Wanted: Your Life Insurance
Remember the hard sell you got when you bought that insurance policy 20 years ago? Well, times have changed. It's quite possible the agent who sold you that policy now represents investors who want to buy it. They'll pay you a lot more than you could get from surrendering it to the insurance company, though the sum will be much less than the death benefit.
These transactions, called life settlements, may appeal to you if your life insurance needs have changed and you don't need the policy anymore. Or perhaps you don't think it's worth the escalating premiums, the result of low interest rates. But before you grab the money from an eager buyer, get some good advice from a financial planner, an estate attorney, or even your doctor.
Here's how the life settlements business works. Some firms like Coventry First LLC are bankrolled by hedge funds, pension funds, and in some cases large insurers like AIG (AIG ). The settlement firms buy the policies from individuals on behalf of investors. The settlement company then acts on behalf of the investors, who become the owners and beneficiaries, and pays the premium until the insured dies. The firm collects the death benefit and pays its investors anywhere from 9% to 12% annual return. Other firms buy and repackage the policies for sale to a third party.
WAIT TO SELL
These deals probably sound a little familiar. They're similar to viatical programs of the 1990s where the terminally ill, many of them AIDS patients, sold their policies to investors to pay medical bills. Life settlement companies, however, target a different market -- people at least 65 years old with some health conditions and life expectancies of 2 to 12 years. To qualify for a buyout, their policies must have death benefits of $250,000 or more.
Should you sell your policy? We asked fee-only life insurance advisor Peter Katt, principal of Katt & Co. in Mattawan, Mich., to analyze the numbers for a 72-year-old client who is considering selling his $1 million universal life policy. The life settlement company would pay $275,000, vs. the $100,000 surrender value that the insurance company would give. Sounds good -- but not as good as holding on without paying the premiums. Katt says you can use up nearly all the cash value to keep the policy in force -- and then sell it for an estimated $475,000 about five years out. Why so much more? The insured life expectancy is five years less, and that means the policy purchased can get paid off sooner. "The longer you wait to sell, the more money the life settlement firm will offer," says Katt, who analyzes these offers for about $1,500.
Selling life insurance policies has extremely high transaction costs. According to a recent report by Deloitte Consulting and the University of Connecticut, seniors who sold their policies to a life settlement firm got just 20% of the face value, while the intrinsic value of the policy is about 64% of the face value. Still, $200,000 for a policy with a $1 million death benefit may sound good if you think the policy has no value other than to you or your beneficiaries. "If a sophisticated investor is willing to pay you for your policy, you gotta believe it's worth a lot more than you know," says Byron Udell, chief executive officer of AccuQuote, an online insurance broker. The high fees, says Alan Brueger, CEO of Coventry First, help to cover the future premiums which average 60% of the face value of the policy.
Don't count on the life settlements firm to give you all the info you need to make an informed decision. "Marketing materials only compare the settlement offer and cash value but never what the estate value is if the policy were held to maturity," says John Skar, senior vice-president and chief actuary of Massachusetts Mutual Life Insurance, one of the insurers that funded the Deloitte study. If you're selling because you need the money, Skar recommends unloading other assets first or even asking your beneficiaries to pay the premiums.
Before you sell, you want to be reasonably sure that you won't need another life insurance policy. If you get remarried or go into a new business, life insurance may be necessary. Your old policy will be active and that may limit your ability to buy more insurance.
Then there are tax issues. Death benefits go to your beneficiaries tax-free, which is one of the attractions of life insurance. Selling the policy will result in a tax bill if the settlement amount exceeds your cost basis.
If you choose to sell your policy, shop for the best price. Udell tries to get four bids. On a $1 million policy, he received offers from $175,000 to $250,000. What accounts for wide variation is different actuarial assumptions and the commissions the settlement companies pay their agents. In short, be as skeptical when you sell your life insurance policy as when you buy it.
By Toddi Gutner