At the end of October, former New York Attorney General Eliot Spitzer sued Coventry First, one of the largest life-settlement firms in the U.S., for alleged bid-rigging and other types of fraud. Not exactly an auspicious development for the rapidly growing life-settlements industry, which recorded estimated sales of around $13 billion in death benefits last year. Regulatory attention to life settlements has intensified as they have taken off in the past few years, and more lawsuits are expected.
Despite the bad rap, there are some legitimate and valuable uses of life settlements for advisors and their clients.
Life settlements grew out of the viatical-settlement business, which launched in the 1980s when AIDS patients who were desperate for cash began selling their life-insurance policies to investors for upfront payment. Both viatical and life settlements involve the sale of an insurance policy to a third party for more than the cash-surrender value of the policy, but less than the death benefit. But life settlements tend to be less predatory than viaticals. Life settlements typically involve policyholders who have 10 to 15 years of life expectancy; viaticals tend to involve policyholders who are terminally ill and have less than two years to live.
Today, there are too many boomers out there with inadequate savings for a 30-year retirement. For some of them, a life-insurance policy is their largest untapped asset. Or, perhaps, your client's life insurance needs have changed and the old policy is no longer adequate. For these clients, a life settlement might be the best bet.
The potential market for life settlements is huge, according to some estimates. Bernstein Research Company has predicted that the business will grow more than tenfold, to $160 billion, over the next several years. And it can be a lucrative business for advisors: Payouts can be as little as 1 percent of the policy face amount, but tend to run closer to 6 percent, and can reach as much as 10 percent.
Who Can Benefit?
According to Jerry Claiborne, a life-settlement analyst with Life Insurance Settlements in Ft. Lauderdale, Fla., clients look to life settlements for a variety of reasons, including:
the client no longer needs or wants the policy;
the client has an opportunity to get a ‘better’ policy — better rating, accumulation, performance, lower premiums;
the client can't afford the premium payments;
the client's estate-planning needs have changed; and
the client needs additional sources of cash and/or income.
Claiborne cites the example of an 87-year-old male who had a $2.5 million life-insurance policy with a $374,000 cash-surrender value. The client no longer wanted to pay for the policy and was planning to surrender it. Instead, the agent suggested a life settlement for more than triple the cash-surrender value, or $1.31 million. The agent received a referral fee of $250,000.
Thomas Henske, a partner with the New York firm Lenox Advisors, tells of another client who had a life-insurance policy in a trust and felt he no longer needed it. For a policy with a death benefit of $5 million, the client might get a life-settlement offer of $1.25 million to $1.85 million for the policy, says Henske. Invested at 5 percent or 6 percent, that cash could generate $62,500 to $111,000 per year in income for the trust.
Of course, it is crucial that advisors do intensive due diligence on the life-settlement company and broker. Many states still don't require licensing of life-settlement brokers, so there is little direct regulatory oversight. And, most b/ds handle these transactions as outside business activities. But in August, the NASD issued a notice to members reminding broker/dealers that some life-settlement transactions — those involving variable life policies — are securities transactions, and so fall under the NASD's jurisdiction. Jane Riley, the compliance officer for The Leaders Group in Littleton, Colo., says that her firm only allows its reps to work with two life-settlement companies that have been carefully vetted. Meanwhile, the advisor's disclosure obligations include the tax consequences, costs and fees and a detailed analysis of the alternatives.