Life settlements are primed to take off again. As life settlements have become more mainstream, they have caught the attention of Baby Boomers who need creative retirement planning options. Also, with flexible new features, life settlements can meet the needs of even more consumers.
Discovering an Overlooked Asset
by Douglas Himmel
The wheels start turning the moment your client or a prospect tells you that they are retiring, selling the business, giving it to the next generation, or going through a restructuring or bankruptcy. How will you respond; what lessons have you learned; and what information will you fall back on from previous engagements to help navigate the road ahead?
Your goal is to serve the client. But how will you do that when each client has their own challenges and circumstances? Life insurance policies that are taken out as a key person policy or as part of a buy/sell agreement are often considered too expensive to maintain and not a primary focus in the transition or transaction. Monetizing these assets can result in a meaningful financial distribution to the seller of a company, or can even fund a restructuring or exit plan. Given this, professionals should ensure that these hidden assets are uncovered. More often than not, they’re overlooked and treated solely as an expense, and not as the valuable and saleable assets.
Having corporate owned life insurance policies has long been an integral part of planning and risk management. This strategy can be a highly effective way to offset the financial effect of a key executive’s sudden death. But the policy often has little or no value to a company that is going through succession planning, having a key person retire, or having an outright sale in which a new management team will be taking over. The life settlement option fits some of these circumstances, and gives the policy owner an alternative to lapsing or surrendering the policy.
The cash-surrender value of a life insurance policy is not typically an accurate reflection of its fair market value. With the emergence of the life settlement option, it is not uncommon for a company to realize far more by selling a policy in the secondary market.
Overview of a Life Settlement
A life settlement is the sale of a life insurance policy from the current owner (the company, if it is a key person policy) to institutional investors, such as commercial and investment banks, pension and hedge funds, and insurance companies. These investors determine what the fair market value of each policy based on the characteristics of the policy and the insureds’ health. If a transaction is consummated, the investor will purchase the policy for a one time lump-sum payment to the policy owner and assume responsibility for the ongoing future payments of all insurance premiums.
Universal life, variable universal life, and even convertible term policies are eligible for a life settlement. In fact, term policies are often viewed as not having any value because they do not accrue cash-surrender value, but they may prove to be the most valuable of these hidden assets. Since there in no cash-surrender value, they are often cancelled or even worse, allowed to lapse for non-payment as the company moves forward with a sale, the executive retires, or the company enters into restructuring or bankruptcy. However, more than 90% of term policies contain a conversion feature, which gives the owner the right to convert from a term policy to a permanent policy. Upon exercise of the conversion right, the company can consummate a life settlement and extract value from the asset.
To qualify for the life settlement option, the general rule of thumb is that the insured must be over 70 and have at least $500,000 of life insurance coverage. Additional factors influence the policy’s purchase price including age, gender, health of the insured, and the size and type of the policy.
The relatively simple life settlement process isn’t too different from writing a policy. An application is signed, medical information is collected, and life expectancy reports and policy information are gathered and sent out to the market. At that point, bids are negotiated between the broker and the potential buyer, a process that the broker typically handles on a contingent basis.
Why is the corporate world a good place to solicit business? Typically, the policies are bigger than those that are individually owned. Key person policies are usually $2 million to $10 million. We’ve been involved in cases in which policies were $20 million to $50 million.
Term Conversion Possibilities
There is commissionable income from converting a multi-million dollar UL on a person in their 60s or 70s. We have been involved in several conversions including a $15 million conversion with John Hancock that sold for $3 million.
Little or No Expectations as To What the Policy Is Worth
The CFOs or the retiring/selling owners are typically ecstatic when they can get more than the cash-surrender value because they took out the policy with coverage in mind, not profit from a sale of the policy.
There Is Little or No Emotional Attachment to the Key Man Policy
This was a business decision to put the policy in force and now it’s a similar business decision to liquidate it.
The Policies Are More Marketable/More Valuable in the Secondary Market
The policies tend to be older (five to 10 years old). It’s easy to understand why the policy is in force so potential buyers don’t have to worry about STOLI or similar concerns
Why Should You Consider the Life Settlement Option?
In this very low interest rate environment, institutional investors are chasing yield, and IRR expectations are down a few hundred basis points. Attractive policies are pricing at higher amounts than at any time over the past five years. Many policies that did not price positively due to longer life expectancies are now seeing positive pricing. Bidding competition has increased to the point that several bidders are participating, and multiple bids per qualified case are received
Professionals who are working with transitioning or troubled companies have an obligation to maximize the value of all assets for the benefit of all parties involved. When insurance policies exist, they should not be surrendered arbitrarily for the cash-surrender value or allowed to lapse without an appraisal of their true market value. To get the highest monetary value for these assets, advisors should consult an experienced life settlement broker who has significant experience and proper licensing. Even when the policy has positive cash-surrender value, a life settlement should be considered since it often provides significant cash influx at exactly the right time. q
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Douglas Himmel is managing director of Melville Capital, A life settlement brokerage agency. For more information call (310) 943-5370