You may have learned of the popularity of life settlements that purport to offer two or three times the cash surrender value. Before you leap to conclusions, take the time to evaluate the offer and the trade-off.
A life settlement is the sale of an existing life-insurance policy by the current owner to a settlement company, who will repackage it for resale to third-party institutional investors. The ultimate investors, usually hedge companies or pension funds, are betting that the net present value of the death benefit will be greater than the purchase price, commissions, broker fees, underwriting expenses and cost of maintaining the policy, netting a 9 percent to 12 percent profit.
In fact, the demand to purchase these policies is so high right now that investors are recruiting wealthy seniors to "rent their lives."
There are several twists to investor-initiated life-insurance schemes that try to avoid state insurance-regulator and insurance-company scrutiny. This article may help you evaluate whether a life settlement may be right for you given your specific situation.
Weigh Your Options Carefully
Several reasons can cause a policy-holder to look at selling a life-insurance policy.
First, his or her financial circumstances may have changed, and he or she needs additional liquidity. Or maybe a premium has become just too burdensome. Another reason may be that the original purpose for buying the insurance no longer exists.
Take, for example, changes in estate-tax exemptions — there's no longer a need for liquidity to pay the tax bill. Or maybe a policy-holder no longer has living beneficiaries due to death or divorce, or perhaps has no charitable interests.
The attractiveness of an insurance policy for a potential life-settlement purchase depends on a person's current age and health status, in addition to the structure of the policy. Life-settlement companies are typically interested in the insured over age 65 whose health has significantly deteriorated since the policy was issued; the optimum age is around 85.
Companies are also looking for an insured with a life expectancy of between two and eight years.
The policy face amount must be a minimum of $250,000, but amounts of more than $1 million are more attractive. Universal life is the preferred policy; less interest remains in whole life policies or even survivorship policies where both insured are living. Ideally, the cash value is less than 10 percent of the death benefit, and the required premium to keep the policy in force is less than 2 percent of the death benefit.
In other words, to entice investors, the purchase price to the policy owner and the future outlay by the investors will be low, but the perceived value to a naive policy-holder will be great.
A life settlement should be considered only if you have no desire to leave an estate to family or to charities, and you currently do have pressing income needs. It's rare indeed that someone has no estate needs.
Consider this: If the demand is high for eligible policies because of their desirable return, is selling the policy in your best interest, and that of the policy beneficiaries? If you have no estate but sufficient income and assets, is this the best time to sell the policy?
Be sure to look at all the variables before making a decision regarding a life settlement.
Craig Langweiler is president of the Langweiler Financial Group, in Newtown. He can be reached at 215-860-8088 or at: [email protected] americanportfolios.com.