Individual Uses of Senior Settlements
Suitability of Coverage
Policyholders may wish to discontinue a current policy for suitability reasons. Sometimes a different type of policy would be a more appropriate method to achieve the policyholder's aims, e.g., changing coverage from a single-life policy to a survivorship or second-to-die plan. A lifetime settlement could prove to be more cost-effective than surrender, or provide for an increase in coverage. Clearly, the policyholder should explore all alternatives (1035 exchanges, etc.) when replacing insurance coverage -- and agents should follow their state's replacement rules. While technically, under a lifetime settlement the policy does not lapse, it is sold -- agents should follow the spirit of the replacement rules when in-force coverage is going to be "replaced" with a different policy. Elderly policyholders may be more concerned with day-to-day life than leaving a legacy to their heirs. By selling their life policies, funds can be made available for the purchase long-term care policies.
Another reason to consider a lifetime settlement is when the policy becomes too expensive to maintain. Some policyholders purchased policies on the premise that policy dividends would eventually lead to "vanishing premiums". If policy dividends did not perform as well as expected, the policyholder may now face larger premium payments than were anticipated when the policy was issued. Also, interest payments on large policy loans may have made it expensive to maintain the coverage.
One obvious motivation to engage in a senior settlement is to unlock underperforming assets. With the advent of a secondary market in life insurance, policyholders are beginning to view their life insurance policies in much the same way as other investments. By selling an in-force policy a viator may be able to exchange an annual premium outlay for annual income in the form of dividends, interest or annuity payments. Or the viator could use the proceeds to retire debt.
The existing policy may be producing sub-standard rates of return. Typically the guaranteed rates of return available on traditional whole-life policies are fairly low. Universal policies may not be delivering the rates of return anticipated at the policy's inception. By selling underperforming policies, the viator frees up funds that may be invested more productively. Policyholders should carefully analyze the comparative risks of the insurance "investment" and the proposed alternative investments before selling the policy.
Sometimes, policyholder's investment objectives have changed. For example, a policyholder might decide late in life to undertake charitable planning that had previously deferred in favor of his or her family’s needs. Through a lifetime settlement, it is possible to re-allocate funds now from one planning vehicle to another, using the settlement proceeds to fund charitable gifts or charitable trusts.
Updating an Estate Plan
Estate plans should be reviewed regularly to ensure that the plan meets the current siutation. For example, a policyholder may have initially purchased life insurance to achieve the liquidity needed to pay estate taxes, but changing circumstances may have made the estate highly liquid now. If the money that was to be received by beneficiaries at death were now available during policyholder's lifetime, it could be reinvested to maximize asset growth or to purchase alternative risk management vehicles, such as long term care coverage.
If an estate has reduced in value -- for example, though lifetime gifts to heirs or due to declining values in the stock market -- the resulting estate tax liability will be reduced as well. The amount of life insurance purchased for heirs to meet this liability may now be more than is necessary or desired. In addition, lifetime settlement proceeds can be given to heirs or charity during lifetime as a method of reducing the size of the estate, further lowering the estate's tax liability.
An obvious reason to update one's estate plan is due to the death of a beneficiary. In the past, given the buy-and-hold nature of life insurance, the common response to the death of a beneficiary was to simply name a new beneficiary or allow the proceeds to flow to contingent beneficiaries. Now, with the advent of senior settlements, the policyholder must ask: Is it prudent to continue the coverage if the primary reason for that policy is no longer alive? Are there better ways to achieve the goals of the estate plan?
Policyholders sometimes have a need to remove an insurance policy from their estates to avoid higher estate taxes. Removing it simply by transferring it from personal ownership to trust ownership may be subject to the three-year "lookback" rule of Sec. 2035. This rule prevents taxpayers from transferring certain assets simply to escape estate taxes. However, a lifetime settlement is considered a transfer for value and is, therefore, not subject to this rule.
Regardless of the reason why the existing life insurance no longer suits the estate planning situation, the substantial funds that result from a senior settlement can help the policyowner to meet his or her revised objectives.
Where a divorcing spouse has a life insurance policy, courts frequently require him or her to name the other spouse as a beneficiary in order to secure an obligation to pay alimony or support. In other cases, the courts have treated the cash surrender value of the policy as an asset subject to equitable distribution. The cash value is considered a marital asset. Now, in cases where the policy can be sold, the other spouse can argue that the policy itself is an asset subject to equitable distribution. Lawyers can argue that the true value of the policy is the present value of the death benefits as of today's date, as opposed to the cash value. If the courts establish that the death benefit is an asset, then it is arguable that it should be treated like pension benefits during a divorce. Or, the sale value of the policy can just be taken into account in the division of property in the divorce.
Take, for example, a widow in her early 80's who no longer needed multiple life insurance policies with increasing annual premiums. She owned a $3 million universal policy with a cash value of $69,000 and annual premiums of $68,000. Through a life settlement, she received $500,000 for the policy and eliminated the $68,000 annual premium. She reinvested the $500,000 in a single-premium annuity and used the money she would have spent on the premiums to make $10,000 individual gifts to all five of her grandchildren and great-grandchildren.
Case Study 1: A 76-year-old man owned a policy with an $8 million face amount and a $795,000 cash surrender value. He sold the policy for $2.3 million rather than let it lapse, cancel it or take the cash value. Had he not sold it, he would have left at least $1.5 million on the table.
Case Study 2: An 82-year-old woman sold a policy on her life for $900,000 that had a face amount of $5 million but a nominal cash surrender value of just $2,500. Without the sale, she would have walked away from almost $898,000.
To give a sense of the type of pay-outs available in senior settlements, the following are real-world examples:
Universal Life Policy
Face Amount $500,000
Cash Surrender Value -0-
Female Age 86
Policy Sold For $90,000
Combo Term & Whole Life
Face amount $10,000,000
Cash Surrender Value $800,000
Male Age 72
Policy Sold For $1,500,000
Face Amount $3,750,000
Cash Surrender Value -0-
Male Age 66
Policy Sold For $760,000
Whole Life Policy
Face Amount $465,000
Cash Surrender Value $26,070
Male Age 64
Policy Sold For $144,000
Face Amount $4,250,000
Cash Surrender Value -0-
Male Age 70
Policy Sold For $$800,000
Whole Life Policy
Face Amount $2,000,000
Cash Surrender Value $99,000
Male Age 70
Policy Sold for $400,000