One of the best ways to make yourself an important resource to your clients and centers of influence is by helping them see value in certain situations in which they saw none before. Many agents have sold insurance to executives of small to medium-sized businesses that fall into this category.
When the insurance was purchased, the company and executive both believed that if the executive lived to retirement, the “key-man” policy they bought would expire. The growth of the secondary market for life insurance policies, however, creates an opportunity for these policy owners that did not exist a few years ago. Today, many of these policies can be settled and create unexpected proceeds. As an agent or broker, you should be familiar with the concept of life settlements so you can help your clients uncover the value that could be hidden in key-man coverage that they neither need nor want any longer.
The two most popular approaches to insuring the key executive of a company are either to use a term policy that will remain in force until the executive’s projected retirement date or to use a cash value product. In cases where cash value products are used, the cash value can be returned to the corporation upon surrender of the policy to repay the corporation for part or all of its premiums, or it can be transferred to the insured as part of a retirement package. In any of these cases, the viability of settling the life policy should be explored before any coverage is cancelled or surrendered.
In most cases, the retiring executive must be older than 65, generally with a policy of more than $100,000, to consider a life settlement. If the insured is younger than 65 and has minor to moderate heath issues, these are also cases that can be considered. Following is an explanation of how you can use a life settlement to create or enhance value for your executive client.
- Settling key-man term policies – This is the hidden jewel for some of your clients. Many financial institutions will buy term insurance policies, convert them, and then hold them until the insured’s death. The key to being able to utilize this strategy is that the term insurance must have an intact convertibility option. If the policy is no longer convertible because of the client’s age (or was not a convertible policy to begin with), then it will probably have no value on the secondary market. But in situations where the term policy is still convertible, any value created by settling the policy is “found money” for your client. Since the client was most likely planning on letting the policy lapse with no value, by settling the policy and creating unexpected funds, you have helped your client uncover a hidden asset within what was previously nothing more than a necessary expense. The value of any term insurance policy is determined by any number of factors, including the client’s age, life expectancy, and the premiums of the policy to which term insurance is being converted.
- Settling cash value policies – In situations where the key-man coverage was funded with policies that contain cash value, the approach is to enhance rather than create value. Since these policies already contain some value, the question is, can the policy be settled for an amount greater than its cash surrender value? If so, you have again helped your client by enhancing the value of their policy and returning more money to either the retiring corporation or the retiring executive. The factors that determine the policy’s value on the secondary market are again the client’s age and life expectancy, but with cash value policies, the amount of cash value in the policy will be factored together with projected premiums in the equation.
In addition to creating more value for your clients, life settlements can be a profitable market for the agent. In many cases, the agent would receive a fee or commission on the life settlement portion of this transaction, as well as receiving a commission on the conversion of the term insurance policy itself. Since life settlements are regulated on a state-by-state basis, be sure to check the licensing, commission allowances, and disclosure regulations of any state in which you are considering transacting a life settlement. In addition, if you are an agent or registered representative, you should consult your primary carrier or broker-dealer to ensure that you are in compliance with their rules governing life settlements.
As the secondary market grows, advisors will have an increasing fiduciary responsibility to inform their clients of all of their potential exit strategies from their life insurance policies. FINRA Rule 2320 requires that “a member shall use reasonable diligence to ascertain the best market for the subject security and buy or sell in such a market so that the resultant price to the customer is as favorable as possible under prevailing market conditions.” This could be applied to the life settlement transaction as follows: If the client is considering surrendering a policy and a more favorable price exists on the secondary market, it would seem that Rule 2320 would mandate that the settlement market be at least considered by the agent or broker as part of their due diligence process. By considering a life settlement upon the retirement of a key executive, you can help your clients uncover hidden assets while also fulfilling your fiduciary responsibilities.
Ronald M. Roth is founder of Genesis Asset Advisors LLC. He can be reached at rr@genesisknows.com.