The Investment Scientist

Life settlement for (convertible) term life insurance

Posted on: October 16, 2012

My friend Dan is in the life insurance business. Recently, he shared with me a case in which he helped a client of his (let’s call him John) get $600k out of his term life insurance with life settlement.

In case you don’t know what life settlement is, it’s the sale of an insurance policy by the owner to a third party for a price higher than the policy surrender value.

How does this work?

Well, let’s look at John’s case.

  • John has a $1mm convertible term life insurance policy whose term is up in six month
  • After the term is up, John can convert the term life insurance to permanent life by paying a much elevated premium of a few thousands dollar a month.
  • John’s health has changed for the worse.  Doctors say he is expected to live only another two years.
  • John does not have the money to pay the elevated insurance premium.

In the old days, there isn’t much John could do besides pray that he would die a lot sooner – like before his insurance term is up. In that case, his heirs would receive $1mm, which is nice for them, but is not going to help John too much. If he should die in six month plus one day, the insurance policy would have lapsed and his heirs would get nothing.

Instead, some institutional money managers, facilitated by intermediary like Dan, can purchase the policy for a fair market value say $600k. This is great for John, since he gets to collect $600k right away.

But what’s in it for the money managers?

Fret not; they are not in this for charity. They will convert the term life policy to a permanent policy, pay the elevated premiums and wait for John to die. At that time, they collect $1mm: $600k in exchange of $1mm, what’s not to like?

Who is likely to benefit from life settlement? Folks whose health has deteriorated or folks who are 75 years old and older and have convertible term life or permanent life insurance policies.

You really owe it to yourself to check out how much you could get out of your life insurance policy through life settlement.

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6 Responses to "Life settlement for (convertible) term life insurance"

The problem is in the details. A reputable money manager will make you a fair though not overly generous offer (his profit is your loss). A non-reputable one will make you an offer that is well below market value, i.e. try to rip you off (see above). Think it won’t happen? So do people who get “hot stock tips” from their brokers. This is a huge financial decision, so get outside, disinterested help from a fee-only financial planner with no connection to the contract or companies.

p.s. Get tax advice. An insurance policy payout on death may not be taxed, but this sale _will_ incur some combination of income and capital gains taxes. What is offered is not what you will receive. Get tax advice. -JA

Jerry, that’s a good point you raised. I need to educate myself better on this type of products so that I can give unbiased advice. On first brush though, anything that give a person an addition option is a plus.

Michael, I just read your article on the LinkedIn Life Settlement Investments – Sales & Marketing Discussion Group and I agree with Jerry that $600K is very high unless the policyholder is terminally-ill and you are looking at a viatical settlement. From my Canadian perspective, and you are welcome to join my Canadian subgroup on LinkedIn, your policyholder and his family would be better off to try and find a premium funder willing to pay the future higher premiums and accrue the interest on the loan. At death the accrued loan is repaid by the life insurer from the face with the balance going to the estate or beneficiaries.As a loan there are no tax implications to the policyholder.

Daniel, thanks for the comment. I wrote up this piece based on my conversation with a friend who is in the business. I could have misquoted him. Regardless, I think policy holders should take a look at the option.

Another question I have w.r.t life settlement is that insurance companies are not going to like it, since otherwise 90% of policies lapse and life insurance companies just get all the premiums for free. Now they have to pay up. Are there ways they can change the contract and refuse to pay. I know a lot of policy contracts are written in a way that give the insurance companies tremendous discretionary power.

Amaze. That was a good read. I will facebook this internet site for later.
I like your style.

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Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.



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