Life settlement
From Wikipedia, the free encyclopedia
A life settlement is a financial transaction in which a senior citizen possessing an unneeded or unwanted life insurance policy sells the policy to a third party, as opposed to surrendering it back to the life insurance company. The seller receives immediate cash for the policy from the purchaser. The entity purchasing their policy becomes the new beneficiary of the policy at maturation and is responsible for all premium payments from the time of the purchase until the seller passes away.
Generally speaking, many policy owners who are the sellers in life settlement transactions are unfamiliar with this option until a financial professional mentions the option to them. This particular type of transaction has not yet become a mainstream financial product like stock and bond transactions, though in the past few years the positive industry growth and attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill Gradison, and The Wall Street Journal has created much interest in the industry.
A recent overview of the life settlements market can be found in the 2005 Industry Outlook compiled by major industry firm Maple Life Financial. A survey found on page 4 of this publication found that almost half of all responding advisors had senior clients who had surrendered a life insurance policy for the cash surrender value (in the case of a term life policy, the surrender value is $0) when many of these clients could potentially have qualified for a life settlement. Many are beginning to speculate that offering life settlements should fall under the fiduciary duty of a financial advisor.
Contents |
[edit] How It Works
In a life settlement transaction, there is a chain leading from the seller of the policy to the end buyer of the policy (known as a life settlement provider.) Each link in the chain has a different responsibility in facilitating the transaction and ensuring that it runs smoothly, while outside vendors typically assist the provider with specialized functions.
[edit] Policy Sellers
Senior citizens who have the greatest chance of selling their policies generally are over 65 years of age, have a calculated life expectancy of more than two years, but less than ten years, and may have experienced a health change that has led to their insurance premiums increasing. This undesirable scenario, often coupled with increasing health care and/or nursing home care costs, makes a life settlement an attractive option to many seniors. There are certain restrictions for their policies as well - policies must be valued at $100,000 or more, and depending on the life expectancy determination of the seller, any and all types of policies can be sold, ie; universal life, whole life, or convertible term contracts.
[edit] Financial Advisors
Senior clients often discuss life settlement transactions with their financial advisors instead of conducting the transaction on their own, since their advisors are usually much more familiar with this non-mainstream financial product. Some examples of advisors that are becoming increasingly involved in the life settlement arena are:
- Accountants/CPAs
- Attorneys (especially Elder Law Attorneys)
- Financial Planners/CFPs/ChFCs/CFCs
- Estate Planners/CEPs
- Certified Senior Advisors/CSAs
- Charitable Trust Officers
[edit] Brokers
The decision to work with a broker is up to the client, since financial advisors can submit the client's case to the life settlement provider directly. However, in an industry where market value for life insurance policies is not common knowledge, brokers typically do the best job of obtaining fair market value for a senior citizens policy. By submitting life settlement cases to multiple providers, they are able to obtain a greater number of bids overall, and help facilitate negotiations between high bidders. For a list of qualified, licensed brokers, please visit the LISA website.
[edit] Providers
Life settlement providers are responsible for paying the client a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset, and do not make it available to outside investors. They also have in-house compliance departments to carefully review transactions, give seminars to both financial professionals and senior citizens about life settlements, and most importantly, they are backed by institutional funds from a major bank.
[edit] Other Involved Parties
- Underwriters - Provide life expectancy estimates on the insured for pricing purposes.
- Funding Sources - Banks that provide institutionally funded firms with cash for payments.
Steps in a Transaction
- Senior citizen with financial needs consults with an advisor, decides to sell his or her policy.
- Client & advisor select a broker who works with institutional providers.
- Broker submits case (and client releases medical information) to various providers.
- If policy meets criteria for a life settlement, providers send offers to the broker.
- Client accepts their preferred offer.
- Client and advisor complete the provider's closing package, and return essential documents.
- Provider places cash payment in escrow and submits change of ownership forms to the insurance carrier.
- Paperwork is verified and funds are transferred to the policy seller.
[edit] Life Settlement History
The life settlement industry grew out of the viatical settlement industry in the 1990's. Viatical settlements were similar to life settlement transactions, except they usually involved sellers with life expectancies of less than 2 years. Many of these people were terminally ill with the AIDS virus, and welcomed the extra cash from the sale of their policy. With the advent of drugs that kept AIDS victims alive for a longer period of time, many investors suffered and had to pay premiums for a much longer term than expected. Some scam artists marketed viatical settlements as an investment product, but never used the investors' money to purchase policies for a portfolio. It was clear that if the secondary market for life insurance was to survive, regulation was necessary.
The National Association of Insurance Commissioners (NAIC) took a crucial step when they released the Viatical Settlements Model Act in 2001, defining guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio. These policies had different criteria than viatical settlement purchases, namely in terms of the client's life expectancy. While viatical settlements had previously attracted negative attention to the secondary life insurance market, major research firms began to take notice of the life settlement phenomenon and portray the industry in a positive light.
[edit] Major Study Findings
One major study that showed some of the potential of the life settlement market was conducted by the renowned University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance." ([1]) This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their underperforming life insurance policies, an opportunity that was not available to them just a few years before.
"We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton Study, pg 6
Another study, perhaps even more influential, was the Conning & Co. Research study "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements. Since 2003, more and more of these eligible senior clients have sold their policies and helped the market increase.
[edit] The Life Insurance Settlement Association and the Life Settlement Institute
Since the inception of LISA in 1995, the focus has shifted from primarily viatical settlement firms to life settlement firms. The primary purpose of this organization, with 126 members, is to "promote responsible legislation and regulation of the industry." This non-profit organization accepts member firms who comply to ethical standards and are fully licensed to conduct business in the life settlements field. Noted as the voice of the life settlement industry, LISA hosts two life settlement conferences a year. The biggest in the industry. LISA is also committed to inform the american public about the existence and benefits of life settlements placing articles in major national newspapers, trade magazines and publications.
The Life Settlement Institute, a small and select group of four members with similar goals as LISA, took things a bit further and sought to increase life insurance and financial professionals' awareness of the industry. Around this time, professionals began placing articles in trade publications such as California Broker, Life Insurance Selling, National Underwriter, Trusts & Estates, etc., further implementing life settlements as a mainstream financial product.
[edit] Other Life Settlement Fast Facts
- When a life settlement should be considered
- Premiums too expensive
- Medical/long term care required
- Charitable/family gifting desired
- Employment status changes
- Business Uses - Key man, split-dollar, or buy-sell agreements
- Irrevocable life insurance trusts (ILIT)
- Bankruptcy
- Market data
- Seniors 65+ - 36 Million
- Active Life Insurance Producers - 175,000
- Life Settlement Brokers - 178
- Life Settlement Providers - 34
- Estimated Amount of life policies to be purchased by providers in 2005 - $10-15 billion
- From the Maple Life Financial Industry Outlook 2005
