In previous articles, I’ve written about the important role of life settlements in financial and estate planning. One of the themes of those articles is that life insurance agents who don’t have a good handle on life settlements might want to tighten their grip for at least three reasons.
First, it the tax laws don’t sunset after 2025, I can see an uptick in interest in life settlements, primarily because more policyholders will conclude that they no longer need to maintain the coverage to pay estate taxes. Second, a life settlement can be a component of an exit strategy from a moribund leveraged life insurance program. Interestingly, both the sunset and the no-sunset scenarios harbor their own reasons for considering the transaction in that context. Third, even if at the end of the day, the client doesn’t sell the policy, the multi-disciplinary exploration of a life settlement itself can be of enormous benefit to the client (let alone a wake-up call) and a great networking experience for the advisors.
Against that backdrop, I’d like to continue on the theme from my last article, “Questions Advisors Should About Life Settlement Proposals” and talk about the “how” of a life settlement and the respective roles of and interaction among the life settlement company, the agent and the other advisors in a transaction.
Who’s on the Line?
A client’s life insurance agent, investment advisor and estate-planning attorney are sitting in a conference room, about to get on a call with a representative of a life settlement company.
The agent has done a couple of transactions with this company. In both cases, the client/sellers were textbook candidates for a life settlement. They were older and/or had demonstrably curtailed life expectancies. They were concerned about cash flow. They owned policies that the life settlement company considered “marketable.” But that’s where the similarities between those cases and the one on the table end.
Let’s Set the Stage
After the introductions, the representative from the life settlement company, whom we’ll call “Rep,” says, “Tell me about the client, the policy and the context, meaning the facts circumstances that cause us to be on the phone today.”
“Okay,” says the agent, “I’ll start. Based on what I know, the client is comfortably within the guidelines that will enable us to get the conversation started. The policy is your basic universal life contract with a face amount of $3 million. I just sent you the latest statement from the carrier and the latest in-force illustration. You can see that the policy was issued preferred, which the client couldn’t qualify for today. You can also see that the policy is running on the fumes and calling for a lot more premium.”
The investment advisor says, ”The client is expressing a certain disquiet about the policy. A certain ambivalence, if you will. The client is well off and doesn’t need the cash value or the relief from the premiums. But the client is asking us whether to keep the policy or do something else with it. Something is bugging the client and we’re not sure if they’re questioning the need for the insurance or the economics of maintaining it.”
The estate planner chimes in, “You can see from the statement that the client owns the policy. The beneficiary is a revocable trust for the benefit of their spouse and then the children. Technicalities of ownership aside, the beneficiaries, especially their spouse, would be impacted by a sale. Are they typically involved in this process in any way? I’m just asking.” To which, the investment advisor responds, “The client absolutely intends to involve their spouse in the conversation and decision.”
“That’s good.” says Rep. “I’m not an attorney and I don’t play one on TV. But, based on what our clients’ advisors have told me over the years, you might want to assume that while you’ll be mostly talking with and advising the client, you’ll have some people looking over your shoulder. So, in some respects, you’re like a trustee. I’m going to send you an article by a guy named Ratner called, “How Trustees Should Incorporate Life Settlements in ILIT Reviews.” You have to assume that if the client sells the policy and then dies quite proximately thereafter, some very unhappy people are going to want to see the file to confirm that the client was fully informed and well-advised. So now, I’m just saying.” Almost in unison, the others say, “We get it.”
Getting Down to Cases
Rep continues, “In my business, there are two kinds of cases. One is the ‘I need cash now’ case, where they look at us and ask, ‘What part about we’re out of here don’t you understand?’ The other is this kind of case, which is more of an investment and financial planning case. In this kind of case, it comes down to whether the client’s family is better off, a term you’ll have to help them define, if the client supports the policy or sells it. By approaching it in that way, you’ll effectively quantify those aspects of the client’s decision that are quantifiable and give the client some criteria for that part of the decision that isn’t. Aside from the obvious of getting an offer for the policy, I can help by providing some input and guidelines for the modeling that I’ve seen other advisors do to give their clients the basis for an informed decision. But that’s all I can do. I’m not a financial planner, estate planner, investment advisor or soothsayer.’
‘So, I’ve just sent all of you two items. One is a step-by-step description of our life settlement process so you can get an idea of what happens, who does what, how offers are developed, how long the process takes and so forth. Let’s take a few minutes to walk through this. The other item is another article by that Ratner guy that you should go through with the agent to get an even deeper understanding of all this: “Questions Advisors Should Ask About Life Settlement Proposals.”
‘Basically, our staff will work with the agent to get all the information and material needed to get an idea of the client’s life expectancy, the policy’s value on the market and the range of offers we can expect. That stuff’s kind of clinical, pun intended. What isn’t clinical will be the agent’s work in getting policy illustrations that depict various scenarios, from maintaining the full death benefit on one hand to only that amount of death benefit that would be supported by the current cash value, with points of demarcation along the way. It’s a lot of ‘what if’s.’
The In-Force Prognostication
‘You chuckled when I said, ‘soothsayer,’ but I wasn’t kidding. That’s because someone has to determine the parameters for the in-force illustrations, including to what age to maintain the death benefit and under what assumptions. We’ll have a range of life expectancy reports that can give you an idea for the scenarios to illustrate. Of course, those illustrations won’t capture the more existential risks associated with policy performance, which the agent can explain to you. We’ll come back to those assumptions in a moment. But the point is that at some juncture, you’ll have to arrive at the operative scenario for your modeling on the ‘keep’ side of the equation, just as you will on the ‘sell’ side.’
‘Meanwhile, you should confirm the client’s basis in the policy so that once you have an offer, the client’s tax advisor can be ready to run then numbers under the operative guidance to determine the net, after-tax proceeds of sale.’
The Investment Component
The investment advisor says, “Sounds to me that on the sell side, I and probably the tax advisor will have to show the client how, at various benchmark years, the capital accumulated by investing the after-tax proceeds of sale compares to keeping the policy, paying the premiums and eventually receiving the income-tax free proceeds. I assume the objective is to enable the client and their spouse to look at the respective columns and ask themselves which assumptions they want to go with and where they want to place their bets.’
The Financial Planning Component
The investment advisor continues, “I also understand why the analysis and file building doesn’t stop here. There’s a financial planning aspect to the analysis. If the client does sell the policy, their spouse is at risk of losing income-generating capital equal to the difference between the tax-free death benefit and the after-tax proceeds of the sale. That amount could decrease every year along the benchmark scale if the client generates positive returns on the invested proceeds. But the operative term is ‘if’. They’ll want to see some projections, again based on assumptions about returns and other factors. But the question will be whether their spouse can and will accept that risk.”
To Sell or Not to Sell
The attorney again, “Rep, you’re right. There are some elements of the client’s decision that we can quantify for him and some we can’t. Funny how something that’s a pure numbers decision at first blush turns out to be anything but. Which brings to me to my question. With so many pros and cons, so many assumptions and variables and so much guesswork in the modeling, how do people arrive at their ‘best guess’ operative scenarios for comparison and then decide what to do? I mean, I can see that selling can prove to be the screaming winner but, you know…”
Rep responds. “It comes down to the definition of ‘better off’ and who gets to define it. Even then, it’s an anatomical decision in the sense that’s either made with the head or the gut. In my experience, it’s made with the gut, which is why it’s our job to make the decision points digestible. With that, let’s break for lunch.”