Having come under regulatory scrutiny and paying sums lower than just a few years ago, life settlements have fallen out of favor with many financial advisers, but some say they can still be a good option for seniors who need income.
In a life settlement, a policyholder is paid cash equal to a fraction of the amount of the policy's coverage. The buyer continues paying premiums and collects the benefit when the insured person dies.
Older clients who can no longer pay their life insurance premiums or who are in poor health are the most obvious candidates for the transactions, according to adviser Rita Robbins, president of Affiliated Advisors Inc. and a life settlements expert.
"VALUABLE SOLUTION'
“It can be a valuable solution when every other possible option has been considered,” she said. “Life settlements can provide a very positive outcome for a client.”
Advisers should regularly review and analyze the value of their older clients' life insurance policies, much the same way that they examine equities and other investments that are part of financial portfolios, said Peter Hershon, regional vice president of The Coventry Group, which buys life insurance policies.
Policies with a face value of as low as $100,000 can be worth selling, though most of the policies that Coventry buys have at least a $500,000 face value.
“It's no longer an option [but] an obligation to let clients know about the life settlements market,” Mr. Hershon said. “We understand life settlements will not be the focus of an adviser's day, ever, but this may come up where we can help get value for something you'd normally surrender.”
For example, a 79-year-old man who wanted to stop paying the premiums on a universal life policy with a $1.5 million face value sold it to Coventry for $196,000. In another case, a 70-year-old man had a term life policy with a $5 million face value that Coventry bought for $150,000.
Life settlements may be the preferred solution when clients don't need the coverage anymore because they have sold a business, gone through a divorce or the death of a spouse, or no longer expect their estate to need the policy benefits to cover estate taxes, said Lawrence J. Rybka, chief executive of Valmark Securities Inc., a broker-dealer with a small life settlements business.
The amount that policyholders receive from selling has declined in recent years.
Because investors in life settlements “have been burned,” buying demand is down, Mr. Rybka said.
In addition, life expectancy continues to rise, putting investors' payoff down the road.
One client who refused a $2 million payment for a policy in 2009 returned to the same company two years later but was offered half the first quote, Mr. Rybka said.
The market has shrunk. The industry bought up policies with $8 billion in face value in 2007 and 2008. It's now about $1.5 billion a year, at most, Mr. Rybka said.
SHUNNED BY SOME
Life settlements are shunned by advisers who don't think that the secondary market pays enough to make the transactions worthwhile.
Keith Newcomb, founder of Full Life Financial LLC, has looked into the value of a few of his clients' policies in the market over the years, but the offers haven't made sense.
“The last time we looked at the possibility of converting or settling a policy for a client, the life settlement numbers weren't attractive, based on the fantastic health of the client even with his advanced age,” he said.
The age parameters of the policyholders that firms are looking for have crept up, and the minimum face value of the policies has slipped down, Mr. Newcomb said.
There often are better solutions, Ms. Robbins said.
In some cases, it may be smarter for a policyholder's child to start paying the premiums on a parent's life insurance policy if the child is the beneficiary and can afford to cover the costs.
Clients who don't need the life insurance policy but have plenty of cash may want to consider whether to continue paying the premiums, because having the policy could lead to a 12% to 15% tax-free investment gain for their estate, Mr. Rybka said.
Such clients might consider selling another asset to cover the premiums.
Life settlement transactions have come under scrutiny by state insurance regulators, which oversee the industry, and the Securities and Exchange Commission has recommended that Congress expand the definition of “securities” to include life settlements.
One-on-one deals involving nonvariable life insurance aren't considered securities transactions. The sale of a fractionalized interest in a life settlement, however, is a security transaction.
There is little risk to someone selling a policy to institutional investors for cash, Mr. Rybka said.
But certain transactions that give a policyholder a fractional interest of the eventual payout, in exchange for not having to pay premiums, are riskier, he said, adding that Valmark doesn't allow its registered representatives to engage in such sales.
The risk — and thus the investment opportunities — lies on the flip side of the life settlement transaction.
Pension plans and endowments have become more interested in life settlements over the past two years because they aren't correlated with traditional markets, Mr. Hershon said.
But “this is not an investment that mom and pop should be involved in,” he said.
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