How to Cash In While You Are Cashing Out

Physician's Money Digest, September 2006, Volume 13, Issue 9

You may not realize it, butyou can benefit from anasset you have withinreach—your life insurancepolicy. Althoughthis option is not prudent for all physician-investors, those who are seniorsand own life insurance policies intendedfor lapse or surrender may want to takeadvantage of this situation by receivinga cash settlement while still living. Theproceeds paid to a senior who sells theirpolicy can then be used to pay for otherexpenses, including long-term healthcare insurance, annuities, and otherfinancial necessities. On the flip side, forthose doctors looking for an "off thebeaten path" investment, life settlementsmay be a viable choice.

An Evolving Industry

The typical market for life settlementsis affluent physician-investors age65 or older with shortened life expectancieswho have policies of $250,000 orgreater. However, the value of the policycan be lower. The current market forthis type of transaction is $13 billion,and is expected to skyrocket to $160billion over the next decade, accordingto a recent study by Stanford C.Bernstein & Co. There currently are $9trillion of traditional life policies on thebooks of insurers, the study notes.

"Life settlements add options toinsureds that haven't been readily availableuntil recent years," says C. ZachIvey, a Certified Financial Plannerpractitioner in Mountain Brook, Ala."It's something I look at every time aclient fits the parameters."

Relatively new, the life settlementindustry evolved from viatical settlements,which responded to the needs ofterminally ill policyholders and gainednotoriety in the 1980s, as most wereAIDS cases. Life settlements, also calledsenior settlements, do not involve a terminalillness (ie, less than 24-month lifeexpectancy) but a determinable lifeexpectancy based on the insured's age,health, and lifestyle.

When to Sell or Buy?

Life settlements are a viable optionwhen policy premiums are no longeraffordable. With life settlements, premiumsdisappear, and policyholders receivea lump sum of cash. One reasonfor a physician to choose this option isif they have outlived all of their beneficiariesand the inclusion of life insurancewould create a taxable estate.Most policies are of the permanent type,while settlements of renewable and convertibleterm policies are also possible.

How to Make It Happen

The transaction is handled through alife settlement provider, who acts as anadministrator. For a fee paid to them bya handful of such blue chip institutionsas American International Group(AIG), Coventry First (a subsidiary ofWarren Buffett's Berkshire Hathaway),Credit Swisse, and Wells Fargo, the settlementprovider acquires the policy,under contract with the institution,pays the insured, pays other acquisitioncosts (ie, commissions), pays the premiums,and monitors each policy and lifewithin the portfolio. As soon as eachpolicy acquisition closes escrow, the lifesettlement company passes title to theinstitutional buyer. The buyer generallyholds the investments until maturityand achieves a return on their investmentof approximately 12%.

From a business perspective, lifesettlements can be considered whenyour practice is up for sale or you arethinking about retiring, according toBill Tsotsos, director of businessdevelopment for Life Insurance BuyersInc, an institutional life settlementbrokerage in Kansas City, Mo. "Unlessthere are possible estate tax considerations,retirement from a practiceor business generally eliminates theneed for life insurance protection. Thepremium obligations foregone alongwith the cash settlement received canbe redirected to other, more productiveopportunities."

Whether the sale of a life insurancepolicy or its retention is a betteroption requires an analysis and thenjudgment by the policyholder. Typically,this is determined by actuarialtables, morbidity statistics, and theresult of a medical questionnaire bythe provider. The longer the expectedremaining life, the smaller the proceedswill be, for obvious reasons. Akey factor in determining how much aphysician-investor will receive is anactuarial estimate of their expectedremaining life: the shorter, the greaterthe amount is paid for the settlement.

Tsotsos says, "Life settlements maynot always be the best solution, but it'salways important to consider them.Holding on to an existing policy oftenmakes the most sense from a financialplanning perspective; however, changesoccur in one's life where the need for lifeinsurance diminishes or is eliminatedaltogether. When these changes occur, alife settlement is a viable alternative tolapse or surrender, because the cashreceived is higher than the surrendervalue offered by the issuing insurancecompany."