Like many other transactions you oversee, life settlements are designed to protect and maximize the resources of the policyholder. Unfortunately, and often unfairly, negative PR and a lack of understanding about this important financial tool have turned it into the black sheep of the insurance product family over the years. In reality, life settlements are too useful to ignore, and you may be doing your senior clients a great disservice if you do not have this product in your business portfolio.
In essence, a life settlement is the facilitation of a life insurance policy that sells for less than the face amount of the policy and more than the cash surrender value, said Brian Staples, former director of life insurance for the Kentucky Department of Insurance and current president of Right LLC, a consulting firm specializing in the secondary market.
Through a life settlement, policy owners can often make three to four times the amount of the policy's cash surrender value. Thus, a life settlement turns a life insurance policy into a more liquid asset -- one that is more valuable to the consumer.
Boiled down, a life settlement is really about financial empowerment. It's about choice. For clients who no longer need their policies and who may require additional resources to cover medical expenses or cost-of-living increases, the ability to sell their policy to a third party can be an invaluable solution -- much more profitable than surrendering or lapsing on a policy.
Here are three other points that are critical to our understanding of life settlements.
1. Life settlements are not viatical settlements
In their short, 12-year history, life settlements have often been confused with other types of settlements. Chief among these are viatical settlements, essentially the parent of life settlements, from which the industry sprung in the late 1990s.
Viatical and life settlements are similar in that they both involve the sale of a life insurance policy on the secondary market, but their fundamental purpose is different. Darwin Bayston, executive director of the Life Insurance Settlement Association, said that defining the difference between viaticals and life settlements is an ongoing goal for his organization.
"A life settlement involves a transaction with someone who's merely 60 years of age or older, whereas viatical settlements always deal with a person who is terminally or chronically ill, and does not have a life expectancy beyond two years," Bayston said.
This life expectancy difference is important because it changes the often-held perception that a life settlement buyer is "betting" on a policyholder's life. While the policy value does rely on the owner's life expectancy, it is also determined by the amount of the death benefit and the cost of future premium payments. And the death benefit payout does not need to be imminent -- or at least not as imminent as some might think: In Agent Media's 2011 Life Settlement Market Study, lifespan estimates ranged up to 110 months from the time of transaction. This helps put the life settlement on par with any other financial sale, erasing doubts about its legality or benefit to the seller.
2. Life settlements help the financially distressed
As the Life Settlement Market Study showed, an overwhelming number of producers said that the clients they represented sold their life insurance policies in order to pay for living expenses (78 percent) or medical bills (56 percent). This means that, while life settlements may traditionally be considered a tool for the wealthy, they actually provide a much-needed service for people with real financial needs. This is particularly true in a down economy.
"Life settlements are best applied to financially distressed retirees who can no longer afford premium amounts because of the recession [and the corresponding] decline in home values, or who simply no longer need their policy because of the extension of the Bush tax cuts [or other changes in their estate plan]," said Clark Hogan, managing director at Opulen Capital.
The data suggests that, very often, life settlements can help seniors who are not financially prepared for retirement -- a growing concern in recent years. Now more than ever, life settlements provide a key service to people with unmet financial needs.
3. Life settlements are a legal right
Increasing state regulation means that the legal and ethical standing of life settlements is coming less and less into question. Yet we are still a ways off from embracing the idea that engaging in a life settlement is a right that should be protected. For Chris Orestis, president of Life Care Funding Group, this idea of legitimacy is at the core of the life settlement definition.
"I would say that the ability to transfer the ownership of a life insurance policy from its current owner to a third party is the legal right of every life insurance policy holder," Orestis said.
In order to facilitate this right, however, agents have a fiduciary responsibility to understand and explain this option to their clients. This requires education and regulatory knowledge. It is a challenge, but a rewarding task.
"Every settlement case that we've closed has been of tremendous financial impact to the policy owner, where once there was a burden," Hogan said.
Nichole Morford is the managing editor of the Agent's Sales Journal. She can be reached at NMorford@SBMedia.com or 720-895-3968.
What to Expect in a Life Settlement Transaction
The broker process
In Agent Media's Life Settlement Market Study, 39 percent of agents said that they have worked through a life settlement broker. A broker acts as a liaison between an agent and a life settlement provider, collecting life expectancy information, soliciting bids, and negotiating for the highest possible settlement.
One of the broker's greatest assets is networking power: Close relationships with providers means that a broker can generally obtain more bids than a lone agent. In turn, this means that your clients are more likely to get a competitive price for their policies. On average, the broker process can take anywhere from three weeks to three months, said Clark Hogan, managing director at Opulen Capital. Here's how it works:
Step 1: Broker and agent consult to evaluate a potential client's current financial picture, including age and policy size and type. If a settlement seems like a suitable tool for the client's needs, the broker will fill in any gaps in understanding of life settlements, and will explain what fees might apply as the transaction moves forward.
Step 2: The broker collects documentation to submit to one or more life expectancy providers. There is no medical underwriting required. This process typically takes two to four weeks.
Step 3: Once the expectancy numbers are in, the broker packages the information together and submits to a network of active providers. The number of submissions depends on client demographics.
Step 4: Providers evaluate the package and start their bid process, which takes an additional one to three weeks, on average.
Step 5: In an effort to negotiate the trade higher, the broker pulls the highest bids and returns these to the marketplace with a shortened bid window.
Step 6: The broker will take a few of the highest bids (say, three) and submit to the client in a bid report card, which shows the policy settler the gross amount of the settlement, any charges placed on that by the brokerage, and the net settlement amount.
Step 7: The agent reviews the bids with the policyholder. If the policyholder finds one of the bids suitable, the transfer of ownership begins. The broker commits to an offer, creates closing documents, and oversees the sign-off and notification of the insurer.
Step 8: Once the sign-off is complete, funds are typically submitted to an escrow account and then released to the seller. A portion of the funds is distributed to the agent and broker for the agreed-upon commission and fee.
Step 9: Upon the death of the original policyholder, the death benefit is paid in full to the provider.
The provider process
Fifty-three percent of agents in this year's study stated that they have performed past life settlements directly with a provider. This takes the intermediary out of the transaction, and, in some ways, simplifies the process. In addition, experienced agents are sometimes able to submit bids to multiple providers, just as a broker would. When choosing a provider, agents rank compliance, customer service, and easy processing as the three most important traits.
Step 1: The agent collects documentation -- including a client application, policy copies, and medical records -- from the policyholder and submits the data to one or more providers.
Step 2: Each provider reviews the materials and submits the medical records to a life expectancy provider.
Step 3: Once life expectancy numbers are in, the provider(s) again review the materials and settle on a market value, which they then offer to the agent in a formal bid. The market value changes from provider to provider, as each firm has an individual demographic that fits their needs.
Step 4: The agent shares the bid numbers with the policyholder. If they accept a bid, the provider sends a closing package to confirm the sale, which the policyholder reviews and signs.
Step 5: Once the provider has signed closing documents, the insurer is notified of the transaction. All future premium payments will come from the provider.
Step 6: Once written verification of the ownership change is complete, the settlement fee is deposited in an escrow account, where the payment is released to the policy seller. The agent's commission is then paid.
Step 7: Upon the death of the original policyholder, the death benefit is paid in full to the provider.
Life Settlement Encyclopedia of Terms
- Accelerated death benefit. A policy rider that allows the insured to collect an agreed-upon percentage of the death benefit prior to their death, if they become terminally ill. The remainder of the benefit is then paid out upon the death of the insured.
- Cash surrender value. The amount the insurer pays to the insured upon the policy surrender. This usually amounts to between 3 and 5 percent of the face value of the policy.
- Lapse. The termination of a life insurance policy, resulting from a policyholder's failure to pay the premium. With lapsed policies, the policyholder loses the entire value of their investment.
- Life settlement. A life insurance policy that the policyholder no longer wants or needs, and which is sold to a third party for a sum less than the face value of the policy but more than the cash surrender value.
- Surrender payment. A fee often deducted from the amount the insurer owes when a policy owner surrenders a policy.
- Viatical settlement. The sale of a life insurance policy to a third party, wherein the seller is terminally ill and has a life expectancy of no more than two years. The policy seller receives a percentage of the death benefit at the time of sale; the purchaser receives the full death benefit upon the death of the insured.
More life settlement coverage from ASJ
Life Settlement Regulation: GAO, SEC Recommendations Don't Hold Water
Life Settlements Poised for 'Natural Growth,' but Producers Still Lacking in Education
Life Settlements: A Good Idea Whose Time Has Passed?
Using Life Settlements as an Estate Planning Tool
Life Settlement Regulations Make It Harder to Avoid the Market
