Why You Need to Know about ‘Life Settlements’

Entrepreneurs tend to be early adopters of newer business products and processes.  So, in the decade during which the secondary market for life insurance has really emerged, many entrepreneurs have transacted “life settlements.”  Still, others are unfamiliar with this product, even though they may have already unwittingly encountered situations ripe for life settlements.

A what?

A life settlement is the sale to a third party of an existing life insurance policy for more than its cash surrender value but less than its net death benefit. Such transactions are usually undertaken – based on the insured’s shortened life expectancy – for the purposes of estate- or financial planning.  (The option also is available to some people who are terminally ill.)

Business applications
Entrepreneurs need to know about life settlements because life insurance policies are often part of the business planning and financial mix with which they must deal.  You see, a fundamental misunderstanding about life insurance is that it is static. On the contrary, and as many savvy entrepreneurs know, life insurance itself changes dramatically and can become obsolete and/or can be “upgraded.”  For instance:

• Key-person policies and other corporate-owned policies need not be lapsed for little or no value; instead, a company and/or its insureds can reap the benefits – cash influx – of a life settlement. A key-person policy could even be settled to fund a separation agreement.
• Similarly, as business needs change, a life settlement allows both individuals and entities to realize the value that was previously “locked” in a life policy.  For example, if a life policy was part of a buy-sell agreement and is now no longer needed…a life settlement might be the solution.

Potential settlement scenarios are seemingly endless.  Therefore, life policies that are no longer wanted, needed, performing or affordable can be seen as a goldmine for a business instead of a drain. 

Valuation of a key asset
Likewise, the very existence of a secondary market for life insurance can help entrepreneurs and their advisors better evaluate and value life insurance policies/purchases.  To wit, by working with an advisor (attorney, CPA, insurance or financial professional) who is familiar with life settlements, you can better determine what amount of life insurance is needed, what its current and future value might be in the market, and how viable it is going forward if you for some reason no longer want or need it.

If you or your advisor is working with a life settlement entity, find out if they are licensed for that business in your state, as appropriate.  Life settlements are regulated on a state-by-state basis, so requirements vary by state.
That said, the fact that the secondary market for life insurance (the name of the life settlement marketplace) is increasingly highly regulated provides the comfort of knowing that these licensed entities are governed.
Similarly, life settlement companies that belong to the Life Insurance Settlement Association (LISA), the oldest and largest industry trade group, must also adhere to strict guidelines and a code of ethics.  LISA membership demonstrates a commitment to industry-wide standards.

Up to speed
LISA also is a good starting point if you want to learn more about life settlements:  http://www.thevoiceoftheindustry.com/.  Too, there are specific life settlement educational resources available, such as Life Settlement University (LSU):  www.LifeSettlementUniversity.com. In the interest of full disclosure, I should note that I am the founder of LSU, although its courses are free and it is not a profit-making venture.

A quick primer
Some basic information to consider about life settlements:

• Generally, candidates for life settlements are 65 years of age or older; own a policy with a face value of $100,000 or more; and have owned that policy for more than two years.
• Well-established settlement providers can work with virtually every policy type including term, whole, universal, variable, group or joint survivorship.
• Policies may be owned individually, or through a corporation, foundation, trust, non-profit organization or business.
• The purchase price of a life insurance policy is based on a number of variables including the age and health status of the policyholder, the face value and type of insurance, and the amount of premium.  In general, a life settlement will garner two to four times the cash surrender value of a policy.
• There are tax liability and other such issues to consider when dealing with life settlements, so you or your advisors should be knowledgeable and/or should partner with an insurance pro who is knowledgeable about settlements or perhaps even partner directly with a settlement firm.
• If you will continue to need life insurance after a life settlement, be sure to verify that you are insurable before settling your policy.  You would not want to settle a policy and then find you cannot get the new coverage you need.

Life insurance exit strategy
You have a business exit strategy; now, with life settlements, you also have a life insurance exit strategy:  Whether or not you currently see the need for a life settlement, you’ll be ahead of the curve knowing about options for liquidating a policy that you own or control in the future.

Most entrepreneurs own life insurance at some point in their life and many entrepreneurs buy life insurance to pay the estate taxes that will be due on the estate that have been amassed over a lifetime of successful ventures.  And, of course, the business-owned life insurance that was purchased for business reasons is usually lapsed or surrendered, so knowing about another, often superior exit strategy for life insurance may be as important as the exit strategy that you have designed for your business ventures.

M. Bryan Freeman has been a licensed insurance agent for 29 years and is a pioneer in the life settlement industry.  He transacted his first life settlement 19 years ago and served four terms as president of the Life Insurance Settlement Association.