Wealth managers and estate planners are becoming more familiar with life settlement transactions, in which your client sells his policy to a third-party investor and receives a cash payout, thereby monetizing the asset immediately. The new owner takes responsibility for paying the premiums and collects the policy’s death benefit when the client passes away.
There are lots of reasons your client may consider selling a life policy: (1) the premiums are no longer affordable; (2) your client may no longer need to replace lost income in case of the death of the insured; (3) your client might own a term policy that’s reaching the end of the coverage period; (4) the need for funds to pay estate taxes may no longer apply; and (5) your client just wants to generate cash to improve his retirement lifestyle.
But it’s important to confront the elephant in the room for many financial advisors who learn about the life settlement option: you may feel an “ick” factor when you think about recommending to a client to consider selling something that’s essentially a contract tied to his own mortality.
Approaching the Conversation
Here are some suggestions for how to approach that conversation with clients in a way that’s sensitive to those professional instincts and respectful of your ethical duties to advise clients of their most appropriate financial planning options:
- Start with the premise that a life insurance policy is a financial asset like any other asset in their portfolio. Life insurance is regarded as private property under federal law, which means your client has the right to sell it at any time if he so desires.
- Explain that at its core, a life insurance policy is just a contract between the client and an insurer, so selling that policy is simply a function of transferring the contract into the name of a new owner. This is similar to the way a home mortgage works. The actual ownership of the contract itself may be sold from one lender to another, but that really shouldn’t matter as long as the client receives fair value from the transaction.
- Stress the importance of a non-emotional attachment when viewing financial assets. Just as your client shouldn’t feel an emotional connection to a stock or bond that would cloud his judgment about whether to keep it or sell it, he shouldn’t view his life insurance policy through an emotional lens. It’s just another asset.
- Help your client understand that the decision to purchase life insurance in the first place was driven by his financial management and estate planning strategy. Those should be the same considerations now. Life insurance is ultimately a financial planning tool, and his policy should be evaluated like any other financial asset—how well is it performing today and is it still supporting his financial objectives now?
All professional advisors have a moral responsibility—if not a fiduciary duty—to understand and inform their clients about options available with unneeded or unaffordable life insurance policies, including a possible sale of the policy.
Of course, the sale of a life policy isn’t for everyone and there are a number of alternatives that may be appropriate for your clients who conclude they no longer need their policy: Keep the policy in-force through a loan or use of the cash surrender value; seek an accelerated death benefit, if available; assign the policy as a gift or charitable contribution; or reduce the death benefit with a lower face value and premiums.
The key point is that a life insurance policy is an investment asset—just like equities, fixed income or real estate—and should be reviewed from time to time to see if it still meets the needs for which it was initially purchased. Based on that objective assessment, there are times when a wealth manager or estate planner may conclude that the policy is no longer needed in the portfolio.
When that situation arises, it’s the advisors’ role to get past any “ick” factor they may feel and help their clients explore all of their options, including the sale of that policy to a new owner if it would be an appropriate strategy in the client’s best interests.