What Advisors Should Know About Life Settlements

Every advisor is familiar with the term “fiduciary”. A fiduciary is “one that stands in a special relation of trust, confidence or responsibility in certain obligations to others”. Fiduciary comes from the Latin root fiducia meaning trust. CPAs, attorneys, financial advisors and insurance agents are fiduciaries to their clients. With that position of trust comes a responsibility and an obligation to advise clients on matters that may affect their financial or economic well-being.
In the last dozen years, an industry has evolved that provides a senior who owns a life insurance policy an opportunity to realize cash (while living) in excess of the policy cash surrender value. Some might argue that the policy owner can withdraw or borrow against the policy cash values. This is, of course, true. What it does not solve is the ongoing premium obligation to keep the policy in force. What if the policy is no longer needed or affordable?

The life settlement industry provides a secondary market alternative to policy lapse or surrender for those unneeded or unaffordable polices.

Why is the secondary market important? Without a secondary market, the only option a senior has to dispose of a life insurance policy is through lapse (non-payment of premium) or surrender (selling it back to the issuing company for a predetermined price). Imagine if you were obligated to sell to sell your home back to the builder for an agreed upon price when you purchased it. Would the market for real estate be as robust as it is with only one buyer? Would any market be strong with only one buyer? Of course not. Prices would be artificially low because of the lack of incentive to pay more than the previously agreed amount. This is the way the life insurance industry works. The secondary market brings to the senior, on average, 3 to 4 times the amount of the cash surrender value depending on the age of the insured, his/her health status, the size and type of policy, and the amount of the guarantee by the issuing company.

The secondary market brings several buyers (generally institutions) to the market for your client’s policy. They compete against one another with the policy going to the highest bidder. Your client is the beneficiary of this competition. As a fiduciary, it is important that you understand that getting multiple buyers involved is the only “true” way to determine fair market value. Sourcing a single buyer does not guarantee your client the highest possible price for the policy.

Fiduciary responsibility dictates that advisors be aware of the secondary market for life insurance and present it as an option to a client when the situation warrants.