If you’re considering cancelling a term-insurance policy or surrendering a cash-value policy and receiving the cash value, you might consider selling the policy to a third-party investor. You could potentially receive a significant amount of money that would otherwise be forfeited.
The Life Settlement or third-party “viatical” marketplace has grown over the last 10 years and continues to evolve as various hedge funds seek to put together pools of policies that provide investors with an asset class that’s not correlated to the stock and bond markets. In other words, mortality has its own characteristics that aren’t influenced by economic conditions. The current capital markets are healthy, and an individual would be well served to explore this policy exit strategy.
Typical policies appropriate for sale include:
- Life insurance that funded a buy-sell agreement that’s no longer needed
- Life insurance that funded a key-man business need that’s no longer needed
- Life insurance that was required by your bank or bonding company that’s no longer required
- Personal life insurance originally purchased to provide income replacement security for your family
- Life insurance purchased inside of a trust to provide for federal estate tax payment or to provide estate liquidity.
Step one – First things first
You must be comfortable with having a non-related third-party investment entity owning and ultimately receiving death benefits on your life or on someone else’s life where you might be serving as trustee. If you’re comfortable with that, move on to step two.
Step two – The policy must be marketable
That means the insured must have a life expectancy of 10 years or less. Generally speaking, older individuals or those that have significant medical impairments are viable candidates. A healthy 50-year-old is not a candidate.
The way to determine marketability is to collect the medical information of the insured and have it evaluated by companies that specifically calculate life expectancy (LE). Purchasers of policies require that these third-party LE companies provide an unbiased opinion as to the LE of the individual that’s covered by the policy. Once the LE is established, then you’ll be able to determine the potential value of the policy.
Most funders (purchasers) today require a minimum death benefit amount of $250,000. The policy type can be term insurance, whole life, universal life, or variable life. All the parameters of the policy will be considered in order to arrive at a probable value for the policy. The funders calculate the potential purchase price based on all those factors and add the cost of paying premiums to policy maturity. The last thing an investor wants is the policy to lapse with no value before the individual dies, so the funder always calculates using a longer life expectancy than what is most probable.
Step three
Our firm is unique in that we utilize a competitive auction process. We believe this provides the best outcome for clients. That said, a policyholder can go online to a company, suck as Coventry, and ask that a policy be valued. The downside of this approach is that you’re working in a vacuum and the company can offer whatever they want to and you’ll have nothing to compare it to. Most agents in this marketplace don’t use an auction, and again, the ultimate value will be limited due to the lack of competitive forces.
When a policy goes out to bid, the auction will last as long as there are two or more bidders. We had one auction go 22 rounds and take two months to complete. The result, however, was a price that was significantly higher than the initial appraised value.
Step four
Once the auction is completed the policy owner then decides whether to move forward with the sale. Closing documents are generated by the purchasing firm and sent for signature. The closing document package is extensive, and it can take up to an hour for all signatures to be obtained and the notary to do their work.
All beneficiaries must acknowledge the sale and if the policy is trust owned, both the trustees and the ultimate trust beneficiaries must acknowledge and agree to the sale. Finally, the insured must approve and request that their doctor certify they are legally of clear mind and able to make such a decision.
Step five
Closing documents are returned to the funder and an escrow is established. If all the documents are in good order, the seller receives a wire transfer for the agreed upon price and the owner and beneficiary of the policy are changed to reflect the purchaser.
California has very strict rules for life settlements and provides a long “right of termination” even after funds are received. There is plenty of opportunity for the seller to change their mind and keep the policy.
To summarize
Determine if the policy is viable for sale through an appraisal process. Utilize a competitive auction to achieve the highest possible price. Establish escrow and both the buyer and seller have full disclosure. Sale is finalized and right of termination expires.
Most people who sell their policies will never hear from the purchaser again. However, there are several people listed by the seller that may be contacted from time to time if there is a question about the status of the insured.
Caveat emptor
The life-settlement industry continues to evolve and, unfortunately, there are some bad actors out there that promise a high price but instead have made back room deals with sellers. The phrase, “caveat emptor,” is very appropriate here. Insist on transparency in the areas of process and compensation. Make sure the individual or firm you work with meets the following best practices:
- Provides complete transparency and disclosure at all points in the transaction
- Has access to dozens of potential buyers so a competitive market is in place
- Provides written confirmation of any conflicts of interest or relationships with specific funders that may provide non-disclosed compensation to the individual or firm
- Has significant experience in the marketing and sale of policies. You might want to request references that have completed a transaction.
Please don’t hesitate to contact me with additional questions. I appreciate being a resource to you.
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