It is estimated that every year, seniors in the US surrender or lapse over $112 billion dollars in life insurance death benefits (1). Most of them probably have no idea of their options, but grow tired of the premium payments and walk away without maximizing the value of an asset they may have paid for over a lifetime. For the uninformed consumer, this could be just a lost opportunity, for the Trust Owned Life Insurance (TOLI) trustee, this can be a source of potential liability.
An alternative to a policy lapse or surrender is a life settlement, the sale of a life insurance policy for a lump sum greater than the policy’s cash value and less than the death benefit. The purchaser of the policy will maintain the policy by paying the policy premium until the death of the insured.
The life settlement industry grew out of the “viatical” movement of the of the 1980s when AIDS victims were given the opportunity to sell their life insurance policies to a third party for a lump sum payment to be used to provide medical and other care in the final years, sometimes months, of life. Advances in the treatment of AIDS made these types of policy sales less common, but the idea of life insurance as an asset that can be sold grew into the life settlement, or secondary marketplace, we see today.
Originally the industry was lightly regulated and some who sold their policies were taken advantage of, but today’s life insurance settlement marketplace is heavily controlled. The vast majority of states (42) have strict regulations that provide a framework for the orderly transfer of policies, with required consumer disclosures that protect the policy seller. The improved regulations have dramatically decreased issues in the sales process.
For the TOLI trustee managing life insurance today, life settlements are an option that must be considered. Because of changes in the estate tax, increased policy costs, and the natural evolution of trust goals, there are more “unwanted” policies to deal with than ever. Those of you who have attended our ITM TwentyFirst University sessions in the past know that we have developed many methods for analyzing options to maximize the value of a life insurance policy. We do this because it is our clients’ (TOLI trustees) responsibility to maximize the value for their clients (life insurance trust beneficiaries), and life settlements can be a way to do that.
Typically, life settlements are available to insureds age 65 and older, though health will play an important role in whether an offer is forthcoming. Most policies sold are universal life policies – especially current assumption universal life, though other policies, even term insurance policies that can be converted to a permanent policy, can be sold. The offers depend on the death benefit of the policy, the annual premium needed to carry the policy, the life expectancy of the insured, and the rate of return that the buyer needs to make the purchase a viable investment.
The sale of a policy has potential tax implications to the seller. A life insurance policy held in trust until a death benefit is paid is received income and estate tax free, however if a policy is sold there is a possible tax liability to the trust.
While all the advantages and disadvantages of a policy sale are beyond the scope of this article, we believe that the full discussion of life settlements in the TOLI world is important enough to schedule a webinar session that will provide a TOLI trustee (and all financial professionals) with a thorough understanding of the process. Our next free webinar session, entitled Learning When Why and How to Do a Life Settlement, will be held on March 28th at 2 p.m. Eastern Time, and will provide one hour of continuing education for CFP, CTFA and FIRMA members. You can register here.
- LifeHealthPRO, February 25, 2015, Forfeited Life Insurance Benefits Pegged at $112 Billion