Life settlement
From Wikipedia, the free encyclopedia
A life settlement is a financial transaction in which a policy owner possessing an unneeded or unwanted life insurance policy sells the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.
Life settlements are an important development in that they have opened a secondary market for life insurance in which policy owners can access fair market value for their policies, rather than accepting the lower cash surrender value from the issuing life insurance company.
Generally speaking, life settlements are an option for high-net-worth policy owners age 65 or older. Independent estimates report that among this group, 20% of policies have a market value that exceeds the cash value offered by the carrier. And while many policyowners are unfamiliar with life settlements until a financial professional mentions the option to them, the concept has gained attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill Gradison, and numerous media sources including The Wall Street Journal, Time Magazine, Business Week and The Economist. A growing number of experts now believe that informing clients about offering life settlements should fall under the fiduciary duty of a financial adviser.
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[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] Financial Advisers
Life settlements are complex financial transactions that are generally conducted on behalf of clients by experienced professional advisers. Some examples of advisers that are becoming increasingly involved in the life settlement arena are:
- Accountants/CPAs
- Attorneys
- Financial Planners/CFPs/ChFCs/CFCs
- Wealth Managers
- Insurance Advisors
- Estate Planners/CEPs
- Certified Senior Advisors/CSAs
- Charitable Trust Officers
[edit] Providers
Life settlement providers serve as the purchaser in a life settlement transaction and 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. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to third parties.
[edit] Brokers
Financial advisors who choose not to submit cases directly to a settlement provider may opt to work through a life settlement broker. Life settlement brokers are intermediaries who bring together policyowners who wish to sell a policy and providers seeking to purchase them. Brokers, in exchange for a fee, will shop a policy to multiple providers, much as a real estate broker solicits multiple offers for one’s home. Not all buyers are alike and a life settlement broker will help ensure that cases are sold to reputable buyers who are likely to close without significant difficulties. It is unlikely a financial advisor will achieve the highest possible price without going through an experienced life settlement broker.
While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after commissions, and more.
Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a broker will benefit the client. In many states, brokers must be licensed to do business in that state. Industry experts state: "It is imperative that the client works with a licensed broker who has the experience to deal with sophisticated institutional buyers to yield the highest price."
In regulated states there are material regulations as to procedure, privacy, licensing, disclosure and reporting which must be met and which in some cases carry criminal penalties. A licensed life settlement broker can help you meet all relevant requirements.
[edit] Investors / Risk takers
Life settlement investors are known as financing entities because they are providing the capital or financing for life settlement transactions (the purchase of a life insurance policy). Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures. The life settlement provider is the entity that enters into the transaction with the policyowner and pays the policyowner when the life settlement transaction closes. In most cases, the life settlement provider has a written agreement with the life settlement investor to provide the life settlement provider with the funds needed to acquire the policy. In this scenario, the life settlement investor is effectively the ultimate funder of the secondary market transaction. However, in some life settlement transactions, the life settlement provider is also the investor; the provider uses its own capital to purchase the policy for its own portfolio.
[edit] Other Involved Parties
Underwriters/Life Expectancy Providers - Provide life expectancy estimates on the insured for pricing purposes. There are four major life expectancy providers, namely 21st Services, AVS, Fasano, and ISC Services.
Some underwriters provide unreasonably short life expectancies by using base tables that are 5 years out of date, ignoring future mortality improvements & current treatments Eg Statins and basing life expectancies on life manuals which are conservative for mortality and not longevity risk. Others apply actuarial analysis to the most recent available data as well as their own experience to develop their base tables and underwriting manuals.
Providers who do not provide short life expectancies are shunned by originators whom are primarily remunerated for volume. Providing more reasonable life expectancies does not inflate the apparent value in these insurance policies. This results in fewer cases being written and less support from originators.
There are no experience studies publicly available which support the accuracy of any of the major life settlements underwriters.
Tracking Agents - Tracking agents provide information to investors regarding the whereabouts and mortality status of each insured. Tracking agents use a variety of methods to collect this type of information such as phone, email, mail, and the social security database. Most tracking agents also provide premium management, death claim processing (collecting the death benefit from the insurance company once the insured has expired) and reporting services.
Steps in a Transaction
- Policyowner consults with an advisor, decides to sell his or her policy.
- Policy owner and advisor decide whether to work with broker or to go directly to providers.
- Client & advisor submit policy for valuation. Client releases medical information.
- If policy meets criteria for a life settlement, providers send offers directly or through a broker.
- Client and advisor review offers and client accepts his 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
Although the secondary market for life insurance is relatively new, the market was more than 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.
The Policy as Transferable Property
The Supreme Court case of Grigsby v. Russell (1911) established the policyowner’s right to transfer an insurance policy. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policyowner could transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policyowner.
This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
- Name the policy beneficiary
- Change the beneficiary designation (unless subject to restrictions)
- Assign the policy as collateral for a loan
- Borrow against the policy
- Sell the policy to another party
A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Viatical Settlements Model Act 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 using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policyowners who no longer needed a given policy. Strong demand for life settlements policies is driving a rapid market expansion that continues today.
[edit] Major Study Findings
One major study that showed some of the potential of the life settlement market was conducted by the 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.
