Life Settlements
What is a life settlement anyway? This is when you sell your life insurance policy to a third party for a small percentage of the face value (or death benefit) of the policy. You must release your medical records, and take a 45 minute phone telephone interview. If approved, a life settlement company buys your policy on behalf of the investor (usually a hedge fund, mutual fund, or pension fund), who then become the owners & beneficiaries of your policy. The investors prefund an escrow account in advance and pay your policy premiums until your death. The investors collect anywhere from a 9% to 15% return (in some cases as high as 25%- depending on how soon you die).
How much cash can I get up front, if I sell my policy? Usually you will get around 28% to 18% of the face value of the policy. Example, you have a $250,000 policy x 28% = $70,000. Many companies are not taking policies less than $1,000,000 in death benefits. But there are still some companies taking $100,000 and $250,000 policies. The life settlement company will determine the payout based on your age, the type of policy, the rating on the insurance company, and the premiums they need to pay until your death.
There are two types of the life settlement’s, one is the traditional life settlement that seniors need, who currently own life insurance policies, and two is the “premium financing investment” for the rich. Let’s talk about the traditional life settlement market first.
The traditional life settlement market is comprised of two different types of people who try to sell their policies. One is the person who cannot afford to pay their premiums on their current policy and those who can afford to pay their premiums on their policy. In this market the age of the policy owner must be 65, but in reality from an agents point of view representing investors…you must be a minimum of 70 years old.
Who should consider selling their policy in the life settlement market? If you meet the following conditions, you should seriously consider a life settlement (if most or all the conditions below are met):
- Your age is 70 years or older.
- You cannot afford to pay the policy premium any longer.
- Your financial needs must be met now, and cannot wait.
- You’re in poor health.
- You earn less than $38,000 a year. Basically, you are always following a strict budget, and you’re debating which bills to pay.
- You have no beneficiaries truly to speak of.
- You have large debts.
Who should not sell their policy in the life settlement market? If you meet the following conditions, you should not consider a life settlement (if most of the conditions below are met):
- Your age is 70 or older.
- You can afford to pay the policy premium.
- You’re in the upper middle-class or wealthy.
- You have an estate.
- You have beneficiaries.
- You have a charitable foundation.
Let’s talk about why you shouldn’t sell your policy. Let’s assume you fall into number #8 through number #13 above. Let’s examine total return for a moment. Why sell your policy for a 52% to 95% loss? When you sell a policy the investor will offer you a percentage of the face value (or death benefit) based on your age and how long they think you’re going to live. Let’s take a case example, your age is 70, you have a $1,000,000 policy. Investors offer you $200,000 cash right now. That’s an 80% loss to your beneficiaries. Your beneficiaries would be in the money, if they paid the premiums on the insured…and just waited. In addition, a life settlement has a tax liability above your basis (the amount premiums you paid in)…so you lose even more money. Your beneficiaries would have received $1,000,000 tax free if you held on to policy. Why sell when you do not need the money?
The life insurance company could sue the estate (of the deceased) over the issue of “insurable interest”…and probably win. This means the agent & the deceased failed to mention that investors were purchasing the policy (who have no insurable interests in the deceased-insured). An insurable interest is; the person purchasing the policy must have an insurable interest in the life of the person being insured (either by love & affection, such as a wife or a blood relative, or have economic interests in the continued life of the insured). This all means the policy held by the investor becomes worthless, and then the investors sue the estate of the deceased for fraud. And since the deceased is dead (and can’t defend himself)…the investors will probably win (and take damages equal to their investment, plus the interest they would have made). No matter what, the investor wins in court, or acquires the death benefit (if the insurance company does not contest).
Unfortunately, there is another problem…called “suitability.” This relates to the insurance agent recommending a life settlement, when the agent should not have made the recommendation to sell the policy. Why should you sell a bond worth $1,000,000 for $200,000? The same principle applies to a life insurance policy. The agent must prove beyond a reasonable doubt to the insurance commission & the securities commission (if questioned)…the insured or deceased had serious money problems and needed as much money they could get their hands on…immediately! If the agent can’t prove that, he or she will be in serious hot water.
The problem in the life settlement market, is the people who truly need to sell their policies (people who fall into numbers #1 through number #7 above) cannot sell their policies…because their policies are two small. A normal policy for the average middle class is around $100,000 to $250,000 in face value (or death benefit). Investors do not want to stick their neck out for anything less than $1,000,000 in face value (or death benefit)…due to the possibility of suing the estate of the deceased. Who wants to invest, and then sue over small change (like an investment of $28,000 on a policy death benefit of $100,000)? In addition, as medicine & genetic science progresses over the next decade, you will see the life settlement market disappear altogether…since the investor will not be able to calculate the estimated return (since science will alter the life expectancy table beyond which can be calculated honestly on even given year).
With the life settlement market, the older you are…the more money you get upfront, since your life expectancy is shorter. The closer you are to age 70, the worse the deal gets. If you have no beneficiaries to help you, and you’re debating which bills to pay…then call an insurance agent up and sell your policy. If you are going to sell your policy, check who the buyer is. Are they reputable? Call the department of insurance and check out if they have a good track record or not. Get four quotes from four different settlement companies, since different companies determine life expectancy differently (and they all pay different commissions to agents)…you may get quotes from $200,000 to $400,000 on a death benefit of $1,000,000.
If you sell your policy, do not get hustled into purchasing another policy with the proceeds of a life settlement. This is called “churning” and is against the law. To get rid of one policy with a lower premium, and buy a policy at a higher premium (just to make a commission)…is very bad!
If you are in the middle class, and cannot afford to pay the premiums…ask your beneficiaries to pay the policy premiums…before hiring an agent to sell your policy. Hopefully, you have other assets to liquidate.
What exactly is a “premium financing investment?” Remember, a life settlement is when the insured already has a policy and has financial difficulty. While in the world of premium financing, a wealthy person evaluates insuring himself for $10,000,000 to $20,000,000 (on average), the investors pay the premium, and after 2 years the policy is sold to the investors…and they become the owner & beneficiary. Why would you do this John? Let’s look at a case example:
Client = Age 88
Life Expectancy = 4 years
Policy Death Benefit = $20,000,000
Policy Premiums for 2 Years = $3,400,000
Client Sells the Policy for $5,000,000 Cash is Two years
$3.4 million - $5 million = $1,600,000 Gain
Taxes = $1,600,000 x 35% tax bracket = $560,000
Net = $1,600,000 - $560,000 = $1,040,000
Now if I was this person, I would be thinking; “I just sat around watching TV and made my estate $1,040,000 larger.” These people are rich, they don’t need life insurance…their beneficiaries are well taken care of. Would I consider this illegal? No. Should it be considered to be illegal? No. But, I do think that this scenario should be taxed similar to a taxable bond. Congress has to think of interesting tax angles to pay-off this administrations debt, and the possibility of having a national insurance plan…so tax law changes are likely in the coming years for this type of investment.
Why is it called premium financing? Usually large banks pay the premiums to the insurance company. The bank usually owns or has interests in the hedge fund, or mutual fund which the investment is being placed (and may even own a large stake in the insurance company). This is BIG business and this is not going away. This asset class is un-correlated with the general equities market, which makes it a great investment (if it remains legal), and it’s a great hedge against inflation (with returns from 9% to 25%). If you are interested in this type of investment, make sure you have a qualified insurance agent, your lawyer, and CPA all agreeing to go forward on this.
Sincerely,
John Bagwell
The Truth About Financial Products.com
www.thetruthaboutfinancialproducts.com
