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Life Settlement Industry Creates Secondary Market.

Imagine a world where buyers are ready and willing to purchase your vehicle at a price substantially more than its value at trade-in and you can choose the highest bidder. No marketing, no haggling, no expense to you. Fiction? Nope. Now this world exists,not for car owners, but for life insurance policyholders intended for lapse or surrender. These policy holders will receive a settlement while they are still living.

The life settlement industry has given birth to a securitized secondary market for acquiring life insurance policies from qualifying life policyholders, who receive an offer guaranteed to exceed the cash value of the policy. In 2002, life settlement providers paid about $340 million to acquire policies with an aggregate cash value of about $94 Million.

Life Insurance Policyholders who qualify for life insurance settlements are in general older than sixty five years of age; have deteriorating health, but are not considered terminally ill; and have “ascertainable and limited” life expectancies between two and fifteen years. Qualifying policies are at least two years old, pay death benefits between $100,000 and $5 million and are issued by an “A” rated insurance company.

AN EVOLVING INDUSTRY

Relatively new, the life insurance settlement industry evolved from “viatical” settlements, which catered to the needs of terminally ill life insurance holders. Viatical life settlements enable an insured to get benefits, prior to death, to pay for the high costs of care. Life insurance settlements, also known as senior settlements, don’t involve a terminal illness (less than 24-month life expectancy) but a determinable life expectancy based upon the insured’s lifestyle, age, and health.

The policy’s market value is the net present value of the benefit at death, factoring in the policy’s duration and carrying costs. some other factors affecting the fair market value include the type of life policy, the policy’s cash value and any loans against the policy.

A life settlement transaction creates a taxable event with two tiers. The first tier is the difference between the cost basis and cash value, most likely taxed as ordinary income. The second tier is the excess of settlement proceeds over the policy surrender value.

The IRS has not yet provided any specific guidance yet, however, whether this is considered to qualify as a long-term capital gain. The treatment of the tax implications of viatical settlement is markedly different. The Internal Revenue Service considers viatical settlements to be tax-exempt accelerated death benefits.

WHEN TO SELL OR BUY LIFE INSURANCE?

Life insurance settlements are a superb option when policy premiums are no longer affordable. Recent declines in short-term interest rates have hurt the cash flow of seniors relying on a fixed-income. With life settlements, the burden of premiums disappear and distressed policy holders receive cash up front.

Perhaps the senior citizen has outlived all beneficiaries and the payout of life insurance would create a undesirable taxable estate. Maybe the senior, due to health reasons, doesn’t qualify for long-term care insurance. Settlement funds could be used to fund long term health care.

From a entity perspective, life insurance settlements should be considered when a business is put up for sale or the owner is retiring. If your client is a non profit, or charity, it may be possible to consider selling donated life policies to realize cash today and eliminate future cash outflows

Why do individuals want to buy life insurance policies? Most life insurance settlement providers are backed by well-known financial institutions that view insurance policies as just one asset in a balanced investment portfolio. These financial conglomerates] rely on actuarial and other quantitative data to buy a profitable policy that will produce a expected rate of return at the policy maturity. These insurance policies are held in a blind trust that may be used as collateral for a bond offering in a process known as secondary market securitization.

FIDUCIARY PITFALLS

Life insurance products are acquired] for a host of reasons and should be a part of every estate and financial plan. As with any financial vehicle, these policies should be reviewed frequently. Usually they are not.

A good insurance policy at the time of purchase does not mean you have a good policy years later. In today’s low short term interest rate environment, many policies written in an environment when rates were substantially higher might require replacement?

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