It has always been our strong belief that a life insurance policy should never be purchased for the purpose of speculating on its possible life settlement value. Sound planning, however, should try to cater to as many contingencies as possible because, over time, there may be significant changes in the needs or circumstances of the insured. One of our recent life settlement cases sheds light on an important planning tip.
The case involved an 87-year-old male and two identical $2 million survivorship universal life policies that were acquired in 1996 for estate planning purposes. The insured's wife had since passed away. The policies were originally bought using a single premium based on the then-current assumptions. Due to declining crediting rates, however, these policies were going to lapse in a year or two. The surviving husband was now suffering from dementia and required very costly full-time care. Neither the insured nor his children could afford to keep paying for both policies as well as meet the insured's medical expenses.
To preserve some of the death benefit, as well as to create immediate liquidity, we suggested doing a life settlement on just one of the policies. As a result, one policy was sold for $890,000, which, at least for now, will provide enough cash to meet the insured's medical expenses and continue to fund the other policy.
What makes this case stand out is that the client had obtained two $2 million policies (one for each of his sons) rather than a single $4 million policy. At the time the policies were bought, it was determined to be more convenient to have two policies.
It is highly unlikely this deal could have been consummated had only one $4 million policy been acquired. Except under very limited circumstances, our experience has shown that most insurers will not permit policies, other than term, to be split — especially if they suspect a life settlement might be in the offing.
Had there only been one policy, the only options would have been to sell the entire $4 million or reduce the face amount. Either choice would have produced a less favorable result. Had the entire policy been sold, they would have had additional funds for the care of the insured, but no remaining coverage. Alternatively, had they reduced the face amount, no additional funds would have been realized for the insured's care.
There is an important lesson to be learned here. Because insurers are reluctant to allow existing policies (other than partial term conversions) to be divided, it may be wise to buy two or more smaller policies at the outset rather than one large one. There is a slight cost to this strategy, as the purchaser incurs multiple policy fees, but that relatively insignificant additional expense provides options that can yield huge benefits as illustrated by this case.
Some insurers won't even permit policies to be acquired in smaller amounts at the outset, fearing that some sort of speculation might be going on. Nevertheless, breaking up a large purchase into smaller policies can be a wise and prudent decision. If an insurer objects to the strategy, then consider splitting the business between more than one company. In these tough economic times, where insurance company financials have been particularly stressed by low interest rates and some have even exited the business, this can also be a wise diversification strategy that should be considered in any event.
It was mostly "dumb luck" that this case worked out as it did. Back in 1996, when the policies were bought, life settlements were not even on the radar screen. It was just determined to be more convenient to have a separate policy for the benefit of each son. The favorable outcome of this case offers insight into a planning consideration that could pay huge dividends for your clients.
While no policy should be purchased speculating on a future life settlement, skillful estate planning attempts to handle as many contingencies as possible. In these times of uncertain estate tax laws and economic hardship, positioning an estate for the possibility of a smaller insurance need or a reduced ability to pay premiums is simply prudent planning.
For more from Robin S. Weinberger and Peter N. Katz, see: