Frequently Asked Questions
1. What is a life settlement?
A life settlement is the sale of an insurance policy to a third party. As the new owner and beneficiary, the third party continues to pay policy premiums and collects the face amount of the policy at the death of the insured. Policies in a life settlement are typically unneeded and unwanted individual life insurance policies, typically with an insured who is a senior over age 65. The price paid for the policy is greater than the policy cash surrender value (“CSV”) offered by the issuing life insurance company (life insurance contracts define the maximum value the issuing life insurance company may pay to redeem a policy as the CSV). Life settlement policies are typically universal life policies purchased as investments by people who are now in their seventies and eighties and wish to use this capital for other purposes.
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2. How is a “Viatical Settlement” different from a “Life Settlement?”
A viatical settlement is a transaction involving the purchase of a policy which covers the life of someone who suffers from a terminal, catastrophic or life-threatening illness. Viatical settlements are highly regulated by state insurance commissioners and require specialty licensing for viatical providers and brokers.
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3. Why did viatical settlements develop a bad reputation in the late 1990’s?
Congress changed the income tax laws in the mid 1990’s to allow proceeds paid in a viatical settlement to be exempt from income tax. This was done to allow AIDS patients access to cash for treatment during their final 24 months. The unexpected outcome was that it led to abuse in both false reporting on income tax returns and a cottage industry of fraudulent applications for policies to cash in on this tax advantage. These false and fraudulent practices were exposed when the introduction of highly effective AIDS medications materially extended the life expectancy of many AIDS patients. This lead to lawsuits by investors who had purchased policies or portions of pools of policies that did not mature in the expected 24-month period.
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4. How did the life settlement marketplace develop?
At the same time the viatical settlement business was unwinding, several large financial institutions and their actuaries realized that the purchase of non-viatical policies (where the insured has a life expectancy of more than 24 months) represented a viable business. Not surprisingly, in 2000 it was insurance holding companies like Berkshire Hathaway and AIG that pioneered the development of the life settlement business. Being insurance companies themselves, they realized that buying a policy on an insured with some health issues presented a good investment opportunity if you could establish a purchase price based upon sound actuarial and medical predictions of the insured’s probable life expectancy.
Specialty insurance underwriting firms have developed that specialize in estimating life expectancy. These firms use a combination of specialized actuarial tables and up-to-date medical information about the insured to develop their life expectancy predictions.
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5. How much can insurance carriers offer to buy back life insurance policies?
Life insurance contracts define the maximum value the issuing life insurance company may pay to redeem a policy as the cash surrender value (CSV). In addition, many policies have significant back-end contractual termination charges that can reduce this surrender payout by as much as 100% of the CSV. These termination charges often eliminate any cash payout from the insurance company at the time a policy is surrendered. Because the life settlement buyer keeps the policy in force by paying premiums, these termination charges are never triggered.
Life settlement buyers and their medical underwriters take into consideration the insured’s current medical condition. The insurance company however, is only allowed to consider the insured’s medical condition when the policy was originally issued. Because of this, life settlement buyers are able to pay more than the insurance company.
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6. How much life insurance is actually out there?
According to the 2006 Life Insurance Fact Book:
• Total life insurance in force in the United States today is $24 trillion;
• $13.8 trillion of the $24 trillion is individual life insurance;
• Universal life insurance accounts for $7.7 trillion or 56% of individual life insurance;
• 7% or $909 billion of individual life insurance is forfeited or surrendered each year;
• 90% of universal life policies lapse and never pay a death benefit,
• 69% of seniors over the age of 65 today own a total of $3.9 trillion of individual life insurance;
• $1.7 trillion insures the lives of females over age 65
• The net life insurance in force in the United States is growing at 5% per year, net of $909 billion of annual forfeitures and surrenders.
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7. Why is universal life insurance so popular?
Universal life insurance is the combination of an interest based “investment” and term life insurance. Universal life has the selling features of flexible premiums and being able to increase and decrease the amount of death benefit, depending upon the balance in the policy cash account. Provided there is sufficient cash in the account, the policyowner can elect to reduce or forgo a premium to meet other cash flow needs. Conversely, the policyowner can pay in more than required, and thus build up the interest bearing cash account.
Universal life was the life insurance industry’s answer to mutual funds and to the extremely high interest rates experienced in the 1970s and 1980s. Traditional whole life insurance contracts earn 3.5% to 5% interest. To be competitive with other products offered to investors, universal life products were developed with relatively high “prospective” interest rates (8%, 10% and 12%). The usual “floor” or guaranteed rate is in the range of 3.5% to 4%. Universal life is often sold to “seniors” as a safe investment because of the guaranteed annual return on the “investment” portion of the product. However, the problem is that the annual increase in premium on a universal life policy can often be more than the buildup of value in the interest based “investment” portion of the policy.
Universal life is popular with agents because it pays the agent the full sales commission in the first year and is ideal for converting people with term insurance to a permanent life insurance product. Often, term insurance is sold with the expectation of converting the buyer to universal life after the end of the two year contestability period.
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8. What percentage of universal life policies are surrendered back to the insurance company or allowed to lapse?
A staggering 90% of universal life policies are allowed to lapse. Universal life insurance has been, and continues to be sold using optimistic examples of future interest rate returns on the “investment” portion of the policy. These optimistic interest rates often have not materialized. Further, these are usually not policies with level premium payments. The annual increase in premium to cover the ever-increasing annual death benefit charge is, on average, 10% per year.
The issuing insurance company usually allows the policyowner to reduce the annual policy premiums to a more tolerable level, but charge this “savings” against the cash value of the policy. Over time, this premium reduction erodes the policy’s cash value to the extent that universal life insurance policyowners often find themselves in a position that they are either unwilling or unable to pay the constantly increasing premium cost to keep the insurance in force and will simply allow the policy to lapse.
Universal life policies often have a large surrender charge or penalty if the policyowner elects to surrender their policy back to the issuing insurance company to salvage any “net” cash surrender value. Often these surrender changes remain in force for 10-to-15 years and exceed the cash surrender value of the policy. These policies are often allowed to lapse because they have no value.
This startling 90% lapse rate is why it is important to monitor policies with sufficient lead time to introduce the concept of a life settlement.
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9. Does the life insurance industry discourage or refuse to pay death benefits where policies have been part of a life settlement?
Life insurance policies are contracts between the policyowner and the issuing insurance company. The arrangement is simple – if the policyowner pays the premiums and does not allow the policy to lapse, the insurance company must pay the death benefit at the death of the insured. The Supreme Court in 1911 said that a life insurance policy is an asset that can be sold.
With $13.8 trillion of individual life insurance in force, a $20 billion (2007 estimate) life settlement marketplace has little impact on a life insurance industry that is growing at 5% per year. Any changes in future life insurance contracts to attempt to preclude life settlements will not impact the industry in the near future.
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10. Who is Life Settlement Financial, LLC?
In October 2006, Life Settlement Financial, LLC, (LSF), was formed as a Delaware limited liability company. LSF’s offices are in San Rafael in the San Francisco Bay Area and Portland, Oregon. We are a group of gerontologists, educators, medical, and business professionals dedicated to enhancing the lives of seniors. The capital to make these investments comes from a group of individuals and financial institutions. Our name can be used in all fifty states and on the internet as well (www.lifesettlementfinancial.com ).
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11. How does LSF price an offer in life settlement transactions?
The offering price is a combination of art and science.
First, we determine if the prospective insured(s) is/are likely to be a good prospect for a life settlement. We evaluate each insured based upon initial database information including the size of the policy death benefit, annual premiums to be paid, insured’s age and type of policy. We obtain subjective additional information about the insured(s) health, living arrangements and cognitive and functional impairments. This additional information saves everyone time and effort by not taking applications for policies that will not qualify. This is done with complete confidentiality.
Second, after the application is taken and the insured’s medical information is obtained from their primary physician, we purchase three independent medical/actuarial underwriting opinions as to the estimated life expectancy (LE) of the insured. When LSF gets the three LE analyses back, we re-underwrite the case to confirm that the outside firms considered the items that we felt were important. In cases where they did not consider specific conditions we challenge the analyses to improve the underwriting.
Third, we average the three LEs before determining the offer price. Our stringent re-underwriting standards allow us to offer policyowners more than other providers.
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12. How simple (or complicated) is the life settlement process?
The process is simple. In taking the application, the policyowner and the insured agree to have the insured’s physician release the insured’s medical records for us to evaluate. We have three independent medical underwriting firms review those records and then average the life expectancy evaluations. Based on the results, we may make an offer to purchase the policy.
1. The rest is math. We bear the risk that the life expectancy evaluations are wrong and we are required to pay policy premiums for longer than anticipated.
2. An offer is made for a cash payment. If the policy is outside our portfolio criteria we offer it to a trusted institutional third-party who purchases the policy for their portfolio.
3. If the policyowner agrees to the offer price, we or the third party put the entire cash purchase price and the policyowner puts the insurance policy into a third party escrow to complete the transaction. When the ownership of the policy and the beneficiary designation are changed, the escrow company releases the cash to the policyowner and the policy to us or the alternative buyer.
4. The transaction is completely transparent and all fees are disclosed in the escrow documents, including, but not limited to, any fees or commissions that may be paid to an advisor or consultant that participates in the process on behalf of the policyowner or insured.
5. This process usually takes 45 - 90 days. However, the time frame is highly dependent upon the speed with which the insured’s primary physician or medical group compiles and releases the insured’s medical history, as well as receiving documents from the life insurance carrier.
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13. What types of life insurance policies does Life Settlement Financial buy?
Life Settlement Financial buys life insurance policies that insure the lives of one or more individuals. These include:
1. Universal life insurance,
2. Whole life insurance,
3. Term insurance that can be converted to permanent whole life insurance
4. BOLI (bank owned life insurance) used to insure bank officers and provide collateral for monies borrowed at a bank or other financial institution after the loan is paid off,
5. “Key Man” insurance used to insure the life of a business owner or key employee,
6. COLI (company owned life insurance) used to protect an executive’s value in a non-qualified deferred compensation (NQDC) program after funds have been paid and the insurance often allowed to lapse,
7. Second-to-die life insurance often used for estate planning liquidity when the insurance is no longer needed for estate tax purposes.
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14. What types of life insurance policies are not purchased by Life Settlement Financial?
Life Settlement Financial does not purchase the following types of life insurance or policies with these characteristics:
1. Variable universal life insurance: those policies are federally regulated securities,
2. Any policy where the escalation in annual premiums to be paid between the date of purchase and the insured’s average life expectancy make it uneconomic to buy and hold the policy. These are usually term or universal life policies that were designed to have low premiums (teaser rates) in the initial years and rapidly accelerating annual premiums in later years. After analysis by the policyowner’s financial professionals, these policies are usually surrendered back to the insurance company for whatever value can be salvaged.
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15. How are the proceeds from a life settlement taxed to the policy owner?
Internal Revenue Code Section 101 defines the cost basis for the policyowner in a life insurance policy as the total of premiums or other consideration paid. Gain to the policyowner in a transaction in which the policy is sold for valuable consideration is calculated by subtracting the cost basis from the consideration received. In most instances, the total premiums paid over the life of the policy, net of the cost of the pure insurance portion of the premiums, far exceeds the total of the cash surrender value and the purchase premium received by the policyowner in a life settlement. Thus, in most instances, there are no income tax consequences, just a return of capital.
In the few instances where the consideration received by the policyowner in a life settlement transaction might exceed the total amount of premiums paid, the amount of the excess could be taxable as ordinary income, or as a capital gain, depending on how long the policy had been held by the policyowner.
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16. What does the term “Secondary Market” mean in life settlement transactions?
Life settlement brokers typically buy policies from policyowners and resell them in secondary markets to other brokers or specialty portfolios for a profit. A policy may go through two or three sets of hands before it finds a home. The result is that the individual insured’s medical and often financial information is being shopped multiple times to numerous brokers on the internet before the policy ends up in the hands of a consolidator who holds the policy to maturity. Reported abuses and fraud have generally come in this secondary market. LSF intends to hold all purchased policies to maturity and not sell them on the secondary market.
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17. Which agencies provide regulatory oversight to the life settlement industry?
Life settlement transactions are regulated by state laws. Life settlements are regulated in most states, many of which have been guided by the model statutes and regulations developed by the National Association of Insurance Commissioners (NAIC). Such rules typically require, among other things, consistent documentation, disclosures, anti-fraud measures, rescission periods and usually require brokers to hold a life insurance sales license. Several state insurance commissioners in the West have openly spoken in favor of life settlements because they provide a financially attractive alternative to surrendering a policy back to the insurance company.
Historically, states have provided an exemption from licensing when a policy is purchased directly from the policyowner to be held by the new owner in its own portfolio, as is the case with Life Settlement Financial and its trusted third parties. There is a trend, which LSF supports, for states to introduce legislation to regulate life settlements. Several states are following an example set by the European Union requiring life insurance companies to inform policy owners in writing that a life settlement is often a better alternative than allowing a policy to lapse. Secondary market transactions are subject to a variety of regulations, often similar to viatical settlements. Secondary market transactions are often state regulated securities requiring licensing and oversight by the state corporation’s commissioner.
When LSF buys policies in a state requiring regulation, we become licensed as a viatical/life settlement provider. All of our forms, contracts, advertising and Producer training materials are submitted to the state department of insurance for approval before being used. Depending upon the state requirements, our Producers may have to become licensed as life settlement brokers. Usually any reporting requirements are performed by LSF on an annual basis.
Recently the National Association of Securities Dealers (NASD) in NASD NTM 06-38 (August 2006), reminded firms and associated persons that life settlements involving variable insurance policies are securities transactions subject to NASD rules. Any insurance policy using variable, e.g., separate securities accounts, are regulated by the NASD and require dual licensing (securities and insurance).
On March 24, 2008, A.M. Best, the company that rates insurance companies and their products issued a Best’s Rating Methodology white paper entitled “Life Settlement Securitization”. This methodology, and some say defacto securitization standard, presented the acceptable standards for life settlement policies that can be securitized and rated in the marketplace. Standards for policy origination, underwriting and servicing were established or clarified. Only policies that have been purchased from the original policyowner may be securitized under this standard. This is a blow to broker-to-broker life settlement sales and to poorly underwritten transactions. Life Settlement Financial meets or exceeds all standards set forth by A.M. Best in this rating methodology.
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18. What is the rationale for a policyowner doing a life settlement to buy long-term care insurance?
Life insurance is most often purchased to provide income protection for a growing family in the event that something happens to a breadwinner. As the children become adults and leave home, and retirement investments replace the need for life insurance, the cost of continuing annual life insurance premiums begins to be questioned as a justified expense. Also, the costs of care for seniors, coupled with not wanting to be a financial or care-giver burden to children, become rightful concerns.
A logical and cost effective way to purchase this long-term care insurance is with the proceeds from a life settlement. These are issues that financial professionals can help their clients explore. There are many varieties of long-term care insurance. We do not sell long-term care, but appreciate its value and the piece of mind it offers.
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19. What is the roll of a life settlement in the senior continuing care marketplace?
In today’s depressed housing market, a life settlement may be the source of cash needed for a senior to qualify for residency at the private-pay continuing care community of their choice. Senior communities that do not rely upon Medicaid funding and only take private-pay residents may require applicants to demonstrate that they have sufficient cash or other dedicated resources at the time of admission to pay for two or three years of community care costs. Until recently they did not think to ask about life insurance because they did not realize it could be sold in a life settlement transaction.
This settlement amount can be used for an independent living, assisted living or skilled nursing care community that either requires a buy-in or a community with a lease arrangement. Having this cash, plus Social Security and any VA benefits will allow the resident to age in place.
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20. How far in advance of a policy lapsing does one normally have to identify and take action to save value in the policy?
The simple answer is about 2-to-12 months.
Just like other financial investments or purchases, there is a lot of emotion involved (aka procrastination) in cutting one’s losses and selling a life insurance product, even when the policy in no longer needed or is an under-performing investment asset. If trusted advisors are willing and able to provide us with enough information to enable us to do so, on a fully privacy-protected basis, LSF is prepared to monitor policies to attempt to identify those policies that appear to be on the road to lapsing. When a life settlement appears to be an alternative, educational materials describing a life settlement can be presented for the policyowner to consider. Although this is not a time-consuming process, it often spans several months.
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21. What safeguards does LSF provide to protect the insured’s medical and financial information?
The life settlement industry is not yet subject to the Health Insurance Portability and Accountability Act, (HIPAA). However, LSF operates as if we are subject to that law. LSF tracks and complies with all state and federal privacy laws.
We take every precaution to protect the insured’s medical and financial information. Hard copy personal information is kept under double lock and key. Sensitive electronic information like social security numbers and dates of birth are encrypted with keys only available to selected Company managers.
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22. What are the economic motivators for a policyowner to give up life insurance in favor of a life settlement?
The economic motivators that move a policyowner to do a life settlement relate to the cash cost of keeping the policy in force, changes to economic priorities for seniors and attractive alternative uses for the cash proceeds from a life settlement.
Cash cost to keep policy in force: For a universal life insurance policy with non-level premiums, average annual premiums may have reached 5% to 6% of the policy death benefit by the time the insured reaches age 75. The annual increase to the mortality charge adds 10% to these premiums each year.
For example, at age 75, the average annual premium on a universal life policy with a $500,000 death benefit could range between $25,000 and $30,000 ($2,083.33 - $2,500 per month), and increase at the rate $2,500 to $3,000 every year thereafter (e.g. $37,500 - $45,000 at age 80)!
How many seniors are willing, let alone able, to afford to keep such a policy in force?
Changes in economic priorities for seniors: Most life insurance was purchased to provide family income protection in the event of the death of the insured. After the children are on their own, the need for this income protection diminishes and is often replaced by pensions and retirement savings. Increasingly, parents decide early on to spend money to provide children a quality education in lieu of a larger inheritance. Later in life, this often means continuing to pay premiums on unneeded, unwanted, and often under-performing life insurance. Six common uses for the proceeds from a life settlement are:
1. Spend the proceeds to enhance life style,
2. Gift the proceeds to children so they have money earlier when it is most needed,
3. Contribute the proceeds to charity,
4. Invest the proceeds as part of a financial plan focused on life as a senior,
5. Use the proceeds to fund the cost of long-term care insurance or other arrangement to help offset the costs of special needs in the event of physical or cognitive disability that could otherwise become a substantial burden of a spouse, children or other family members,
6. Use the proceeds to fund residence in a senior community
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23. The American Council of Life Insurers (ACLI) says there is no economic justification for a policyowner to do a life settlement. How do you refute this statement?
The ACLI is the main lobbying organization for their industry whose member companies reap the benefit when 90% ($909 billion) of universal life policies lapse. This position of no economic value in a life settlement was drawn from a 2005 Deloitte and Univ. of Connecticut study underwritten by the Hartford and other insurance companies. A rebuttal to this study on both economic and actuarial grounds was published later that year by Hal Singer and Eric Stallard. A copy is on the LSF web site.
There is strong economic justification for a policyowner entering into a life settlement to either conservatively invest the proceeds or use them for another purpose.
Take this example using the following assumptions:
1. Male age 75 [LE=9.86 yrs] has a $1,000,000 universal life policy [an interest rate based account, plus ever increasing term insurance],
2. $150,000 accumulated cash value would be paid to the policyowner if the policy is surrendered to the issuing insurance company,
3. Policyowner receives $265,000 proceeds from a hypothetical life settlement,
4. Policy premiums are $30,000 annually, plus 9.0% annual compounded increase in the premium [increasing mortality charge],
5. 2.5% annual compounded inflation is added to the cost of each premium,
6. Assume 5.5% after tax average investment return if you had the money to invest in a balanced index fund or exchange traded fund [ETF].
Outcome: If the policyowner sells the policy in the above example and invests the proceeds, the value of the investment account exceeds the policy death benefit in year 10, the average life expectancy of our insured, age 75, in this example.
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24. What is “stranger originated life insurance” (STOLI) and why has it been in the news of late?
Stranger originated life insurance (STOLI) refers to a situation in which a third party without an insurable interest in a prospective insured convinces that person to purchase a life insurance policy. Once purchased, the third party, “stranger,” becomes the policyowner and beneficiary of the policy. The stranger pays or finances the policy premiums for much or all of the two year contestability period and then attempts to sell the policy in a secondary market life settlement transaction for a profit. When the policy is sold, a portion of the profit is shared with the insured. These transactions are more common than you might imagine. When these transactions are discovered by the insurance companies, they are investigated (A) for fraud at the time of application, and (B) death benefit payments are withheld because the policyowner did not have an insurable interest in the insured, (e.g. the policyowner is not a relative, employer or trust related to the insured), a requirement under law.
Insurance companies are rightfully pressuring state insurance commissioners to regulate against such transactions. Recently, several of these transactions have been uncovered on the East Coast and the alleged perpetrators are being sued in Florida and New York. Insurance companies are also putting language in new insurance contracts prohibiting these stranger owned transactions.
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25. What steps have been taken to control the proliferation of stranger originated life insurance (STOLI)?
At their June 2007 meeting in San Francisco, the National Association of Insurance Commissioners (NAIC) drafted a model statute for consideration by state legislatures to limit STOLI insurance. This model statute or variations of it are being passed by many states not allowing the transfer of life insurance for between two to five years from the date of original purchase. States are also now beginning to regulate life settlement transactions and requiring life settlement brokers to be licensed.
In addition, the life insurance industry has started using new pricing tables that discourage the practice among life agents of writing policies on seniors with the intent of doing a life settlement and then using the proceeds of the settlement to write additional policies on that same senior in two years.
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26. What is to prevent life insurance companies from going into the life settlement market and buying policies issued by other insurance companies?
There is nothing prohibiting them from buying policies issued by other life insurance companies in life settlements. The factor keeping them out of the market is how to explain to their policyowners why they will pay more to buy policies issued by other companies than they are able to pay to their own policyowners who want to surrender a policy for cash.
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27. What information and services does LSF provide?
LSF provides the education and tools needed to make the process easier. We help sort prospects and convert them to transactions that yield cash proceeds to be put to work in a way that best suits the policyowner’s needs. Below are the tools and services we provide:
a) Frequently Asked Questions for education;
b) Unbiased educational brochures provided for prospective applicants;
c) Secure web site based policy tracking system for visibility into a transparent transaction;
d) Telephone and e-mail support;
e) Full state-compliant application packages;
f) Published insights into relevant state and federal laws and regulations; and
g) Third party independent escrows to further protect confidentiality.
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28. How does LSF work with State Health Care Associations?
LSF has partnered with the State Health Care Associations to provide life settlements to community residents through the management companies that are their members. The management companies and their various community administrators and marketing professionals assist LSF in approaching residents, their family members and advisors to educate them on the benefits of a life settlement. When life settlements are completed, LSF pays a transaction fee to them. Because these organizations are not-for-profit associations, these fees are used to design programs that are provided to the senior communities and the public at large. The management companies are not compensated beyond the additional cash now available to prospective and existing residents.
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29. How do you determine if seniors have unneeded and unwanted life insurance?
We ASK! Today’s seniors grew up at a time when purchasing insurance for family income protection was considered more important than many younger people today believe it is. They also were conditioned to buy and hold this insurance, no matter how painful continuing to pay the premiums might become. Simply asking about their life insurance often opens up a discussion that leads to the conclusion they have a policy or policies they no longer need for protection. Also, determining with them if the potential life settlement value, plus being relieved of future premium payments could ease their cash flow will help them focus on whether or not the policies continue to be necessary.
Another sad category of policies to evaluate are universal life policies sold to seniors as an “alternative investment”. These universal life policies are often sold with an emphasis on the potential interest rate “safe investment returns”. Many of these policies are also sold with “teaser” reduced premiums in the initial years that reset to much higher premiums after a 3/5/7 year reset point. These policies also may have surrender charges in excess of the CSV or “investment“ value of the contract. Selling these policies in a life settlement allows the policy owner to al least recoup the CSV.
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30. What steps does LSF take to buy or place every policy for which an application is taken?
The purchase of a life insurance policy is mathematically driven. The decision to make an offer to purchase is a direct result of a combination of factors that includes the medical condition of the insured and the future premiums needed during the life expectancy of the insured. It is our intent to either purchase or arrange for purchase, every policy that makes sense actuarially.
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