Posted on Sep 25, 2014 in Columnists, In The Know, Insurance Matters
(Part 1 of 3) A fact not widely known is that a person may be able to sell the life insurance policy that they have on themselves. In a “life settlement” transaction, a life insurance policy owner sells their policy in exchange for a lump sum payment. Candidates for a life settlement transaction include insureds whose health and continued survival outlook have declined since the policy was issued, and the amount of the payment offered to the policy owner (the “seller”) is less than the net death benefit on the policy, but more than its net cash surrender value. That dollar amount is calculated based on a financial projection which takes into account the terms and conditions of the insurance policy and its expected performance into the future. In addition, that financial projection is based on the insured’s anticipated life expectancy and on other important assumptions.
A reason for selling could be that the owner of a life insurance policy no longer need the insurance provided by the policy. Business needs may have changed; a spouse may have died, children may have grown up, or they may have difficulty making premium payments or simply need cash. In such circumstances, many policy owners surrender their policies or let their policies lapse by ceasing to make premium payments – unaware that selling a policy through a life settlement transaction may be another alternative.
Many of the sales via a life settlement transaction are made through life settlement brokers who charge commissions and other margins. The life settlement broker usually resells the policy to an investor which may be an individual or a financial institution. The investor expects to realize a lucrative rate of return upon receipt of the death benefit when the insured dies. The policy owner profits from selling the policy because the sale price usually exceeds the amount available at that moment from other options.
Although life settlement transactions have been around for more than 20 years, there is still a degree of controversy about them in instances justified by abuses that have occurred in dealing with either seller(s) or investor(s). In other instances, perhaps controversy has not been justified.
Disclosure of information to either seller(s) or investor(s) is one of the areas where misunderstanding and disputes have occurred with some frequency.
Some in the life settlements industry propose that life insurance companies be obligated to inform policy owners of the potential availability of a life settlement transaction, something currently not required and resisted by the life insurance industry.
From the seller’s and from the investor’s side, information is either not fully disclosed or is not appropriately disclosed. Information disclosure requirements applicable to the life settlements industry are often insufficient.
So what are some of the items a seller or an investor should be interested in receiving full disclosure on? Although many are common to both, how each one of them looks at it may be different. Following are some items to be considered:
Performance of the life insurance policy for the next few years: Most policies have a surrender charge, expressed as a percentage of the cash value, which decreases over a period of time, known as the surrender charge period. As a policy’s surrender charge period decreases, the annual increase in the net cash value can be significant. In some cases the annual increase in the net cash value can exceed the annual premium payable for that year. This should be taken into account by a seller. Keeping the policy for a few more years and postponing the sale until a later date might provide the seller a better return than an immediate sale. For the investor(s), the increased availability of the net cash value provides an escape mechanism should they need to liquidate their investment and cut their loss at a time when the market is weak.
Life Expectancy. This is an estimate of the insured’s remaining lifetime determined based on his/her own medical history. In practice in many if not most cases, a mortality table is set up to represent the insured’s anticipated future mortality expressed as annual probabilities; his/her life expectancy is calculated on basis of that table. The worse their health is, the shorter their anticipated life expectancy and vice versa. Review of a life expectancy estimate should not just include review of the estimate itself but should also include a critical review of the pattern of the mortality curve represented by the mortality table that was used. A seller is interested in making certain that the life expectancy estimate used for the price offered is not overstated which could lead to a “low ball” offer. An investor is interested in making certain that the life expectancy estimate is not understated which could lead to an overstated expected rate of return; a higher price for the investment; and, possibly even a requirement to invest additional moneys into the transaction down the road.
While often more than one life expectancy estimate is used, it is advisable for the seller and investor to seek the guidance from an unbiased independent expert professional who has had experience with life settlements, with mortality tables and with the issues associated with them.
Next month in the second part of this series, I will address other items of interest when contemplating selling or investing via a life settlement transaction.
Peter J. Bondy is an expert actuarial and insurance consultant. He has had experience with issues associated with life settlement transactions and has served on actuarial professional task forces and working groups on life settlements matters; he continues such service. Peter also provides insurance policy analysis and actuarial appraisal evaluations, 225-323-5904, email firstname.lastname@example.org.
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