With markets going crazy and interest rates dropping in the wake of the global coronavirus pandemic, universal life (UL) products can be a source of salvation and quick cash or an albatross, depending on how well they’re managed or sold.
UL insurance was introduced to consumers and advisors in 1979 when interest rates were in the mid- to high double digits. Most didn’t understand that this new form of permanent life insurance shifted performance risk to the policy owner. If interest rates remained high, those policies could build up considerable cash value. However, the unusually high interest rates of the late 1980s plummeted and have hovered in the 3%-5% range, before their current drop to at or near 0%. These policies may lack the ongoing funding strategies that can save them from imploding and so are in danger of doing just that. Fiduciaries aren’t aware of these problems within their clients’ policies. Here’s what they should look out for and how to determine whether they should discuss the option of selling the policy through a life settlement.
Who’s Affected?
This insurance blind spot is negatively impacting certain demographics more than others. To illustrate, we pulled a representative sample of 1,000 completed life settlement transactions over the past 17 years and found that 88.89% involved insureds ages 76-100. Additional research revealed that 98% of those policies settled on the secondary market were some form of UL and term insurance. Many of these clients are what’s known as “orphaned policy owners,” which means that the agent they originally dealt with is no longer servicing the policy. They’re usually assigned to new agents who are incentivized to place new coverage and focus on younger insurable prospects. This creates a management void for those policies.
Fiduciaries can take some preliminary steps to identify at-risk clients, starting with asking clients three questions that will help them quickly uncover who may need help:
- Are you considering lapsing or surrendering your life insurance policy. If so, why? Their answer will help the fiduciary understand their need(s).
- If yes, is this policy a UL policy?
- Have you had any changes in health since the policy was issued?
If a client answers “yes” to all three questions, then ask if she’s explored traditional nonforfeiture options. If none of those options is acceptable to the client and she plans to let the policy lapse or to surrender it, she may want to consider the option of a life settlement.
Life Settlement Option
There are three ways to sell a policy. The first and most familiar choice is to forfeit/surrender it back to the insurance carrier for the cash surrender value (CSV), a predetermined fixed amount. The second choice is to sell the policy to a buyer who offers more than the CSV, but far less than the fair market value (FMV). In this scenario, the seller considers it a win because she receives more than if she’d just forfeited her policy to the carrier and received the CSV. What she may not understand is that life insurance is an asset, and she may be best served when buyers compete for the right to purchase the policy. This leads us to the third, and often most prudent, choice: to engage the services of a life settlement broker/fiduciary to represent the seller’s best interests and create a competitive bidding auction to obtain true FMV for the seller. The following example shows how choosing the right value option helps your client and mitigates liability risk for you as the fiduciary.
Example: Your client is an 84-year-old female with a $1.5 million survivorship UL policy with one insured deceased. The carrier purchase price (fixed predetermined CSV) is $25,000. A single buyer/single bid offer from an institutional buyer would yield $75,000.
A broker-negotiated auction offer with 14 incremental bids would yield $475,000 (FMV).
Finding the Value
Sort your client files or databases by age, starting with those age 90 and above, then moving to those ages 80-89 and then those ages 70-79. Younger insureds can qualify with a significant change of health since the policy was issued. Once you’ve identified those clients, take the following steps to gather information necessary to uncover a range of value:
- Appraise all UL and convertible term products owned by your clients who are age 75 and older or by those younger than 75 who’ve had a health change since the policy was issued.
- Determine if your client is unable to perform any of the activities of daily living.
- Identify any UL policies with clients paying premiums out of cash value.
Request the following illustrations on UL policies:
- A zero premium illustration to determine how long the policy will run without additional premiums paid.
- A current maturity illustration showing the minimum level premium needed to maintain a level death benefit to age 105 and solving for $1 to $1,000 of cash value at age 105.
- For policies with high cash value, a maturity illustration showing the maximum allowable cash withdrawal, reducing the death benefit by the same amount.
This is an adapted version of the author's original article in the April 2020 issue of Trusts & Estates.