Table Of Contents
A Broad Investment Comparison
Investors, both in the USA and internationally trade using formalized platforms like the JSE, Nasdaq, LSE, and the Chicago Commodities Exchange. There are many others in Japan, Hong Kong, Singapore, and Australia, to name a few. While there’s an inherent risk in equities, bonds, precious metals etc, the regulations underlying traditional exchanges offer a degree of comfort and peace of mind, when buying and selling through these media.
Over the years, however, various asset classes have positioned themselves as ‘alternative investments’ in an attempt to attract investor dollars. Two examples include:
Life settlements is an investment category that’s unable to claim the backing of a regulated JSE-type of exchange. Still, it remains similar to diamonds and artwork in its investment appeal because policies are too considered assets. To determine the value of a life insurance policy on the secondary market, financial advisors are encouraged to use a life settlement calculator to get an immediate quote.
Institutional investors are increasingly regarding life settlements as ‘alternative investments’. Because of this trend, market participants are increasingly striving to remove most of the risk factors and wasted expenses, outside of the asset itself, so that all parties involved can make a considered decision with reasonable transparency. Additionally, state governments are stepping up to monitor and regulate this market, resulting in increased consumer confidence and contributing to this market’s growth over the past few years.
Why Life Insurance Policies Are Now Considered Assets
In 1911 The US The Supreme Court ruled that anyone owning a life insurance policy can rely on it to contain all the value metrics of a property.
Thus, it allows the owner to sell it to anyone they want. Since that time, life insurance policies, which routinely offer enormous tax-free benefits to the life insured’s dependents, have attracted attention as an investment opportunity and an excellent way to save money. The court opinion elevated life settlements to the same legal footing as any other assets. So, a life insurance policy allows the owner to stipulate and change the policy beneficiary or beneficiaries, leverage the policy as loan security (i.e., borrow funds based on the policy value), and transact the policy.
“Lapsing” generally refers to an individual policy owner terminating a policy, usually by discontinuing the monthly premium payments. By allowing a policy to lapse, the policy owner may lose both the cash surrender value and the net death benefit.
In 2015, seniors over the age of 65 allowed approximately $112 Billion in life insurance policies to lapse.
Over 250,000 universal and variable universal policies with a face value of approximately $57 billion were lapsed by seniors over age 65. When term and whole life policies are included, the number of policies exceeds 1.1 million with a face value of $112 billion. If the data were available for 2016, the amount would likely be even greater.
According to a 2018 study by investment management firm Conning, $200 billion worth of settlement-qualified life insurance will lapse or be surrendered each year through 2027. In fact, it’s estimated that 88% of all universal life policies that are issued are lapsed or surrendered without ever paying a death benefit. According to Milliam USA (2004), almost 85% of term policies fail to pay a death claim. In fact, 74% of term policies and 76% of universal life policies sold to seniors at age 65 never pay a claim.
The number of lapsed policies underlines exactly how insurance institutions are profiting billions of dollars each year. Every lapsed policy represents years of monthly premium investment lost to the owner forever, a pure profit to the insurance company. Life insurance companies don’t make money from maturing policies. It is ultimately their business model to collect premiums and then see the policy lapse.
Insurance regulators at the state level have only recently started to crack down on the insurance companies. The National Council of Life Insurance Legislators drafted and passed The Life Insurance Consumer Disclosure Act, requiring all life insurance companies to provide policyholders with written notice of alternatives to the lapse or surrender of life insurance policies. The act specifically mentions policyholders aged 60+ or who are known by the insurer to be terminally or chronically ill.
On April 29, 2009, the United States Senate Special Committee on Aging found that life settlements, on average, generated up to eight times more than the cash surrender values life insurance companies paid out for lapsing policies
California Couple Successfully Sues Lincoln National For Failing To Disclose Life Settlement Option
A couple in California was unaware of the life settlement option as they were twice-forced to reduce the size of their policy in order to afford the monthly premium payments. The original $7.2 million policy had been reduced to a $2 million policy before the couple discovered they had other options all along.
The couple claimed that no mention was ever made of the life settlement option. Throughout the proceedings, the couple claimed that their insurance provider, Lincoln National Insurance Company, offered only two options:
Surrender their policy for its cash value
Pay the higher premiums
The judge in this case agreed with the plaintiffs that the insurance provider had a duty to provide written disclosure of this option to the policyholder.
Why Life Settlement Brokers Are Worth Every Penny Of Commission
Hiring a broker is always in the policyholder’s best financial interest.
Life settlement brokers invest $2,500-$4,000 of their own company funds into each life settlement client that they represent. Acquiring medical records, illustrations, getting official documents prepared with all of the required signatures each have respective fees covered by the broker. Life settlement brokers are financially invested in each case represented.
The qualification and underwriting process involves extensive communication with doctor’s offices, life insurance companies, providers, and all other parties involved. This part of the process can be arduous to complete and involves repeated calls and emails to keep things moving, especially when dealing with the insurance companies.
It’s important for policyholders to remember that life insurance companies are losing money on the deal. So, insurance companies delaying the process at every turn is common and to be expected. A financially invested broker will assure this process keeps moving along.
Once the underwriting process is complete, the broker will begin accepting bids to buy the policy from life settlement providers and investors. Overseeing the bidding process involves ongoing communication with the buyers until the highest offer is accepted.
Hiring A Life Settlement Broker Vs Dealing With A Direct Buyer
After your client has decided to explore a life settlement they will eventually need to choose between hiring a life settlement broker or dealing with a direct buyer. The difference between the two options is clear:
Direct buyers represent their company’s best financial interest by acquiring policies at the lowest possible price.
Life settlement brokers represent your client’s best financial interest by fielding competing offers from multiple funders to help secure the highest possible price.
The Tax Benefits Of A Standard Life Insurance Policy
Life insurance policies offer key tax advantages. Death benefits are usually paid to beneficiaries free of income tax. Benefits paid out before the insured’s death because of chronic or terminal illness are tax free. Policy cash value can accumulate without being subject to tax. Withdrawals up to the amount of the policy owner’s tax basis are not subject to income tax. Cash values exceeding the owner’s tax basis may be borrowed from the policy income tax free as long as the policy stays in force. The owner may exchange an existing policy for a new policy or annuity free of income taxes.
Life insurance is one of the most popular long-term investment vehicles available in the USA. It’s one of the few financial contracts tax authorities won’t touch because it focuses on family economic stability and continuity. The minute one removes the policy from its intended path, reliance on tax relief largely disappears.
When the policyholder no longer plans to see the arrangement through to death and signals a change of intention is when the IRS starts getting involved. The policy transforms into a conventional investment (like equity), and the question of profit and loss enters the equation. If the life settlement cash payout is greater than the accumulated premiums invested it’s likely taxable even though there may be a few relief factors that modify the calculation.
Similarly, for investors (i.e. life settlement buyers) a taxation calculation will need to be considered. Buyers will eventually earn a profit or incur a loss. Tax percentage will depend on where the investment resides (in a company, a 401k, or some other structured platform.)
It’s untrue to say that a life settlement retains its original tax benefits because it’s still a life insurance policy.
However, even though taxation is a consideration, it doesn’t disqualify life settlements as a worthy option for both buyers and sellers. If tax is payable after a transaction, undoubtedly a profit was earned and therefore a benefit was evident. But, when compared to the alternative of lapsing the policy and losing all the premiums paid over the years, a life settlement can potentially be a very attractive option even with taxation.
How The New TCJA Tax Law Affects Life Settlements And Why Estate Planners Should Be Aware
The new TCJA tax law has effectively doubled the estate tax exemption. The new 2018 tax exemption is $11.2 million for a single person and $22.4 million for a married couple. This will significantly lower the number of estates that will actually be required to pay this tax.
Since a significant number of life insurance policies are purchased solely for estate tax purposes every year, the new increase in estate tax exemptions suggests many of these policies will no longer be needed. This means that, although in some cases it could make more sense to keep the policy active by continuing the monthly premium payments, many policyholders will now be considering lapsing or surrendering the policy. To avoid the potential loss of a valuable asset, it’s more critical than ever that financial planners, trust officers, tax advisors, and attorneys all be made aware of this new tax law and explore a life settlement for their clients.
TCJA Rejects IRS Income Taxation Of Life Settlements, New Ruling Benefits Consumers.
A second major change to how life settlements are taxed greatly benefits policyholders.
Previously, life settlement tax law stated that for policies surrendered, for a profit, the policy owner’s basis is their total investment in the policy, referring to the total amount in premiums paid less withdrawals and dividends taken from the policy. But for purposes of a life settlement, the IRS ruled that the basis would have to be reduced by the total cost of insurance charges assessed against the policy.
Example of TCJA’s changes in taxation to the seller of life settlements
• Policy face amount: $1 million
• Life settlement proceeds to seller = $120,000.00.
• Premiums paid = $70,000.00
• Cost Of Insurance = $30,000.00
• Cash Surrender Value = $50,000.00
Previous methods of calculation:
• Step 1: Computation of basis: $70,000 premiums paid – $30,000 COI = $40,000 adjusted basis
• Step 2: Computation of tax liability: $120,000 sale price – $40,000 adjusted basis = $80,000 taxable gain
New methods of calculation resulting from the TCJA:
• Step 1: Computation of basis: $70,000 premiums paid = $0 taxation for up to $70,000 of the sale price.
• Step 2: Computation of tax liability: $120,000 sale price – $70,000 basis = $50,000 taxable gain as a long-term capital gain.
The TCJA’s change reduces the taxable gain in this example from $80,000 to $50,000. The new calculation reflects how policy gains are taxed after policies are surrendered to the insurance carrier. The updated tax law brings more clarity to financial advisors and their clients.
A policyholder who sells a policy in a life settlement is generally taxed in three tiers as follows:
1. Amounts received up to the tax basis are received tax-free.
2. Amounts received in excess of the tax basis up to the amount of the cash surrender value are taxed at ordinary income rates.
3. Amounts received in excess of the cash value get favorable capital gains treatment.
Major Investor Capital Returning To Life Settlements Market
Increases in new laws and regulations, like The Life Insurance Consumer Disclosure Act, have greatly contributed to the growth of the life settlement market. New regulations have mostly focused on transparency which has resulted in an increase in consumer trust and confidence in the life settlement option. According to the Life Insurance Settlement Association (LISA) “Absence of Consumer Complaints Validates Safety of Life Settlement Transactions”.
Along with new transparency laws bringing new policyholders into the life settlement market, national ad campaigns from major companies focusing on tv, radio, and internet have resulted in a dramatic spike in consumer awareness as well, much to the benefit of all life settlement companies.
Such an increase in consumer awareness, along with new transparency laws improving consumer confidence, the market has experienced a major influx of investors.
Big Name Investors Active In The Life Settlement Market
In 2013, Warren Buffet’s Berkshire Hathaway confirmed the purchase of a life settlement portfolio valued at $300M.
Berkshire paid $60 million to acquire the portfolio of over 100 policies. Policy selection, medical review, and actuarial analysis were completed by Miravast Asset Management Ltd., and Berkshire was represented by law firm Stroock & Stroock & Lavan LLP throughout the transaction.
With such a significant purchase, Warren Buffet’s renewed interest in the market, having been active in the space since 2001, will inspire even more confidence in the asset class. In addition to big names like Warren Buffett, Bill Gates has invested more than $500 million of his personal net worth in the asset class.
With respected investors like Warren Buffett and Bill Gates active in the market, along with institutional investors such as Credit Suisse and Deutsche Bank currently investing in the life settlement asset class, it is not surprising that the market has gained reliability and credibility as an investment vehicle.
An Aging Population Could Expand The Life Settlement Market Into Year 2030
Another factor behind the recent growth of the life settlement market is the expanding senior population. The number of seniors (Age 65+) is projected to continue rising from 42 million in 2012 to an estimated 70 million in 2030. This only increases the potential of the life settlement market.
Likewise, the ratio of policies that can be purchased has actually increased. This is for a few reasons:
• Life settlement brokers and providers are becoming better at understanding which policies are “investor- qualified” before bringing them to the marketplace.
• Medicaid statues in various states have proposed using life settlements to fund health care.
• States classify life insurance policies as ‘assets’ when considering an applicant for Medicaid.
Life Settlements And Medicaid
There’s a growing recognition that life settlements provide an answer to relieving pressure on the long-term needs of the elderly in the middle and lower-income groups. Texas and nine other states have passed Medicaid life settlement bills over the last six years to alleviate the burden by hundreds of millions of dollars.
A life settlement option converts existing life insurance into an FDIC insured account that is used to pay for the cost of assisted living care directly each month. Qualifying for this type of life settlement is generally quick and, if accepted, the client can usually choose their preferred nursing home care, hospice, specialized Alzheimer’s care, or skilled nursing care.
According to The Life Insurance Settlement Association, more than 80 percent of all life insurance lapses or cancels before it ever pays out in a death benefit. Financial advisors with clients considering using Medicaid to pay for long term care expenses should consider the benefits of a Medicaid life settlement.
Advisors and clients can instantly determine if a policy qualifies for a life settlement by using a life settlement calculator. If the calculator suggests a policy qualifies for a life settlement, the next steps involve hiring a life settlement company to represent the case and bring the policy to market for bidding.
|Insured Age||Face Amount||Minimum Waiting Period||Health Status|
|Clients should be at least 70 years old.||The face amount of the policy should be at least $250K.||The policy should be in force for at least 2 years. Some states require more than 2 years (see chart 1.1)||The policyholder has been recently diagnosed with a terminal illness.|
Types Of Policies That Qualify For Life Settlements
All types of life insurance policies qualify for a life settlement. However, whole life, universal life, and term life policies are considered the most valuable. Policies are most valuable when the premiums are paid in full because this means the buyer/investor will not have to pay premiums after purchasing the policy.
A convertible term life policy, in particular, allows the policy buyer to convert or renew it without any further medical qualification (i.e., proof of insurability). Of course, the premiums will likely increase at such a juncture – a cost factor every LS buyer should account for before acting.
Non-convertible or renewable term policies are high risk for any life settlement buyer based on the life- insured living beyond the defined policy period. It only works in the viatical arena if there’s a high probability that the life insured won’t outlive the policy’s stipulated age limits.
Variable life policies qualify for life settlements but can be less desirable if the monthly premiums are considered too high. FINRA has jurisdiction over life settlements involving variable policies because variable insurance products are securities. Variable life insurance policies tend to have the highest fees.
Required Waiting Periods Before Clients Become Qualified For Life Settlements
a. Thirty states require two years.
b. Eleven states require five years.
c. Minnesota requires four-year wait.
d. Two states cover viaticals only (New Mexico and Michigan)
e. Twenty states – accounting for 53% of the population – adhere to the National Conference of Insurance Legislators (NCOIL) Life Settlement Model Act.
The first life settlement occurred in the early 1900s. Since then, especially over the past two decades, the market has experienced growth due to increased consumer awareness from national ad campaigns and increased government regulations involving disclosure and transparency. However, most financial advisors report being either unaware or unfamiliar with the market.
According to a 2015 survey published by WealthManagement.com, four out of 10 U.S. financial advisors indicated a “limited familiarity” with life settlements or are “entirely unfamiliar” with these transactions. Additionally:
– Out of those those familiar with life settlements, only 11% had either recommended a life settlement or assisted a client with a transaction.
– Many advisors believe they need a specialized knowledge of life settlements in order to recommend them to clients.
– Nearly 3 in 10 drew a strong association between life settlements and “stranger-originated life insurance”, which became illegal in 2010.
– Some advisors also believe the transactions are only for the terminally ill.
– Others had the impression life settlements are illegal altogether.
“Revisiting A Shocking Statistic
According to a 2018 study by investment management firm Conning, $200 billion worth of settlement-qualified life insurance will lapse or be surrendered each year through 2027. It’s estimated that 88% of all universal life policies that are issued are lapsed or surrendered without ever paying a death benefit. According to Milliam USA (2004), almost 85% of term policies fail to pay a death claim. In fact, 74% of term policies and 76% of universal life policies held by seniors age 65+, policies that are more likely to qualify for a life settlement, will never pay a claim.”
The number of lapsed policies underlines exactly how insurance institutions are profiting billions of dollars each year. Every lapsed policy represents years of monthly premium investment lost to the owner forever, a pure profit to the insurance company. Life insurance companies don’t make money from maturing policies. It is ultimately their business model to collect premiums and then see the policy lapse. Considering the number of families and individuals that own life insurance, a financial advisor, who’s financial interests closely align with brokers, has real potential to get their clients a return on their investment that spans decades.
Life Settlement Brokers And Financial Planners Have Mutual Interests
Life settlement brokers invest $2,500-$4,000 of their own company funds into each life settlement client that they represent. Acquiring medical records, illustrations, getting official documents prepared with all of the required signatures each have respective fees covered by the broker. So, life settlement brokers are actually financially invested in each case that they represent. Your clients should feel confident in knowing their broker is looking for the highest possible price, the maximum return on their investment.
Advisors ensure all parties, including brokers and the insurance companies, disclose all available options. For example, a life settlement broker is legally obligated to disclose alternative options like the ‘Accelerated Death Benefit’, which in some cases is more lucrative for the policyholder. So, financial advisors can help ensure all parties are operating in good faith. Being familiar with recent court decisions that set legal precedents and understanding how the new life settlement tax laws can benefit clients. Financial planners can help ensure the life settlement process results in more favorable and profitable outcomes.
When a client understands the life settlement market, including what constitutes a qualified policy, how much a policy is worth, crucial timelines, the many benefits of a broker, etc, they are ultimately more confident in their decision to transact, or not. Having connections to experienced life settlement brokers who bring policies to a buy-ready network of life settlement providers and investors, only increases the value of the financial advisor.
Policyholders working with financial advisors experienced with the life settlement market are in a better position to make the best financial decision, even if that decision is ultimately not to pursue a life settlement. A crucial element in making the best life settlement decision is education.
In conclusion, the supply of qualified policies, as well as demand for life settlements, is growing. New regulations are protecting buyers and sellers. The major players and household names have brought investor capital and due- diligence back into the market. State governments have recognized the value of life settlements through disclosure laws and Medicaid statutes. This market’s forecast looks bright because awareness is on the rise, capital is returning to the market, and because your clients can look to life settlements as a viable alternative to lapsing or surrendering policies.