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Life Settlement
A life settlement is a financial transaction in which a policyowner possessing an unneeded or unwanted life insurance policy
sells the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes
the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.
Life settlements are an important development in that they have opened a secondary market for life insurance in which
policyowners can access fair market value for their policies, rather than accepting the lower cash surrender value from
the issuing life insurance company.
Generally speaking, life settlements are an option for high-net-worth policyowners age 65 or older. Independent estimates
report that among this group, 20% of policies have a market value that exceeds the cash value offered by the carrier. And
while many policyowners are unfamiliar with life settlements until a financial professional mentions the option to them,
the concept has gained attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill
Gradison, and numerous media sources including The Wall Street Journal, Time Magazine, Business Week and The Economist.
A growing number of experts now believe that informing clients about offering life settlements should fall under the
fiduciary duty of a financial advisor.
How it works
In a life settlement transaction, there is a chain leading from the seller of the policy to the end buyer of
the policy (known as a life settlement provider). Each link in the chain has a different responsibility in
facilitating the transaction and ensuring that it runs smoothly, while outside vendors typically assist the
provider with specialized functions.
Steps in a transaction
- Policyowner consults with an advisor, decides to sell his or her policy.
- Policy owner and advisor decide whether to work with broker or to go directly to providers.
- Client & advisor submit policy for valuation. Client releases medical information.
- If policy meets criteria for a life settlement, providers send offers directly or through a broker.
- Client and advisor review offers and client accepts his preferred offer.
- Client and advisor complete the provider's closing package, and return essential documents.
- Provider places cash payment in escrow and submits change of ownership forms to the insurance carrier.
- Paperwork is verified and funds are transferred to the policy seller.
Providers
Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the
client a cash sum greater than the policy's cash surrender value. The top providers in the industry fund many
transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in
the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions
that are customized to a client's particular situation. They have in-house compliance departments to carefully
review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states
have regulations in place regarding the sale of life insurance policies to third parties.
Brokers
Financial advisors who choose not to submit cases directly to a settlement provider may opt to work through a
life settlement broker. Life settlement brokers are intermediaries who bring together policyowners who wish to
sell a policy and providers seeking to purchase them. Brokers, in exchange for a fee, will shop a policy to multiple
providers, much as a real estate broker solicits multiple offers for one’s home. Not all buyers are alike and a life
settlement broker will help ensure that cases are sold to reputable buyers who are likely to close without significant
difficulties. It is unlikely a financial advisor will achieve the highest possible price without going through an
experienced life settlement broker.
While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the
offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after
commissions, and more.
Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a
broker will benefit the client. In many states, brokers must be licensed to do business in that state. Industry experts
state: "It is imperative that the client works with a licensed broker who has the experience to deal with sophisticated
institutional buyers to yield the highest price."
In regulated states there are material regulations as to procedure, privacy, licensing, disclosure and reporting which
must be met and which in some cases carry criminal penalties. A licensed life settlement broker can help you meet all
relevant requirements.
Investors
Life settlement investors are known as financing entities because they are providing the capital or financing for
life settlement transactions (the purchase of a life insurance policy). Life settlement investors may use their
own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of
structures. The life settlement provider is the entity that enters into the transaction with the policyowner and
pays the policyowner when the life settlement transaction closes. In most cases, the life settlement provider has
a written agreement with the life settlement investor to provide the life settlement provider with the funds needed
to acquire the policy. In this scenario, the life settlement investor is effectively the ultimate funder of the
secondary market transaction. However, in some life settlement transactions, the life settlement provider is also
the investor; the provider uses its own capital to purchase the policy for its own portfolio.
Life settlement investments are not typically suitable for individual investors. Risks are associated with life
settlement investments that individual investors may not recognize and that unscrupulous promoters may misrepresent
or fail to disclose. For example, funds invested in life settlement investments are usually not accessible on the
demand of the investor, as are investments in many other types of securities, such as mutual funds. These factors
and others render this type of investment unsuitable for the financial needs and interests of the average individual
investor. For this reason, the norm today, especially among reputable life settlement providers, is to obtain capital
only from life settlement investors who are established and credible institutional sources of capital rather than
individual sources of capital.
In most cases, a life settlement investor must be a qualified institutional buyer as defined in the federal Securities
Act of 1933. A qualified institutional buyer (QIB) is defined under Regulation D, Rule 144A as an entity owning and
investing large amounts of securities, with the threshold ranging from $10 million to $100 million of securities not
affiliated with the entity and dependent on the type of entity. QIBs are eligible to participate in a restricted
investment market known as the "Rule 144A market" that is not available to the public because the issuer of the
securities has chosen not to make the required public disclosures or to register the securities. The purpose of the
qualified institutional buyer requirement in life settlements is to prevent unsophisticated or undercapitalized
investors from participating in—and potentially being harmed by—complicated life settlement transactions.
Financial institutions meet the qualified institutional buyer test and are therefore suitable life settlement
purchasers. In addition, institutions have teams of experienced investment analysts and are experts at managing
investment risk; they can impose a “corporate governance” discipline on the life settlement transaction process
intended to minimize questionable market practices; and institutional funding provides a high degree of consumer
protection with regard to privacy and confidentiality (a policyowner’s or insured’s personal information should
never be in the hands of an individual investor.)
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