The underfunding crisis that's facing a swath of life insurance policies that were written in the 1980s and 90s could bode well for the life settlements industry — the secondary market for life insurance.
Financial advisers, attorneys and trustees are struggling with universal life insurance policies that were written decades ago using optimistic assumptions for interest rates at time when they were as high as 15%. UL policies provide not only a death benefit, but also a cash value account that's credited interest and that clients can fund with a portion of premium dollars. Costs of insurance are deducted from the cash value.
High-interest-rate assumptions back then meant that the people who bought these policies didn't expect to pay a lot to cover the cost of the policy. They thought that the high credited rates of interest would help cover that expense.
However, in today's low interest rate environment, carriers are unable to credit interest at those high rates. Customers are now deciding whether they should pay more money to keep the policy in force, cut their death benefits or let the policy lapse altogether.
A fourth option also is emerging: Sell the underfunded life insurance policy to an investor via a life settlement.
The life settlement market allows investors to buy an unwanted life insurance policy from an insured person, who gets cash up front — an amount that's less than the death benefit of the policy — while the investor becomes responsible for paying the premiums. At the end, the investor collects the death benefit when the insured person dies.
“This is an opportunity to leverage a disaster,” said William Scott Page, president of The Lifeline Program, a life settlement provider. He noted that the company has had an uptick in appraisal requests for universal life insurance policies.
Larry J. Rybka, chief executive of ValMark Securities Inc., a broker-dealer that also has a life settlements operation, says that they have 20 policies that are going to market this year, worth $65 million in face amount, up from 10 that were sold last year.
He noted that there likely are other factors into clients' renewed interest in offloading unwanted policies. For instance, the estate tax exemption for couples is up to $10.5 million, meaning there are clients who bought policies in the past, believing they would need large amounts of coverage to address estate taxes.
“With [interest] rates down, these clients are pressed to maintain a lifestyle in retirement,” Mr. Rybka said. “With the specter of having to pay more premiums, they now want to give up the policy.”
He notes, however, that wrapping up a life settlement transaction is hardly a speedy process; it can take at least three months.
Not everyone anticipates a massive flood of abandoned underfunded life insurance policies to hit the secondary markets, however. Lori Skibo, national sales director at Rita Robbins & Associates, notes that selling a policy to an investor is not easy feat — and policies on the verge of collapse probably won't seem very attractive.
“If the contract is truly underfunded and the buyer has to dump a ton of money to bring it up, then it might not be a profitable sale to the life settlements company,” she said.
Ms. Skibo, who has worked in the life settlements industry, added that buyers are especially picky about the policies they choose to purchase. “For every 100 applications that would come in, there may have been 10 to 15 that are viable transactions, and of that, only half would come to fruition and be settled,” she said.