Life settlements are fast growing into a staple of the insurance and financial planning world. Most financial professionals have heard of life settlements, which is the sale of a life insurance policy of a senior (age 65 and over) for a lump sum that is greater than the policy’s cash surrender value but less than its death benefit. Policies that are viable for a life settlement are generally those beyond the contestability period wherein the insured has a life expectancy of between 2 and 15 years. Today life settlements are dominated.
Institutional funders and pension funds. Despite the continued growth in the life settlements market, the number of insurance or financial professionals that have actually completed a life settlement is surprisingly low. This can be attributed mainly to a lack of in-depth knowledge of life settlements on these professionals. Considering that life settlements are a relatively new option for policy owners, many financial professionals, although having heard
of life settlements, have still not had the opportunity to delve into the subject on a deeper level. Many policyholders come to a juncture wherein they continue to pay life insurance premiums on an unwanted policy in hopes of again at maturation or to recoup some of the investment by trading the policy for its cash surrender value. Corporate policyholders often face additional dilemmas when dealing with departing executives with key-man or split-dollar policies or insurance purchased as part of a buy-sell agreement.
With a life settlement, the policyholder realizes an amount much greater than the cash surrender value in exchange for the policy’s ownership. Term life insurance policies are also applicable when converted into permanent insurance. Life settlement transactions involving key-man or buy-sell policies can provide businesses with increased cash flow to solve immediate financial problems. In contrast, transactions concerning split-dollar policies typically involve retirement planning and charitable giving issues.
In short, life settlements offer policyholders of all kinds an array of options previously unavailable to them. In a recent advisor survey, nearly half of the respondents had clients who had surrendered a life insurance policy, many of whom might have qualified for a life settlement transaction and subsequent lump sum cash payment. In this article, I will discuss the underwriting process related to life settlements, which is of paramount importance in the process, just as it is in life insurance itself. However, there is a great deal of difference in the process for each respectively.
Settlement amounts are determined by many factors that arrive at a Net Present Value, which is the present value of future benefits from the death benefit minus the present value of future payments associated with sustaining the policy until maturation. These expenses include premium payments, cost of capital, and administrative costs. This calculation enables the purchaser to factor in the desired profit from the investment and proposes an
offer to the seller of the policy. Because the investor will be sustaining the policy premiums until maturation, the insured’s life expectancy becomes critical in assessing the value or sale price of the policy. If the insured’s life expectancy assessment is too short, the purchaser will have paid too much and risks a financial loss. By contrast, should the assessment of an insured’s life expectancy be longer than their actual life span, the offer to the seller would have been less than it could have been.
Thus resulting in an undervalued sale for the policy owner. Institutional investors in life settlements generally obtain life expectancy reports from two or more independent LE (life expectancy) providers. Many of the larger institutions investing in life settlements have proprietary underwriting personnel on staff. LE reports can vary significantly based on interpretations, medical data on the insured, and/or the actuarial tables used.
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