89,000 (the amount in excess of the current cash value) would be subject to capital gains taxation.

What are some factors that determine the amount of the potential payout from a SLS?

The age and gender of the insured, the type of policy, the current (and future) premiums as a percentage of the death benefit, cash surrender value (if any) of the policy as a percentage of the death benefit, outstanding loans as a percentage of the death benefit, medical condition of the named insured, and the financial rating of the carrier are all factors that can impact the amount. Keep in mind—and this certainly sounds morbid—the more serious the medical conditions of the insured individual, the shorter the life expectancy, the more valuable the potential payout!


Who are “providers” and where can they be found?

Currently, there are thought to be less than 200 settlement providers—also referred to as the “secondary market”—in this industry. Some are institutional providers (Berkshire Hathaway, Citigroup, GE Capital, JP Morgan, etc.) and some are individual investing groups. There is even an association for the industry—Life Insurance Settlement Association— found on the Internet at: www.lisa.org. Many of the larger providers are members of this association. A quick search will reveal numerous “hits” for settlement companies. Simply type in “life insurance settlement.” Most life insurance periodicals will have several ads for the larger and more aggressive settlement companies.


Should an agent work directly with one of the providers?

Certainly, nothing prevents this, but it is highly recommended to work through a reputable settlement broker who has an affiliation with several of the leading providers. If an agent goes directly to one or two settlement companies, he/she cannot be certain the offers they make are the best for the client. However, a settlement broker will shop the case with numerous organizations, handle all details after the initial paperwork, and should be able to justify a “best offer.”


What are some reasons a person might wish to consider a SLS?

  • Enjoy a higher quality of life
  • Enjoy personal independence and dignity
  • Purchase financial products or investments that are more suited to their present life circumstances
  • Exercise greater control over their health care options
  • Take care of any personal debt
  • Take a dream vacation
  • Buy a new car or home
  • Make gifts to loved ones or charities
  • Compensate for lost income
  • Take care of financial arrangements
  • Eliminate the life insurance premium
  • Have peace of mind

How do the “traditional” life insurance companies feel about the emerging SLS concept?

Simply put, they are not too fond of it. The reason? All life insurance contracts are based on actuarial assumptions. One key assumption is the “future lapse rate” of the various types of contracts. Based on this and many other assumptions, the actuary can set a sound, but profitable, pricing and cash value structure. Older contracts, especially term and universal life, have substantial lapse assumptions at the older ages of the insured. It is assumed that many of the cash value building contracts will either be cashed in or they might allow the cash value to keep the death benefit in force for some period of time. Obviously, a contract purchased by a settlement company will be in-force at the time the insured dies. This “failure to lapse” will certainly impact the bottom line of life insurance companies that experience a substantial number of ownership transfers to the SLS market. While the numbers of transacted SLS cases are not substantial in relation to the total number of in-force life policies, the emerging concept is causing some concern in the “traditional” life insurance community.


Is the SLS market here to stay, and should a licensed agent get to know it better?

Most definitely! First, let’s consider the money. Total life settlement transactions grew to $2.57 billion (face value) in 2013 (The Deal—annual survey of the life settlement market, June 23, 2014). Conning & Co. (Hartford, CT), a leading insurance and asset manager, predicts the future to be extremely robust. Between the years 2014 and 2023, Conning feels there is potential for more than $180 billion in life settlement business. However, they forecast the actual volume in the same 10-year period for settlement transactions in the U.S. to be $3 billion per year. So, while there is huge potential, only a small percentage of actual settlements will be realized, due to a lack of awareness by life insurance contract owners and agents.

Next, let’s consider the various regulatory groups. A quick search on lisa.org will reveal the regulations and license requirements by the various states (lisa.org/Industry Resource/State Regulations). The regulations vary greatly by state, even if the contract to be considered for sale is a VS or SLS. The Life Settlement Association and various other regulatory bodies are pushing for more protection for policyholders from unscrupulous practices. Most states have adopted the NAIC Model Act. Agents need to check with the relevant state department of insurance regarding the specific licensing and CE requirements that might be necessary in a particular state. A knowledgeable settlement broker can also assist in this area. The bottom line: when associations are formed and when regulatory bodies enact licensing and continuing education rules, these are usually good clues that the “concept” is alive and well!

Another consideration is the number of professional advisors (accountants, attorneys, financial advisors, etc.) Such advisors are now beginning to see articles in their trade publications regarding the SLS concept. Some articles even recommend that the professional advise their client of an alternative (the SLS concept) to surrendering an unwanted or expensive life insurance contract. It could be very beneficial for a knowledgeable life agent to work closely, and even counsel, these advisors who might need assistance in placing a SLS. Most agents that are direct writers, and those individuals with a securities license are typically prohibited from becoming involved in these transactions. Thus, the independent agent can be a major resource to these advisors and their clients.


Common Scenarios

All agents, life and property/casualty, need to be aware of eight common scenarios where a SLS may be viable for the owner (and the agent). Here is a brief overview:

(1) The sale of a business or other illiquid asset.

A policy bought for a buy-sell agreement or estate liquidity may become unnecessary. Compounding the problem is that the business was typically paying for the policy in some manner; either directly, if the policy had been business-owned, or indirectly, through the use of a bonus or splitdollar arrangement. With the business no longer in the picture, both the need for the policy and the ability to pay for it may have vanished.

(2) Business owner retiring or exiting from business.

Business owners frequently acquire a number of life insurance policies over the course of operating their company which they no longer want upon retirement or termination. These include buy-sell, key person, fringe benefit, creditor protection, and even pension policies. As stated in (1) above, keeping a policy that is no longer needed without a business to pay for it can be problematic.

(3) A decline in estate value and/or a decrease in estate tax liability.

Both today’s struggling economy, as well as the drastic reduction in estate tax liabilities brought on by the American Taxpayer Relief Act of 2012 (ATRA), make this particular scenario quite common. Keeping the life insurance policy, might still be a good deal for their heirs, but people are typically reluctant to keep more life insurance than is absolutely necessary. There are even ways to consider a SLS should the policy be owned by an Irrevocable Life Insurance Trust.

(4) Term policies or riders that are about to expire, lose their conversion privilege, or come to the end of their current premium guarantee.

Term policies are among the most likely life settlement prospects to be overlooked. Many advisors and clients don’t realize that a term policy (including group term), if convertible, can be sold in a life settlement. Since term policies generally do not have any cash surrender value, a life settlement can truly provide “found” money. Furthermore, these situations typically result in a conversion sale for the agent in addition to the settlement.

(5) Retirement.

When retiring, people usually evaluate their financial resources and expenses. At that time, it is common to find policies, bought to replace income upon death of a wage earner, that are no longer needed. Additionally, the cost of such policies, especially if term insurance, may become unaffordable. These policies can be ideal for a life settlement and the proceeds can really make a difference in retirement. With the aging of baby boomers, there will be an estimated 10,000 Americans reaching retirement age every day for the next 16 years. This represents a massive market for potential life settlements.

(6) The policy is no longer affordable due to policy performance.

Interest rates have declined steadily and have been at historic lows for an extended period of time. Many policy owners are now being blindsided by premium requirements that dramatically exceed what they expected to pay. This is especially true of older Universal Life contracts. This premium surprise may not only go beyond their budget, but it may also disturb their estate plans by exceeding their annual gift tax exclusion.

(7) Chronic illness.

While chronic illness would ordinarily be a time when the death benefit of a life insurance policy would seem most imminent, certain illnesses are longterm in nature and require very costly medical or custodial care. When all else fails, a life settlement can provide critically needed funds to help pay those expenses.

(8) Life contracts owned by a charity.

Many people have strong positive feelings toward one or more charities. Occasionally a person will “gift” a life policy to their church (or another 501c3). Obviously, the new owner (the charity) is now responsible for the premium. There could be financial problems to the charity should they have numerous policies—some perhaps with very large premiums. Here is where the SLS might come into play. Sell one (or more) of these contracts so the cash it receives from that SLS sale can be used to pay the premiums on the other contracts.


Conclusion

The SLS marketplace in the United States is currently very strong and indications point to this continuing for the foreseeable future. The clients serviced by most property/casualty and life agents have little or no knowledge regarding the SLS concept. However, the client generally relies on their agent for advice and counsel regarding insurance updates and recommendations to their coverage. Helping them find additional money with an unneeded or unwanted life insurance contract can be a major “win” for them—and the agent.


Learn More, Earn More

Life & Benefits Essentials

Attend a CIC Life & Health Institute to learn more about life insurance and planning for personal insurance needs. The CISR Life & Health Essentials Course offers a more basic approach to these subjects. Life & Benefits Essentials, available from The National Alliance Research Academy, is another excellent resource for information on life insurance and retirement planning.


Jerry Rhinehart, CIC, CLU, ChFC, RHU, has worked in the insurance industry since 1976. He is a member of The National Alliance’s National Faculty, as well as a past CIC board member. In addition to his involvement in life and health insurance sales, he frequently writes articles for various insurance publications and is a speaker on numerous topics concerning life and health insurance.


1The life insurance policy owner should always check with their tax professional regarding any and all tax ramifications a SLS might have.

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