A GROWING MARKET The growth in the secondary market for life insurance policies has soared over the last decade.
Consumers have long viewed life insurance merely as a means of providing liquidity to pay estate taxes, to protect surviving family members, to fund buy/sell agreements or to meet other business needs. Based on this narrow view it’s no wonder so many CPAs fall into the trap of agreeing to allow unneeded policies to lapse or be surrendered for just their cash values. This is especially true if the coverage is no longer necessary and the premiums have become burdensome. However, this may be bad advice since such policies often have a secondary market value far exceeding their cash value. Case study. A 76-year-old man owned a policy with an $8 million face amount and a $795,000 cash surrender value. He sold the policy for $2.3 million rather than let it lapse, cancel it or take the cash value. Had he not sold it, he would have left at least $1.5 million on the table. HOW TO IDENTIFY THE RIGHT CIRCUMSTANCES Many types of insurance policies qualify for settlement, including term, whole, variable or universal life, any type of survivorship, adjustable life, joint first to die, group (if convertible) and retired lives reserve. The aftermarket for life insurance operates in two areas—viatical and lifetime settlements—each with different tax implications. Viatical settlements involve the sale of a policy insuring the life of someone who is either terminally or chronically ill. Proceeds are free of federal income tax and state income tax in some states (such as New York and California) since they are considered a death benefit. Lifetime settlements are for people without the health problems required for viatical settlements but with a life expectancy of 15 years or less. According to current mortality tables, this means males age 70 or older and females age 74 or older. Sometimes the insured has simply outlived his or her family or beneficiaries. Clients should also consider selling an unneeded life insurance policy when they can use the proceeds to:
Corporations should consider selling unnecessary life insurance policies on employees’ lives if:
Businesses may also benefit from selling a policy in the secondary market to
BUYER’S CRITERIA While there is no size limit on policies a consumer can sell in the secondary market, the usual face value is around $1 million. Many buyers, however, routinely purchase policies worth significantly more. Companies will even buy a partial interest in a policy. The lower the cost to carry the policy and the faster the expected payment, the more attractive an offer a policy is likely to attract. Companies that buy life insurance policies in the aftermarket use these criteria to determine the price to offer:
TRANSACTION MECHANICS Once a buyer has expressed interest, selling a life insurance policy requires no medical exam. Here are the usual steps to close the deal.
Payment structures. Payment terms are generally flexible to meet the seller’s needs. The most common payment methods include lump sum, installments (to defer taxes) and annuities. Case study. An 82-year-old woman sold a policy on her life for $900,000 that had a face amount of $5 million but a nominal cash surrender value of just $2,500. Without the sale, she would have walked away from almost $698,000. PROFESSIONAL DUE DILIGENCE It’s important for CPAs to understand both the market and the players clients are dealing with. Life settlements are unregulated and involve substantial sums of money. Not all transactions are fair. A Texas man was indicted for buying policies from AIDS patients without paying them. On the flip side, The Los Angeles Times reported the arrest of several AIDS patients who concealed their condition to get insurance coverage with the intent of selling it in the aftermarket. Indeed, sophisticated buyers are sometimes wary of policy sellers who are HIV positive. With recent advancements in AIDS drugs, the life expectancy of these individuals is such that investors often receive little or no profit. CPAs should use these due diligence guidelines to help judge the deal and the buyer.
TAX IMPLICATIONS To the individual policy sellers, life settlements usually involve three layers of taxation:
WHAT’S NEXT? By
putting some research and thought into the disposition of
unneeded life insurance policies, CPAs can help clients and
employers realize extraordinary value from the growing
secondary market. The exhibit below includes a list of
resources where CPAs can get additional information on the
legal, ethical and tax implications of selling life
insurance policies.
Neil Alexander, CFP, is founder and president of Alexander Capital Consulting, LLC, in Los Angeles. His e-mail address is nalex@alexcap.com . |
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