Over the past few years, life settlements have proved themselves a useful, popular, and financially successful option for the right client. They’ve become so ubiquitous, some people may have forgotten that they are still fairly new, dating back only to around the year 2000. As a result, we’re starting to see growing pains, and for a variety of reasons, agents may want to step back and ask themselves, “Is this really the best thing for this client at this time?”
New barriers for life settlements
In the past decade, life settlements were just the ticket for a retiring executive — someone who didn’t need a seven-figure policy anymore but was looking for a better option than simply returning it to the carrier. The executive got the cash and the purchaser got something for a well-planned portfolio. It was win-win.
But the marketplace has changed, especially for policyholders who have more than a 10-year life expectancy on their policies. It’s very hard to find a buyer who’s willing to pay a fair price. Indeed, seeing a lack of interest in investing in life settlements, many Wall Street firms are getting out of the business altogether. Mercer reports that $8 billion in policies were settled in 2009 — a big fall from 2008, when the figure was $11.7 billion. We used to see buyers interested in life settlements if they could get an internal rate of return at 9 or 10 percent. Now, they’re not interested unless it’s up to 18 or 20 percent.
And we’re seeing demographic changes, as well; the life expectancy reports on which insurance companies rely have gone up by as much as 30 percent. In brief, we’re all living longer, so investors simply have to wait longer in order to collect.
Where we stand today
None of this means that the life settlement market is dead, but it does go to show that settlements are subject to the same laws of supply and demand as any other product. Investors are cherry-picking the best policies with the shortest life expectancies. The supply is large, so the pricing is low. For your clients, only a “perfect storm” situation would make a life settlement a viable option today: Basically, a qualified policyholder needs to have a good, inexpensive life insurance policy, plus a serious illness and a life expectancy of 10 years or less. To be blunt, investors want a good value on something they feel they can collect on in the near term.
Of course, the problem of what to do with an outdated policy hasn’t gone away — but today’s climate does mean agents will have to dig a little deeper to decide what’s best for a particular prospect.
Start by working closely with your clients to figure out what they’re trying to accomplish with their policies. Their objective might have changed since the purchase, and the policy may no longer make sense. As the life settlement firm Coventry points out, 88 percent of all universal life policies are either surrendered or allowed to lapse; so much of the life settlement market has been driven by those 88 percent. Maybe now’s the time to consider a 1035 exchange to a new policy — or perhaps you’ll want to help your clients take out the cash and use it to purchase annuities or a long term care insurance policy.
The future: Not business as usual
One big mistake agents can make right now, however, is to think that these life settlement changes are just a momentary blip, and that once the economy settles down and we all get used to the new mortality tables, it will be business as usual.
Additional regulations, including more required disclosure, will continue to make life settlements a tough sell. This is to be expected as any financial product matures, and for the serious professionals, it will be good in the long term as it will flush out the bad players.
Government agencies won’t be the only entities putting pressure on the industry, either: Insurance companies themselves are inhibiting growth by throwing up roadblocks. Coventry notes that the total face amount of life insurance with market value exceeding surrender value is $108 billion. Basically, that’s money that policyholders will not surrender assuming they can get a price on the open market. This scares insurance companies that have based their profit margins on a certain percentage of lapsed policies. If companies see a large decrease in lapsed policies because of the life settlement business, their profits begin to disappear.
A lot of people entered in this business in the last five years because they saw an opportunity, and with that opportunity dwindling away, they’re looking for greener pastures. But those who are committed to providing life settlements for appropriate clients will remain. Indeed, insurance professionals who are serious will be well-positioned for the next phase of life settlements, even if the industry takes a while to reach 2008 levels. For example, as Mercer notes in an April 2010 report, the life settlement market “is a potentially profitable alternative asset class for sophisticated investors ... The global financial crisis was a wake-up call for many investors who realized that traditional alternative assets, such as hedge funds, had failed to provide investors with adequate strategy diversification. Life settlements provide a genuine alternative.”
However the life settlements market shakes out, if you keep one important rule in mind, it will be hard to go wrong: Always make sure you’re putting your clients first and finding the right product in the market to match their specific needs.
David Kleinhandler is managing partner at DKA Advisors, a financial planning company that serves high-net-worth individuals and businesses with innovative life insurance and annuity products. He can be contacted at davidk@dkainsure.com.
| Watch out for Fraud |
|
It’s important for agents to be on the lookout for potentially fraudulent transactions. They should educate themselves on the tax status of life settlements and be aware that insurance companies are taking a closer look in particular at stranger-originated life insurance (STOLI). There’s a history of rogue agents trying to convince people to buy policies and then flip them immediately for a profit. You don’t want to be involved in these kinds of activities. | |