Life Settlement Planning Opportunities

(I previously blogged about life settlements here, but there’s much more to say about the subject. Thus, I asked my colleague,  Joel Kastin, an insurance broker, to contribute an article discussing life settlements, and he agreed to participate.  Joel is, therefore, my first guest blogger of 2009.  Joel Kastin has been a New Jersey licensed insurance broker for twenty years. Until 2005, he was the Director of Insurance at a large insurance brokerage assisting over 200 CPAs and attorneys in providing their clients with solutions to their insurance needs. He also has worked as a licensed insurance instructor, offering product knowledge and continuing education credits.  When the brokerage firm was sold to a public company, Mr. Kastin created his own independent insurance brokerage in Waldwick, NJ. Welcome to my weblog, Joel, and thanks for sharing your knowledge of life settment planning with readers.)

Since 1998, many older life insurance policy owners and their financial advisers have discovered important advantages in using life settlements in their estate planning strategies.

What is a Life Settlement?

A life settlement involves a sale of a life insurance policy. A life settlement can be used with all types of life insurance policies, including term life, whole life, universal life, variable life and survivorship life policies. In many cases , the policy owner will obtain more money through the sale of the policy in a life settlement than is available through the cash surrender value of the policy.

Why Would Anyone Sell a Life Insurance Policy?

Two words describe why owners of life insurance sell their policies: “Changed Circumstances.” A partial list of the changes in life circumstances which cause owners to sell their life insurance policies include:

  • Insurance needs have changed.
  • The insured has outlived his/her beneficiaries.
  • Funds are no longer available to pay insurance premiums.
  • The insured’s health condition has declined.
  • The policy owner is going through a bankruptcy.
  • The insured is selling his/her business or is retiring.
  • There is a change in the tax situation of the insured/owner.
  • The owner is planning to surrender or lapse the policy.

Benefits for the Owner/Insured:

  • The proceeds of the life settlement can be used to purchase a less-expensive life insurance policy. (Life insurance costs have been greatly reduced in the past ten years).
  • A long term care policy can be purchased and/or a fund established to provide for long term care if the individual is uninsurable.
  • Cash is available for investments.
  • Money is available in order to make gifts to family members.
  • A single premium immediate annuity can be purchased to provide the owner/insured (and spouse) with a guaranteed lifetime stream of income.

Benefits for the Business Owner:

  • Funds can be used to pay off business debts.
  • Cash can be used to finance a deferred compensation plan.
  • A buy-sell agreement funded by life insurance is no longer appropriate due to the sale of the company or the retirement of a key executive.
  • Key-person insurance policy is no longer needed.
  • Bankruptcy of a firm requires the liquidation of assets.

In addition to the benefits for the insured and business owner, there is one very important benefit for the financial adviser in recommending the a life settlement to a client who is considering the surrender or lapse of a policy. Financial advisers have a fiduciary responsibility to inform their clients of the availability of life settlements since clients may receive little or no cash surrender value upon surrender or lapse of their policies while life settlements have the potential to generate much larger cash payments. There have been instances where a client has lapsed a policy on the recommendation of a financial adviser because the policy was no longer needed or affordable only to later find out later that a life settlement was available and the client lost money by failing to explore a life settlement. The client was understandably upset and in some cases felt the adviser was liable for the loss.

Guidelines for Determining if a Life Settlement is Suitable

  • Insured must be age 70 or older.
  • Life expectancy of 15 years or less due to health and/or age.
  • Policy death benefit a minimum of $100,000.
  • Cash surrender value less than 30% of death benefit.
  • Annual premiums less than 5% of death benefit.
  • Policy loans less than 30% of death benefit.
  • Owner of the policy can be a corporation, a trust or an individual.

(Please bear in mind that these guidelines are approximate and each case is reviewed on its own merit.)

The Application Process for a Life Settlement

  • An application form, an authorization form (to secure medical records) and a disclosure form are completed.
  • Medical records are ordered from the insured’s physicians(s) and life insurance ledgers are ordered from the carrier. (A physical examination is not required.)
  • The policy and medical information are reviewed.
  • As many as twenty companies are contacted in order to acquire the highest offer. These companies are known as funders.
  • The offer is submitted to the policy owner for review.
  • If accepted, a contract is sent out by the funder for signatures of the insured, owner and beneficiaries.
  • Once a change of ownership is finalized with the carrier, the proceeds of the life settlement are paid to the owner within 3-5 days.

Tax Implications

Generally speaking, the tax obligations on the proceeds of a life settlement vary. Typically, a portion of the proceeds is considered cost basis, a portion is taxed as income and a portion is taxed as capital gains. It is strongly suggested that policy owners consult with a tax professional when considering a life settlement or any other financial strategy.

Examples of Successful Life Settlement Plans

Case Study #1: Cash Settlement
Case outline: Male age 82 with a 5-7 year life expectancy. Policy was owned by a trust for estate planning purposes. Because of a reduction in the estate size, the policy was no longer needed and the premium was creating a hardship.
Death benefit- $1,150,000
Premium- $45,000 annually to age 95
Cash Surrender Value- $48,000
Life Settlement- $300,000- disbursed to the trust

Case Study #2: Estate Plan Revision
Case outline: Male age 84 with a 4-6 year life expectancy. Two life insurance policies were in force for estate planning purposes. An estate planning review determined that a lower amount of insurance was needed.
Death benefit- $3,535,000
Premium- $100,000 annually to age 92
Cash surrender value- $445,000
Life Settlement- $1,100,000
After settlement- the cash settlement was used to purchase a Single Premium Immediate Annuity that paid $100,000 annually for life.
New Death Benefit- the annuity payment was used to pay for a new $2,000,000 policy.
Benefit from the Life Settlement- the client was afforded the ability to maintain the appropriate amount of coverage without any additional out of pocket expense.

The State of New Jersey Department of Banking and Insurance requires that anyone who assists a client in securing a life settlement must be properly licensed. Donald D. Vanarelli, Esq., owner of this weblog, and Joel Kastin, author of this article, both hold the appropriate license. If you are interested in determining if your life insurance policy qualifies for a life settlement, all you must do to begin the process is to complete a one page worksheet. Please contact Ginny at our office at 908-232-7400 for additional information, or to initiate the process.