The Department of the Treasury and the Internal Revenue Service released new guidance that is “designed to expand the use of income annuities in 401(k) plans.”
Why the Life Settlement Industry is Here to Stay
By Stephen Terrell
A 2012 study from insurance industry research firm Conning states, “life settlements continue to offer a value added benefit to policyholders as long as insurers are unable to provide cash surrender amounts that reflect a policy’s mortality-adjusted economic value.” This benefit to policyholders became amplified as fallout from the Great Recession continued to affect policyholders. High unemployment sustained by the economy’s lagging recovery means a growing number of baby boomers and seniors need to generate income during retirement. The funds from a settlement can provide significant financial relief for a policyholder, typically during or near retirement. How much relief?
Guessing exactly how much cash a policyholder can expect from selling his or her life insurance in a life settlement isn’t easy. Each transaction hinges on variables which are never quite the same: Life expectancy, face amount, premium payments and cash value all come into play. Despite the fact that offers can vary widely, and most providers shy away from any generalizations about settlement amounts, Conning’s 2011 study on life settlements reported that the average life settlement value is 20 percent of the life insurance policy face value.
At first glance, 20 percent might seem like a huge discount off of a policy’s potential value. However, one should compare this value against the average cash surrender value, which amounts to only 10 percent of a policy’s face value. One should also remember this 20 percent average value is just that, an average. As anyone in the industry knows, settlement offers vary greatly due to life expectancies and premium costs. Lastly, life settlements serve as an option for those that do not want or do not need life insurance. In April 2010, the Insurance Studies Institute surveyed U.S. seniors; in this survey, 40 percent had lapsed or surrendered their life insurance policies. An overwhelming number of policyholders receive little or nothing, after decades of paying premiums. In fact, life insurance companies heavily rely on the high probability that they will never pay out a customer’s policy; they reap most of their profit from lapsed, unclaimed policies.
Even after comparing settlements against the alternatives for unwanted life insurance, consumers and agents don’t understand why the average discount on the full policy value is 20 percent. Why not 40 percent or at least 30 percent? The life settlement industry suffers from a pervasive fundamental lack of understanding about how much profit is made and how much profit is risked by investors. Providers need to advocate for more widespread education and awareness regarding life settlements. Even agents who are aware-of or familiar with settlements, may not be able to explain to a consumer why the average settlement value appears highly discounted from the face value of a life insurance policy. All agents should be able to communicate a consistent message about the option of a life settlement to consumers – something, perhaps they cannot do without first understanding for themselves, all of the risks, costs and financial rewards for all parties involved.
Therefore, with the intent to clarify confusion caused by contradicting messages, and dispel skepticism on a relatively new option for unwanted life insurance, let’s deconstruct how a life settlement provider reaches an offer.
Below is an illustration of provider costs for a settlement offer for an 80-year-old with a 10-year life expectancy and $1 million policy.
In this example, the settlement provider offers $200,000 to the policyholder (this reflects the Conning 20 percent industry average). If the life expectancy remains accurate, the total cost for the settlement provider equals $632,000 after 10 years. But if the policyholder outlives the predicted life expectancy by just four years, the total cost at year 14 equals $1 million. With the cost now equivalent to the policy’s pay-out, the provider breaks even on the settlement. If the policyholder outlives the life expectancy by eight years, the total cost at year 18 equals $1.5 million. As you can see, the provider takes substantial risks. If the seller lives past age 98, then the provider loses $500,000.
What exactly do settlement provider “costs” cover? Costs comprise: the offered settlement amount (in this example, $200,000), insurance policy premium payments -- providers pay policy premiums for the rest of the policyholder’s life, underwriting costs, medical evaluation costs, administrative fees and tracking costs.
With these risks and costs in mind, the average life settlement value of 20 percent of a policy’s face value is placed in its proper context. The variables influencing a settlement offer - provider costs, investor profit and potential risks – change from policyholder to policyholder. Settlements are complicated transactions as numerous factors determine the offer, factors which must account for the unpredictability of life. The discount off the face value reflects the costs and real risks involved in a life settlement, but those costs and risks fall on the provider, not the policyholder or the agent.
Life settlements are not for everyone, but for those who no longer need or want life insurance coverage, a settlement is likely the smartest option for the policyholder and the agent. Funds from a settlement can drastically alter a client’s financial situation. Even for seniors who currently enjoy a financially prepared and comfortable retirement, a settlement returns more funds to the policyholder than a cash surrender or lapsed policy.
Life settlements provide an option to policyholders that they can’t get elsewhere and which baby boomer and senior policyholders need now more than ever. As long as life insurance companies can’t match the value of a settlement for policyholders who no longer need insurance, which insurers can’t do without sacrificing competitive premium payments, there will be a consumer need for life settlements. It is this fundamental need that will continue to drive the life settlement industry.
Stephen E. Terrell is senior vice president of market development and branding for The Lifeline Program, a life settlement provider based in Atlanta, Ga. For more information, call 770-724-7300 or visit www.thelifeline.com.