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Informed Investor: Premiums increasing for many universal life insurance policies - Part III

This third column discussing recent increases in universal life insurance premiums—and what affected policyholders can do to counteract them—examines “life settlements.” This column looks at some of the problems associated with life settlements, which occur when a third-party investor purchases a cash value policy from a policyholder in exchange for a lump sum.

As a result of a prolonged period of low interest rates, many insurance companies are increasing premiums on some universal life insurance policies sold to individuals years ago. This is the third of three columns discussing how affected policyowners can deal with these increasing premiums. The first column examined one alternative to paying higher premiums—allowing a policy to lapse or to surrender the policy. The second column discussed another alternative: Doing  a “section 1035 exchange.”

The third alternative discussed in this column is to seek a “life settlement.” A life settlement occurs when a third-party investor purchases a cash value life insurance policy from a policyholder in exchange for a lump sum that typically exceeds the policy cash value and is less than the face amount of the policy. A life settlement can be a more attractive alternative to surrendering a policy or letting it lapse due to the fact that the policyholder may receive a greater benefit on a settlement than a lapse or surrender would provide.

The lump-sum amount that a third-party investor offers a policyholder typically is based on several factors, including the policyholder’s: (1) age; (2) medical history; and (3) life expectancy, as well as the policy premium and market interest rates.

How a Life Settlement Typically Occurs

A cash value life insurance policyowner may discuss a possible settlement with his or her insurance agent who then contacts a life settlement broker. Life settlement brokers may also be life insurance agents or securities brokers. Depending on the requirements of the states in which they do business, life settlement brokers may be licensed.

The broker obtains the policyowner’s/insured’s authorization to release medical records and forwards the policyowner’s application and medical information to one or more companies known as life settlement providers. The provider obtains life expectancy estimates on the insured and bids on the application.

Once the policyowner agrees to sell his or her policy to a life settlement provider/investor, the provider/investor continues to pay the policy premiums and collects the face value when the policyowner passes away.

Life settlements are still virtually unknown to the general public; nevertheless they can represent a somewhat better alternative to letting a cash value life insurance policy lapse or be surrendered. Despite the fact that life settlements can offer great benefits, they have also developed an unpleasant reputation due to the lack of privacy throughout the final sales process. The Securities and Exchange Commission has issued some considerations and guidelines for cash value life insurance policyowners and investors in life settlements, discussed below.

“Return” on a life settlement. The return on a life settlement depends on the insured’s life expectancy and the date of the insured’s death. As a result, the accuracy of a life expectancy estimate is crucial. If the insured—the policyowner—dies before his or her estimated life expectancy, the provider/investor may receive a higher return. If the insured lives longer than expected, then the provider/investor return will be lower. If the insured lives long enough or if life expectancy is miscalculated, additional premiums may need to be paid and the cost of the investment could be greater than anticipated.

The competence of a life expectancy underwriter and the accuracy of the life expectancy estimate are critical on a life settlement. Note that for the most part life expectancy underwriters are not licensed or registered by state insurance regulators. Also, information about the methodologies and review procedures that life expectancy underwriters use is not generally disclosed.

Under certain circumstances, the provider/investor may not receive the death benefit. An example involving nonpayment of the death benefit is if the life insurance company that issued the policy refused to pay out the benefit because it believes the policy was sold under fraudulent circumstances. The heirs of the insured may also challenge the settlement, or the insurance company may go out of business.

Life settlements can give rise to privacy issues. Insured individuals generally wish to keep their medical records and personal information confidential. Providers/investors on the other hand want access to the insured’s medical and other personal information in order to assess the advisability of their investment and to monitor it on a continuing basis.

Individuals interested in becoming investors in life settlements are highly encouraged to determine whether the professionals involved in a life settlement transaction are registered or licensed. They should check on the licensing or registration status of a life settlement broker or provider by contacting their state insurance regulator. Contact information is available on the website of the National Association of Insurance Commissioners at www.naic.org. Information on the registration status of a securities broker is available on the Financial Industry Regulatory Authority’s online BrokerCheck (www.finra.org).

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