Life Settlements - What Seniors Should Know

Much has been written recently about the sale and purchase of life settlements. There are risks associated with each side of the transaction some of which are set forth below. Please keep in mind that this information is being provided for educational purposes only and is not designed to be complete in all material respects. Thus, if you have any issues associated with life settlements, you should seek qualified legal counsel to assist you.

Because of the nature of the product, the sale of this product is generally associated with senior citizens. That is why a life settlement is sometimes referred to as a senior settlement. The transaction involves the sale of an existing life insurance policy to a third party other than the company that issued the insurance policy for more than the policy’s cash surrender value, but less than the net death benefit.

Under certain circumstances, life settlements can provide much needed cash to seniors who have no other source of funds to help meet their living expenses. This is especially true if the policies were going to lapse or for people whose life insurance needs have changed.

But as with all financial transactions, life settlements can have high transaction costs and unintended consequences. And even if you decide a life settlement is right for you, it can be hard to tell whether you are getting a fair price relative to the transaction. There is no trading market for this product. Each transaction is negotiated separately.

If you are considering selling your life insurance policy to a third party, you can help protect yourself by familiarizing yourself with your existing policy so that you fully understand your options, becoming fully informed about life settlements, shopping around for the best offer, and dealing only with licensed buyers and brokers. FINRA recently issued an alert relating to life settlements, which I have modified in some respects so that you can educate yourself relative to the product and the process of valuing the same. You should consider, at a minimum, the following factors before entering into a life settlement transaction.

Until fairly recently, if you owned a life insurance policy that you no longer wanted or needed, you had two choices: surrender the policy for its cash value, if it had a cash value, or allow it to lapse. Now, there is a third option: selling your policy (or the right to receive the death benefit) to an entity other than the insurance company that issued the policy in a transaction known as a life settlement.

The life settlement market emerged as an offshoot of the viatical settlement industry that developed in the 1980s as a source of liquidity for AIDS patients and other terminally ill policyholders with life expectancies of less than two years. Unlike viaticals, however, life settlements involve policyholders who are not terminally ill, but generally have a life expectancy of between two and ten years. Life settlements also tend to involve policies with higher net death benefits than viaticals.

The life settlement market has continued to expand rapidly in recent years as baby boomers move into their retirement years. One recent report estimates that existing policies with a collective face value of $11.8 billion were sold by policyholders to investors in 2008.

The purchasers of life settlements, sometimes called life settlement companies or life settlement providers, generally are institutions that either hold the policies to maturity and collect the net death benefits or resell policies or sell interests in multiple, bundled policies-to hedge funds or other investors. In exchange, you receive a lump sum payment. The amount you will receive in the secondary market depends on a range of factors, including your age, health and the terms and conditions of your policy-but it is generally more than the policy’s cash surrender value and less than the net death benefit.

When you sell your life insurance policy, whoever buys it is acquiring a financial interest in your death. In addition to paying you a lump sum for your policy, the buyer agrees to pay any additional premiums that might be required to support the cost of the policy for as long as you live. In exchange, the buyer will receive the death benefit when you die.

Life settlements have proven profitable not only for institutional investors who purchase policies, but also for the providers and brokers who handle these transactions. As a result, competition among life settlement providers for individuals seeking to sell or otherwise terminate their life insurance policies has become increasingly intense. Because the life settlement industry is relatively new and may target seniors who may be in poor health, it can be prone to aggressive sales tactics and abuse. The characteristics of these practices have been discussed in other posts made on this site or in our blog.

That does not mean that you should never consider a life settlement. A life settlement might make sense for you if you no longer want or need your current policy — or if you can no longer afford the expense of paying insurance premiums and are willing to give up or replace the coverage. Even then, however, you should proceed with caution. Here are some of the key factors you should consider:

• Ongoing life insurance needs — If you are considering buying a new policy with the proceeds of the life settlement, you will need to determine whether you will be able to get a new policy with equivalent coverage — and at what cost. Your old policy will still be in force and may affect your ability to get additional coverage. Even if you can get a new policy, you may have to pay higher premiums because of your age or changes in your health status. If your goal is to retain coverage but lower the premiums you pay or otherwise obtain different features, you might want to consider options such as reducing your existing amount of policy coverage or making a “1035 Exchange.”

If you’re thinking of switching from one life insurance policy to another, you should consider whether a “1035 Exchange” would be more beneficial than a life settlement. Depending on your circumstances, if you opt for a life settlement, you may have to pay taxes if the cash surrender value of your policy — or the amount of a life settlement — exceeds the premiums you’ve paid.

The Internal Revenue Service allows you to exchange an insurance policy that you own for a new life insurance policy insuring the same person without paying tax on the investment gains earned on your original contract, which could be a substantial benefit. Because this is governed by Section 1035 of the Internal Revenue Code, these are called “1035 Exchanges.” But there are other factors you should consider when deciding whether to exchange your policy, including potential loss of death benefits.

• L costly alternatives — If one of the factors driving your decision is a need for cash, be aware that surrendering your life insurance policy for its cash value or pursuing a life settlement are not your only options — especially if you would ideally like to retain your coverage. For example, you might want to see whether you can borrow against your policy. You might also be eligible for accelerated death benefits, which allow an individual with a long-term, catastrophic, or terminal illness to receive benefits on his or her policy prior to dying. Check with the company that issued your policy before leaping into a life settlement. You may still decide that a life settlement is the best alternative for you, but you should be aware of all your options before making up your mind.
• Difficulty determining fair prices — One of the hardest things to know when you are selling a life insurance policy is whether you are getting a fair price for your policy. There is no transparent secondary market for life insurance policies. The best way to make sure you are getting a fair price is to shop around. This can mean directly contacting multiple life settlement companies, using a licensed life settlement broker who will shop your policy around on your behalf, or contacting your broker or other financial services provider.
• Impact on your finances — A cash payment from a life settlement can have unintended financial consequences, especially if your financial circumstances have changed from when you first bought the policy. For example, if you currently receive state or federal public assistance, such as Medicaid, a life settlement can negatively impact your ability to participate in that program. Before you proceed with a life settlement, be sure you fully understand the financial implications for you and your family. You may want to consult your attorney, accountant, or other legal or financial professional.
• Impact on your survivors — Consider carefully your need for current income against the future financial needs of your survivors. Even if you have determined that they do not need the proceeds from your insurance policy at this time, ask whether there could be a chance that this situation could change. If so, ask yourself whether you can obtain the liquidity you seek from other sources or by trying alternative ways to tap into the insurance proceeds as suggested above.

If you decide to go forward with a life settlement, here are some questions you should be sure to ask.

1. Is the life settlement broker or provider licensed in my state? A growing number of states regulate life settlement companies and life settlement brokers to some degree, and may require that they be licensed. Be sure to ask your state insurance commissioner whether the life settlement company or broker you are dealing with is properly licensed — and whether either has a record of complaints. If you are working with a securities broker, FINRA BrokerCheck should be your first resource to learn about his or her professional background, registration/license status and disciplinary history.
2. What will happen to my policy? Ask what the life settlement company that is buying your policy will do with it. Will they hold it themselves? Sell it individually? Or package it with other policies and sell interests in the package to other investors? The ultimate buyer of your policy will become responsible for paying the premiums and will collect the death benefit when you die — and, as noted below, any interim and ultimate buyers of your policy will also have access to a great deal of personal information about you, including your health status.
3. What information will I have to provide? To whom? For how long? When you sell your life insurance policy, you will have to sign a release authorizing the release of medical and other personal information so that the buyer can determine how much to offer for your policy. You may also have to agree to provide periodic updates about your health. Once the buyer obtains that information, it may be shared with other parties, including lenders or third-party investors.
4. How can I protect my privacy? Before accepting any offer from a life settlement company, you should carefully read the application, and make sure that the company has procedures in place to protect the confidentiality of your information. If it will be sold, ask to whom, and whether the end buyers will have access to your personal information. If you use a life settlement broker, find out the names of the life settlement companies from whom the broker solicits bids, and ask about the privacy policies of all parties or potential parties to the transaction. In many cases, state regulations govern the handling of confidential information. Contact your state insurance commissioner to find out what regulations apply.
5. What’s the best price I can get for my policy? If you are using a life settlement broker, ask what bids were received, and what steps the broker used to make sure you are being offered the most competitive price available. If you are approached by someone soliciting you to sell your life insurance policy, make sure you understand that person’s role in the transaction: is he or she a life settlement broker who represents you, or is the person affiliated with a particular life settlement company? If the answer is the latter, the person may only obtain an offer from that company, making it hard for you to know whether you are being offered a competitive price for your policy.
6. What are the transaction costs? Life settlements can have high transaction costs. The commissions paid by life settlement companies to life settlement brokers and other financial professionals involved in the transaction can be as high as 30 percent. Ask your broker or other financial adviser what they are being compensated for their role in the transaction and how their compensation is being calculated. Also inquire about what other parties are receiving commissions. If someone recommends a particular life settlement to you, find out what they are being paid, and by whom.
7. What are the tax consequences? The lump-sum payment you receive in exchange for your life insurance policy can be taxable, depending on your circumstances. Before entering into a life settlement, check with a tax professional about the tax implications of any transaction you are considering.
8. What if I change my mind? Always remember that you do not have to accept an offer to purchase your life insurance policy, even if you shopped around for the best price. If you do accept an offer and later reconsider, be aware that some states have laws that allow you to change your mind within a certain amount of time.
9. Is the life settlement in my interest or my investment professional’s? At least one marketing brochure targeted at investment professionals not only touts the potential commissions from life settlements, but also emphasizes that additional revenues can be generated from the seller’s purchase of other investment products using the proceeds from the life settlement. Citing industry statistics, the brochure notes that almost half of all life settlement transactions result in the purchase of new life insurance. In other words, your investment professional stands to make two commissions off of a life settlement transaction. And you may end up replacing a perfectly good policy with a costly new one.
10. Am I being pressured to make a fast decision? If you feel that you are being subjected to high-pressure sales tactics, and other aggressive advertising, marketing and sales efforts, beware. A legitimate investment professional will provide clear answers to your questions and will give you the time you need to make an informed decision.

Obviously, if the purchaser of the life settlement is an institution investor in these types of products, they have established guidelines as to what they are going to pay for a life policy and have in place due diligence guidelines that must be satisfied before the transaction is completed. But these is no requirement that life settlements can only be purchased by institutional investors. If someone has approached you about purchasing a life settlement and you have no experience in such a transaction, it is imperative that you seek competent assistance concerning this transaction. You would need guidance from a number of professional sources, including legal counsel.

Note: One of the things that has concerned me for many years is the thought process of some investors when it comes to the necessity of retaining experts to assist the investor in making the appropriate decision. Many investors do not want to retain and pay a qualified professional to assist in the due diligence phase of the transaction, especially if it involves a unique product or transaction. The problem with not initially spending the money is that the cost associated with an investment gone bad, assuming that anything can even be done, is ten-fold after the fact.