Warren Buffet. Just the name connotes financial success. Most Americans have a high-degree of respect and admiration for Mr. Buffet’s achievements. And many people would love to be able to acquire just one share of Buffet’s Berkshire Hathaway stock at the hefty price of $120,000. Few would argue that it is a good risk.
It may surprise you; however, that Berkshire Hathaway invests $600 million annually in life settlements and even has owns a private company that sells life settlements.
A life settlement generally refers to the sale of a life insurance policy by a policy-owner for less than the face value of the policy to third party investors. The third party investor(s) plans to profit at death of the insured by collecting more in death benefits that were paid out (e.g., the purchase price, the transactions costs, and premiums).
Until recently, the only options for liquidating an underperforming or unneeded policy was to let it lapse, sell it back to the original insurer for its current net cash surrender value, or exercise a policy non-forfeiture option. But thanks to an increasingly competitive secondary market, known as life settlements, life insurance is no longer being treated as simply a death benefit. Like other types of personal holdings, life insurance has evolved to become an asset with a fair market value and may be sold by its owner at a market price higher than its net cash surrender value under specified circumstances.
This sale of an insured’s existing life insurance policy to a third party known as a life settlement provider in exchange for a lump sum cash payment is called a life settlement. Instead of retiring a life insurance policy for its net cash surrender value, letting it lapse, or exercising a non-forfeiture option, you can sell the policy and use the money you receive through the transaction to fund other investments, make cash donations to a charity of your choice, supplement your retirement nest egg or income, purchase replacement life insurance, if needed, or provide education funds to a deserving family member.
Generally speaking, life settlements are an option for high-net-worth policy owners age 70 or older. Independent estimates report that among this group, 20 percent of policies have a market value that exceeds the cash value offered by the carrier. Life settlements have gained attention from high-profile proponents such as Warren Buffet, 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 adviser. With this being said, those established in the industry are now placing an emphasis on life settlement education for financial professionals so that they can accurately present the life settlement option to all clients who might benefit from it.
Do Life Settlements Create A Moral Dilemma?
The elephant in the room that no one likes to talk about, is that we all eventually die. And, all insurance products, and yes, that includes health insurance, are underwritten by actuaries using life expectancies. Life settlements are an opportunity for the insured to have a better life style while they are LIVING rather than saving the death benefit for their beneficiaries when they pass.
Life settlements offer a unique alternative opportunity has no correlation to the stock market, real estate market or even national and world economies. But there are a small percentage of investors who wonder if it is morbid to wait for people to die.
“What is morbid about turning a death benefit into a LIVING benefit?” asks JP Snyder President Jeffrey Snyder. “Most insured’s who exercise this third option improve their lifestyle considerably. They have more choices and opportunities to enjoy their life.”
When you purchase a life insurance policy for yourself, you purchase it for the explicit benefit of your beneficiaries to utilize upon your death benefit. In 99 percent of all cases, families are not waiting or hoping that their loved-ones perish.
When you invest in a healthcare company, such as a pharmaceutical company, are you not “hoping” someone is “sick” enough to need the pharmaceutical company’s products? How many of us watch the GE commercials during the super bowl for the latest hospital equipment (MRI and CT) that are helping doctors diagnose disease earlier. Is GE “waiting” for someone to die? It invests in life settlements.
Are cardiac surgeons “praying” for someone to have heart disease? Or merely trying to improve the individual’s health while they are living? The surgeon, hospital, and pharmaceutical companies all benefit by peoples illness yet I think we all agree, they don’t “wish” for someone to die.
When you invest in any product that uses the S&P, Dow Jones or NASDAQ index and purchase stocks or bonds from many brokerage houses such as Merrill Lynch, you are already investing in life settlements because the large institutions that comprise these indexes and funds have invested in them. They invest in life settlements for the historical returns of *15.83%, yet they want you to invest in their stocks and bond recommendations for historically returns averaging 7 percent and significantly less in these trying economic times.
Three reasons why an insured might originally purchases a life insurance policy with a high death benefit:
1. They served as senior level management or principals and were required by their company to have “key person” insurance while working for their company. Generally these policies were paid by the company while the individual was still employed with the “benefit” of keeping the insurance policy after separation or retirement as long as the individual or insured continued paying the premiums. Once the individual separated or retired and began paying the premiums, they then became the policy owner.
2. They were business-owners who were obtaining loans and credit lines by banks which necessitated the purchase of “special use life insurance” required by the banks as part of the loan requirements.
3. The most common reason an individual of “high net worth” might purchase a large death benefit policy is to offset estate taxes. As tax laws have changed raising exemptions, so do life insurance needs. For example, the exemption used to be $600,000 for an individual. Today, the estate tax exemption amount has increased to $2 million. These individuals may no longer want or need to pay premiums for the purpose of offsetting taxes since the estate tax exemption amount has more than tripled!
With each of these situations, it’s clear to see how over time the need for this specific policy might change. So what does an insured do when they no longer want, need, nor can afford annual premiums? Prior to the “Life Settlements market” there were only two options:
• Strip the cash value
• Surrender/lapse the policy
Now with life settlements, there is a third, lesser-known and under-utilized option of selling your policy for a fair market value based on your life expectancy. In the state of Florida, it is actually required for a licensed insurance agent to inform an insured of the option of selling the policy for a fair market value on this secondary market.
To find out more about life settlements:
Life Settlement Factors To Consider
• Is at least two years mature (after contestability clause)
• The insured is at least 70 years of age (there may be exceptions, but not many)
• A death benefit of at least $500,000
• The insured’s life expectancy is no more than seven years
*The average Equity Fund Investor received a 3.51% annualized return.
Source: Dalbar Inc., Wall Street Journal