The Problem Faced by Some Life Insurance Policyholders
Before the development of the life insurance secondary market (some thirty years ago) Policyholders often faced limited options when they either no longer needed the policy or couldn’t afford it. Permanent policies (e.g., Whole Life, Universal Life) are designed to have a Cash Surrender Value (CSV) to the extent the policy has been overfunded by the premiums paid plus earned interest. Each month, a carrier will deduct an amount from the cash in the policy, it’s cost for keeping the policy in force. This “Cost of Insurance”, or COI, increases with the age of the Insured, the person on whose life the policy is written.
Universal Life Policies
Permanent policies that allow flexibility in the payment of premiums. When Policyholders skip paying the premiums, the CSV will be depleted. In such cases, older Policyholders often find out that the catch-up premiums needed to cover the ever increasing COIs are prohibitive just when they “need” the coverage the most.
Term policies
Designed to be inexpensive but do not provide for any cash build-up within the policy, and hence there is never a CSV component at all. Some term policies have a right of conversion to a permanent policy before a specified age of the Insured (e.g. 75), but that new permanent policy will have much higher, often prohibitive, premiums.
Life Settlement as an Option
What are the Policyholders’ options when they don’t need the policy or cannot afford it? In general terms, they can lapse the policy, get nothing in return, and “lose” all the premiums they paid. Or, if it’s a permanent policy, they can surrender it, for the Cash Surrender Value, which may have been largely depleted.
A third option now is a sale (aka a Life Settlement) in the secondary market. When a Policyholder sells a policy, it will be for an amount greater than the CSV. The market is regulated under the laws of at least 43 states, where specialty Brokers for Policyholders, as well as “Providers,” financial firms that represent Investment Funds, must be licensed by that state’s insurance department.
There is generally no out-of-pocket cost to a Policyholder to take the policy to market. Brokers typically represent their clients for a percentage of the sales price only. A good Broker will offer his client’s policy to multiple Providers, each of which may represent more than one Investment Fund. It’s a competitive market and if a transaction closes, the Policyholder will receive a market price determined more on the basis of the future premiums required to be paid, and the predicted life expectancy of the Insured, and less so as to the CSV, if any.
Upon a successful closing:
- The Investment Fund will pay a lump sum dollar amount to the Policyholder (and his Broker).
- The Investment Fund becomes the new owner and beneficiary of the policy.
- The Insured remains as the Insured under the policy.
- The Investment Fund pays the premiums going forward and will collect the death benefit upon the death of the Insured.