Should You Sell Your Life Insurance?

Physician's Money Digest, February15 2003, Volume 10, Issue 3

The notion of lifetime settlementsis not new, but recentinsurance industry advertisinghas begun to extol their advantages,pushing them to the front offinancial industry offerings. Looselybased on the heavy marketing of viaticalsettlements a few years back, lifetimesettlements are marketed to theseller, where viatical programs weredirected to the buyer of a life insurancepolicy. Lifetime settlements arebasically the sale of used insurancepolicies. The sellers can receive cashin place of an insurance policy theymay no longer need, and the buyerscan get a large return on their investmentswhen the insured passes away.

What needs to be addressed is notthe decision to purchase a policy, butrather the implications of an insured'sdecision to sell a policy. In addition togetting the best value, there are taximplications that will play into thedecision to sell off a policy. Last year,more than $1 billion of life insurancesettlements were made. Among thebuyers of life settlements are Viaticus,a subsidiary of CAN; Life PartnersHoldings in Texas; Policy Funding ofBoynton Beach, Fla; and MedicalEscrow Society in Tavaras, Fla.

As it became more difficult togauge life expectancy viatical settlementslost their luster. An insured livingeven a year or 2 longer thanexpected would seriously throw offthe numbers and could result in lossesfor investors expecting handsomereturns. In lifetime settlements, policiesare typically bought from peopleage 65 and older who are not terminallyill but who are expected to die inless than 10 or 12 years. With illnessessuch as cancer, diabetes, and heartailments, especially in older people,it's easier to get an idea of lifeexpectancy. The financial aspects ofthe deal are more predictable as well;especially when the price is based ona longer estimated life expectancy.

The shorter the seller's life expectancy,the greater the purchaseprice for the policy, as a percentageof the policy's face value. If a sellerhas a life expectancy of 12 months,for example, and has an insurancepolicy with a $1-million death bene-fit, they may be able to sell it for$600,000. The buyer would have toalso pay the current premiums due,all in the hope of receiving the $1million as soon as possible. Insuredswith longer life expectancies willreceive a lower bid for their policy asa percent of the policy's face value.

APPLICABLE CIRCUMSTANCES

There are 2 basic reasons thatsomeone might be prompted to considera lifetime settlement. Either theyhave an insurance policy where thedeath benefit is no longer needed andthey cannot see paying the premiumsany more, or they have immediateexpenses that cannot be covered inany other way. There are many situationswhere these reasons can arise.

The insured can turn the policy infor its cash value, but in the eventthere are health problems, it maybring more money by selling the policyand letting the buyer keep the policyin force by paying the premiums.

Lifetime settlements are generallynot for healthy individuals, so a medicalemergency may make a lifetimesettlement a necessary alternative. Apolicy that was purchased when theinsured was younger and healthy maystill have a low premium in relation tothe death benefit. If the insured'shealth has deteriorated and lifeexpectancy has been reduced, the lowpremium may make the policy attractiveto buyers if the insured needscash. In effect, the change in theinsured's health has made the policymore valuable, often more valuablethan the cash value itself.

Sometimes a change in the needfor insurance can prompt a lifetimesettlement. Insurance is always purchasedwith a particular objective,and changes in life can result in achange in the need for insurance.Also changes in the law can promptthe decision to sell to be considered.The elimination or reduction ofestate taxes may make large policiesto cover estate taxes attractive to buyers.The reason to be careful here isthat laws can be changed again, orrepealed, as in the case of the currentestate tax rules, which are scheduledto expire in 10 years. All by itself, achange in the law is probably not areason to sell off a policy.

If someone with an existing policy,which was probably purchasedwhen the insured was in goodhealth, is still paying lower premiumsfor the policy, it may make sense forthe family to keep paying the premiums.Since the death benefit will bepaid out to the beneficiaries, it maybe more advantageous for them topay for the premiums themselves.

Selling any asset at a discount, orin these cases for an amount lessthan the death benefit that is guaranteed,should be considered seriously.However, if the cash is needed andall other resources have been exhausted,it may become necessary.

Keep in mind as well that whenthe sale of a policy is negotiated,the buyer will need to have all currentmedical information available,which will effectively make yourmedical records public information.If the policy is subsequentlyresold, the medical informationcan effectively be spread all over.Many of the firms that deal in suchtransactions will work with buyerslooking to buy a number of policiesat once, making the deal moreanonymous for the seller.

THE TAX ANGLES

The big question regarding lifetimesettlements is how they aretaxed. Viatical payments made to aterminally ill individual have generallyescaped federal income tax. Severalstates also honor this exclusion.To qualify for the tax benefit, aphysician has to certify that deathis reasonably expected within 24months. The payment must comefrom a viatical settlement providerwho'll report the amounts receivedto the IRA on Form 1099-TLC. Theproviders must be licensed in theindividual states where the insuredresides. In states where viatical companiesaren't licensed, providersmust comply with standards of theNational Association of InsuranceCommissioners. If the buyer doesn'thave the right credentials, you couldend up paying unnecessary taxes.

Lifetime settlements don't involveterminal illnesses, so the taxexemption afforded viaticals doesn'tapply here. The tax treatment iscloser to the treatment of regular lifeinsurance policies that are cashed in.The tax consequences will dependon the amount paid and the seller'sbasis in the contract, which are usuallythe premiums paid.

Patrick J. Flanaganis a New

Jersey-based registered representative affiliated with First

Montauk Securities, member NASD/SIPC. He welcomes

questions or comments at 800-969-0899. Any opinions expressed are

the author's and do not necessarily reflect

the opinions of First Montauk Securities or

its officers, directors, or affiliated registered

representatives.