Many people think of life insurance in rather uninspired terms. They generally consider it a liability and an expense that shows up in cash flow projections, not a true asset. This is sometimes why investors will surrender a policy or let one lapse. But before doing either of those things, policyholders should consider a life settlement. When used strategically as part of a comprehensive financial plan, a life settlement can provide significant value to individuals, companies, trusts, or other policyholders. Let’s look at what life settlements are and how they can help unlock creative solutions for affluent investors and families.
What is a life settlement?
A life settlement is the sale of an existing life insurance policy for an amount greater than the cash surrender value, but less than the death benefit. This functions very similarly to other property or asset sales. So, in the same way a homeowner can sell their house on the open market, individuals can also sell existing life insurance policies in an open market.
This is important because it reinforces the fact that life insurance policies have a value over and above the cash that sits inside the policy. This is even true of term policies that have no real cash value and are therefore often seen as worthless assets by policyholders. But in a lot of cases, those do have significant value, particularly if they have conversion privileges to a permanent product. In one instance, an $8 million policy was sold for $2.5 million despite appearing as a zero on the company's balance sheet!
So, a life settlement shouldn’t be thought of as a simple product sale, but as a solution that allows policyholders to strategically use the market value of life insurance policies.
Who is involved in life settlement transactions?
Like any other transaction, life settlements involve two sides each seeking to advance their own self-interest. So, before entering negotiations, it is vitally important to understand who represents whom in life settlement transactions.
Buyers in the life settlement market include:
- Institutional funds
- Pension plans
- Global banks
- Private equity firms
- Reinsurers
- Asset managers
Some institutions looking to buy life insurance policies will attempt to negotiate with policyholders directly or will present themselves as if they are working on behalf of that seller. They may offer 3x the surrender value of a policy, which can be an attractive proposition to policyholders. But what those buyers are really doing is trying to avoid competition, because the truth is a seller might be able to get 10x that value in the open life settlement market.
This is why sellers should never take the first offer at face value and should always seek representation from a licensed broker who has a fiduciary responsibility to advocate for policy holders. A reputable life settlement broker will work to create the strongest case file possible for that particular asset and go to the market to negotiate on behalf of the seller. But more than that, they will create a policy auction in which multiple buyers submit competing offers for a particular policy. This can significantly increase the value the policyholder ultimately receives.
Before working with any party, asking the simple question, “Who are you licensed to represent?” can dramatically influence the opportunity for policy owners to secure the highest value from the regulated life settlement market.
What do buyers look for?
The current life settlement market is strong and there is a lot of capital competing for policies. So, once a policyholder has decided to settle their policy in an open market, it can be helpful to understand what makes an attractive opportunity to buyers.
In general, buyers are comfortable purchasing policies from any type of owner, including individuals, charities, survivorships, trusts, or corporations. Typically, buyers are interested in policies for individuals who are at least 70 years old. Policies may have any face value, including up to $50M or more. But typically, buyers are only interested in policies that have at least $100,000 in face value. Universal life insurance policies are some of the most attractive policies in the life settlement market, although term policies can also be sold. Term policies that can be converted to universal life insurance will be more enticing. Policies that are written to reflect a change in health status can also bring more interested buyers.
The value of a life settlement
Life insurance plays a lot of different roles for affluent families and can serve as an important cornerstone to a solid financial plan. Therefore, it’s important to review policies annually and make sure they are being properly maintained. But in circumstances where the value is more beneficial to a family today than it is waiting until an unknown point in the future, the settlement market can be a valuable option. Understanding how life settlements work and who is involved can be the key to realizing the highest possible value on a life insurance policy.
Want more insights on how to use life insurance strategically to advance your goals? Let us know and we’ll schedule a complimentary 20-minute consultation to review your needs and identify ways we can help you achieve the financial future you always envisioned.