Is a Life Settlement Right for Your Client?

This article, written by Noam Weiss, asks how to understand whether or not a client should embark upon a Life Settlement.

With the ever-expanding use of life settlements by financial professionals of all varieties, the question being asked more frequently is: Does a life settlement make sense in my client’s specific situation?

Life settlements are easily defined as the exchange of a life insurance policy for a cash settlement. Today’s marketplace features sophisticated capital institutions on the funding side of the business as well as increased government regulations to protect the insured and the policyowner. These changes, along with the value proposition being offered and the abundance of eligible life insurance policies, are creating an expanding secondary marketplace. Utilizing a life settlement company, any financial professional can access this marketplace to determine a policy’s fair market value. At Settlement Benefits Association, we conduct these policy appraisals for free and without obligation. However, this information is only part of the value equation.

Just like any other financial decision that we assist our clients with, we must consider the client’s unique individual situation. This perspective should include, but not be limited to, such questions as:

• What are the financial goals of the client?
• How close is the client to obtaining those goals?
• What other assets does the client own?
• Which of these assets are liquid?
• What is the client’s health and family situation?

When evaluating this portfolio, advisers need to understand the role of life insurance. Often, life insurance is used to maintain a certain standard of living or to bridge the gap between the financial needs of dependents and the amount available from other sources. These sources, such as Social Security benefits, available cash, and other investments, may not be able to cover the dependents’ needs. However, you must also consider how this asset portfolio will change with the infusion of cash generated by the life settlement itself.

Understanding the ramifications of keeping or selling a life insurance policy should also include a look at potential tax liabilities (if any). Although the following information is not intended to substitute for the advice of a tax expert or CPA, generally, the tax structure is as follows:

• Zero tax on the basis amount of the policy. (The basis represents premiums paid into the policy.)
• Ordinary income tax on earnings above the basis. (The combination of the basis and earnings is known as the cash surrender value.)
• Capital-gains tax on the amount in excess of the cash surrender value.

Furthermore, as professional advisers, we need to understand the other ramifications of keeping or selling a policy, including opportunities for charitable giving, the availability of less expensive replacement coverage or the purchase of long-term care insurance using the life settlement proceeds, whether the policy is draining cash in a trust, and so forth.

In summary, to understand whether or not a client should embark upon a life settlement we must first understand the client. 

We must contemplate the client’s broader financial picture and the place of life insurance within that picture. Only then can we truly understand the full implications of selling a policy and understand which option is best for our clients.