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From
E.
Frederick Petersen III
The Petersen Law Firm
One Corporate Center
10451 Mill Run Circle; Suite 400
Owings Mills, MD 21117
(443) 392-2585
I have over 20 years of experience helping my clients
and referral partners’ clients develop and enhance their
estate plans by incorporating up-to-date wealth
preservation techniques. Contact me to learn how the New
STANDALONE IRA TRUST can benefit your clients!
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Volume 2,
Issue 7 |
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Life
Settlements: Understanding the Opportunity for Your
Clients
This month's
issue of The Wealth Counselor addresses a topic that
many professionals do not understand fully, life
settlements. For the right clients, a life settlement
offers a significant advantage over the alternatives -
and one that the client and the planning team should at
least consider.
Life Settlements - The Basics
The secondary market for life insurance policies has
entered the mainstream of financial services products.
Therefore, advisors whose clients include seniors or
aging baby boomers should have a working knowledge of
how a life settlement can provide liquidity to meet a
variety of estate planning and elder care needs.
A life settlement is a product for seniors (generally
over the age of 70) who are seeking an economically
sensible exit strategy from unwanted life insurance
policies. A life settlement transaction involves the
sale of an existing life insurance policy, typically
valued at $250,000 or more, to an institutional investor
(known as a "provider") in exchange for a lump-sum
payment greater than the cash surrender value, but less
than the death benefit. The institutional buyer becomes
the new owner of the policy, assumes responsibility for
premium payments, and collects the death benefit upon
the insured's death.
Planning Tip: Where the
owner/insured no longer needs or desires a life
insurance policy, a life settlement can generate
significantly more income than a policy surrender.
As long as the life settlement payment does not
exceed "basis" or the premiums paid for the policy,
the payment will not be subject to income tax.
Based on industry statistics, the average life
settlement candidate is a 78 year-old male who owns a
universal life insurance policy valued at $1.8 million,
and the average lump sum payment typically ranges from 3
to 5 times the cash surrender value. In addition to
universal life insurance policies, most other types of
life insurance policies may qualify for a life
settlement, including variable universal life (VUL);
term policies (if convertible); whole life;
survivorship; and group policies (if portable and
convertible).
Planning Tip: Life settlement
offers from providers can vary widely. To obtain the
highest possible value for a client's life insurance
policy, advisors should seek the services of an
experienced settlement broker who can shop the
market and obtain multiple offers from providers
authorized to do business in the state in which the
policy ownership resides. A listing of settlement
brokers operating in the secondary market is
available online at:
www.lisaassociation.org.
Life Settlements for VUL Policies Are Securities
Transactions
Although universal life insurance policies comprise the
bulk of life settlement transactions, VUL policies -
particularly those with investments in subaccounts that
have not performed according to market expectations -
may be prime candidates for settlement in the secondary
market. In August 2006, NASD issued Notice to Members
06-38 addressing member obligations with respect to the
sale of existing VUL policies to third party investors
operating in the secondary market for life insurance.
This notice reminded us that, according to the NASD, the
sale of a VUL policy is a securities transaction subject
to applicable NASD rules.
Those elements of Notice 06-38 directly impacting the
handling of VUL life settlement transactions concern:
- Establishing the client's suitability for the
product;
- Conducting due diligence on the confidentiality
practices of brokers and providers;
- Performing "best execution" by soliciting bids
from multiple licensed providers;
- Establishing written procedures involving
product training and supervision; and
- Prohibiting the payment of compensation on a
transaction except by another member firm
(broker-dealer).
Some broker-dealers have taken the position that
although they will not proactively promote or advertise
the product, they are putting procedures in place to
make the option available to their registered reps in
situations where a life settlement may be the most
suitable solution for the client.
Planning Tip: Following the
issuance of NASD Notice 06-38, many independent
broker-dealers began screening life settlement
brokers and establishing preferred vendor
relationships to service this business from their
registered reps. Financial advisors should check
with the broker-dealer home office regarding the
procedures for transacting a VUL life settlement and
any preferred vendor relationships.
Life Settlements for Trust-Owned Life Insurance
As baby boomers prepare themselves for the great wealth
transfer, financial advisors and legal professionals are
poised to establish more trusts. According to the
results of the sixth annual "Industry Attitudes" survey
published in October 2006 by InvestmentNews, 70 percent
of the financial advisors responding to the survey
indicated that they expected to set up a greater number
of trusts for their clients.
This statistic is important because life settlement
industry statistics indicate that approximately 40
percent of life insurance policies sold in the secondary
market involve trust-owned life insurance policies. For
financial and legal professionals acting as trustees or
fiduciaries for trust-owned life insurance policies, or
for any professional whose clients have trust-owned life
insurance, conducting periodic reviews of policy
performance is highly recommended.
For example, policies purchased with the expectation
that policy values or dividends would be available to
pay future premiums may now require additional premium
payments to maintain coverage. In some cases, the trust
makers may choose a life settlement for the
underperforming policy and then use the proceeds from
the life settlement toward replacement coverage with a
better-performing product.
Planning Tip: All wealth planning
professionals whose clients have trust-owned life
insurance should consider engaging an insurance
professional with expertise in conducting regular
policy reviews. Life insurance policies are complex
financial instruments, and once a trustee discovers
that a trust-owned life insurance policy is at risk,
they will want to discuss all possible options with
the insurance professional and the insured.
Common Uses for Life Settlements
There are numerous reasons why seniors choose a life
settlement, but some of the most common scenarios are:
(1) the preferred alternative to a 1035 exchange; (2)
the insured's estate tax burden has decreased and thus
the insured no longer needs liquidity to pay estate
taxes; (3) the insured wants cash to give to family or
their favorite charity; (4) the insured can no longer
afford the policy or plans to surrender it; (5) the
policy is a key-person policy and no longer needed by a
retiring executive; (6) the insured needs funds for
medical or long-term care.
Planning Tip: Life settlements are
often preferable to the client accepting a low cash
surrender value or surrendering the policy.
Conclusion
Within the past five years, the secondary market for
unwanted life insurance policies has grown exponentially
and is now estimated to be a $20 billion industry. Due
to increased regulatory oversight and the infusion of
institutional capital from investment banks such as
Credit Suisse, Bear Stearns, Goldman Sachs, Deutsche
Bank, and foreign and domestic hedge funds, this
emerging industry is approaching a plateau of tenability
and maturation.
Consider working with an experienced insurance
professional to conduct periodic reviews of your
clients' life insurance policies, and if suitable,
recommend a life settlement.
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