Life Settlements And The Key To Fair Market Value One of the most important aspects of advanced estate planning is the secondary market for life insurance. But, like any other financial planning strategy, it is not for everyone. The life settlement has traditionally been used an exit strategy for unwanted or unneeded life insurance that might ordinarily be lapsed or surrendered. Now life settlements are being used with other strategies to provide estate liquidity using alternative funding methods, such as premium financing. Trusted advisors have a fiduciary responsibility to inform their clients of all of their options when reviewing their estate plan. The fair market value of life insurance should be at the foundation. Anyone who ever bought or sold real estate knows the importance of fair-market value. In recent years, our access to real estate equity has kept our economy from screeching to a halt. Most of us probably breathe a sigh of relief every time we get our tax statements in the mail and look at the assessed value. We know that the tax is a percentage of the assessed value from a county appraiser and we are thankful that it's not based on fair-market value. But, we would likely see the largest act of civil disobedience since the Boston Tea Party if the county appraiser consulted the realtor every year. We would feel slighted, to say the least, if we had to sell real estate for its assessed value instead of its fair market value. Our equity is based on a more accurate appraisal, which takes into account supply and demand imbalances, among other things, and leaves us with more opportunities. Now, another widely owned asset offers the same opportunity for a more accurate appraisal of fair market value. The asset is life insurance. The secondary market for life insurance is nothing new. Viatical settlements have existed in one form or another for years. They are usually associated with investing capital in a fractional share of a policy in which the insured has a terminal illness. Generally, the insured has a life expectancy of fewer than 24 months and is pursuing a tax-free portion of the death benefit to fulfill an immediate need for cash. Life settlements involve the sale of a policy by someone over 65 who no longer needs, wants, or can afford the policy. The life settlement is often used as an exit strategy for under-performing universal or variable life policies in which "vanishing premiums" have reappeared or the death benefit is no longer guaranteed. These settlements are transacted on all types of individual and survivorship policies including term policies. The settlement amounts are always in excess of any cash-surrender value for the same reason that real estate is largely bought and sold for more than its assessed value. Traditionally, before a life insurance policy is issued, an underwriter reviews the insured's medical records and makes an offer to the insured based on accepted findings. Unless the case is declined, different offers could be made including, preferred, preferred plus, standard, table 2, and table 3, etc. Companies using the term "clinical underwriting" to assess mortality risks on an individual basis imply that their underwriting is more accurate at the time of issue. This benefits consumers in the same way settlements do at the outset by taking a more individual approach to assessing an applicant's medical history. Because of this, an occasional smoker can still be looked at as a "non-smoker" risk and be offered more affordable coverage.
Once the policy is in force, underwriting of the client is never revisited. This approach to pricing life insurance policies serves the insurance carriers, but does little for the consumer when the insured has a change in circumstances. In fact, it only reinforces the power of the carriers. The ability to purchase a life insurance policy back from an insured is limited to the carrier that issued it in the first place. Their offer is the policy's cash-surrender value, which is based on medical underwriting at the time of issue. Any change in expected mortality that would increase the policy's value can only be captured in the secondary market when medical underwriting gets revisited, allowing for a more accurate appraisal of the asset. A typical settlement application includes some very important information, which is used for the appraisal. Basic questions concern the type of policy, the insurance company, and when the policy was issued. The insured signs a The Health Insurance Portability and Accountability Act (HIPAA) form. Under HIPAA, the insured can share his or her medical history by authorizing a copy of their medical records to be reviewed. This is where the most accurate and timely information concerning the insured's health status is used to assess life expectancy. The third piece of critical information that is reviewed is a current illustration of the life insurance policy. It will show the estimated cost to carry the policy to maturity. The non-binding offer can be given to the client once these variables are known. If the offer is accepted, the policy owner and beneficiary are changed to the institution making the offer, which assumes all premium obligations. The insured gets the settlement proceeds once the changes have been recorded at the carrier. Any amount, up to the cost basis, is a tax-free return-ofpremium. The amount above that, up to the cash-surrender value, is taxed as ordinary income. Finally, the amount above the cash-surrender value, up to the settlement amount, is typically taxed as a longterm gain since the policy must be at least two years old. (This tax opinion was issued in 1997 by KPMG Peat Marwick.) Life Settlements as Conventional Wisdom The idea of using the secondary market to evaluate life insurance is slowly becoming conventional wisdom for many reasons. Most important is that household names, such as The Bank of New York, GE Capital, and Lloyd's of London, have committed billions of dollars to this market. This builds credibility for regulators and the public as the perception shifts to recognize life settlements as a sophisticated financial planning technique. Many clients who are life settlement candidates would probably never purchase investments without knowing all the facts and having a sound exit strategy. The time has come to determine the usefulness of life insurance, especially if the premiums have become a financial burden to the policy owner. The liquidity that the secondary market provides can only enhance the value of life insurance by increasing demand in the primary market. Also, a more accurate appraisal of the asset is the key to unlocking the hidden value for the benefit of the consumer. over 50 life insurance