New value in old policies.Clients can recover significant wealth that may be trapped in unneeded life insurance. Many clients have life insurance policies they view as unnecessary because they no longer meet their original need. As estate tax rules change and the policies clients purchased to pay these taxes become unnecessary, this trend is likely to increase. JE McGowan Consulting estimates the potential secondary market for life insurance policies exceeds $18 billion annually. Before clients abandon old policies, CPAs should step in and help them recover the potentially significant wealth that may be trapped there. Allowing unneeded policies to lapse can be a costly mistake. CPAs can help both individual and corporate clients or employers sell the right to collect on these otherwise dormant assets in the aftermarket. Determining if selling a policy is a good idea is a relatively easy process for CPAs--and potentially lucrative for policyholders. A GROWING MARKET The growth in the secondary market for life insurance policies has soared over the last decade. * In 1990, only six companies made an active secondary market. They purchased about 500 policies with a face value of between $40 million and $50 million. * Today, the Federal Trade Commission estimates that $500 million in life insurance policies are sold annually on the secondary market. With companies entering and leaving the market, it's difficult to estimate the number of active participants. * Actuarial data suggest 40% of all policies on people age 65 and older will not be held to maturity. * The National Association of Insurance Commissioners The National Association of Insurance Commissioners (NAIC) is an Internal Revenue Code Section 501(c)(3) non-profit organization which seeks to organize the regulatory and supervisory efforts of the various state insurance commissioners from around the United States. estimates that in 1996 nearly $1.5 trillion face amount of life insurance policies expired, lapsed or was cancelled by policyholders; each policy was a potential source of wealth had the owner sold it on the secondary market. Consumers have long viewed life insurance merely as a means of providing liquidity to pay estate taxes, to protect surviving family members, to fund buy/sell agreements or to meet other business needs. Based on this narrow view it's no wonder so many CPAs fall into the trap of agreeing to allow unneeded policies to lapse or be surrendered for just their cash values. This is especially true if the coverage is no longer necessary and the premiums have become burdensome. However, this may be bad advice since such policies often have a secondary market value far exceeding their cash value. Case study. A 76-year-old man owned a policy with an $8 million face amount and a $795,000 cash surrender value The amount of money that an insurance company pays the insured upon cancellation of a life insurance policy before death and which is a specific figure assigned to the policy at that particular time, reduced by a charge for administrative expenses. . He sold the policy for $2.3 million rather than let it lapse, cancel it or take the cash value. Had he not sold it, he would have left at least $1.5 million on the table. HOW TO IDENTIFY THE RIGHT CIRCUMSTANCES Many types of insurance policies qualify for settlement, including term, whole, variable or universal life, any type of survivorship survivorship n. the right to receive full title or ownership due to having survived another person. Survivorship is particularly applied to persons owning real property or other assets, such as bank accounts or stocks, in "joint tenancy. , adjustable life, joint first to die, group (if convertible) and retired lives reserve. The aftermarket for life insurance operates in two areas--viatical and lifetime settlements--each with different tax implications. Viatical settlements involve the sale of a policy insuring the life of someone who is either terminally or chronically ill. Proceeds are free of federal income tax and state income tax in some states (such as New York New York, state, United States New York, Middle Atlantic state of the United States. It is bordered by Vermont, Massachusetts, Connecticut, and the Atlantic Ocean (E), New Jersey and Pennsylvania (S), Lakes Erie and Ontario and the Canadian province of and California) since they are considered a death benefit. Lifetime settlements are for people without the health problems required for viatical settlements but with a life expectancy Life Expectancy 1. The age until which a person is expected to live. 2. The remaining number of years an individual is expected to live, based on IRS issued life expectancy tables. of 15 years or less. According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. current mortality tables, this means males age 70 or older and females age 74 or older. Sometimes the insured has simply outlived his or her family or beneficiaries. Clients should also consider selling an unneeded life insurance policy when they can use the proceeds to: * Liquefy liquefy /liq·ue·fy/ (lik´wi-fi) to become or cause to become liquid. an otherwise dormant asset. * Fund new, more cost-effective life insurance coverage. * Create funds to make other investments. * Fund an outright charitable gift or charitable trust The arrangement by which real or Personal Property given by one person is held by another to be used for the benefit of a class of persons or the general public. . * Make cash gifts to other family members. Corporations should consider selling unnecessary life insurance policies on employees' lives if: * The company has been sold to a third party and the policies' original purpose was to fund a buy/sell agreement on one partner's death. * The insured key person retires or is no longer involved in the business. * The policy is part of litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute. When a person begins a civil lawsuit, the person enters into a process called litigation. among partners. * The company must sell assets to raise cash. * The policy was purchased to fund deferred compensation or other benefit programs that have now changed. Businesses may also benefit from selling a policy in the secondary market to * Purchase an interest in another enterprise. * Facilitate the transfer of a business to the next generation. * Repay debt. * Buy back stock from a partner or shareholder. BUYER'S CRITERIA While there is no size limit on policies a consumer can sell in the secondary market, the usual face value is around $1 million. Many buyers, however, routinely purchase policies worth significantly more. Companies will even buy a partial interest in a policy. The lower the cost to carry the policy and the faster the expected payment, the more attractive an offer a policy is likely to attract. Companies that buy life insurance policies in the aftermarket use these criteria to determine the price to offer: * Policy face value. Depending on the buyer, the minimum face value is seldom below $250,000--or $500,000 for some buyers. * Insured's age. The older the insured, the higher the offer. * Health impairments. The more severe the health condition, the higher the likely offer. * Existing policy structure. * Existing policy value. * Existing policy premium. The potential buyer uses this to determine the cost of maintaining the policy until it pays off. TRANSACTION MECHANICS Once a buyer has expressed interest, selling a life insurance policy requires no medical exam. Here are the usual steps to close the deal. * The seller submits to the buyer the necessary paperwork, including an application, a copy of the life insurance policy, an in-force ledger (an annual schedule of policy details) to age 95, an authorization form, a copy of any trust agreement if the policy is trust-owned and the insured's medical records for the past two years. * The buyer extends an offer to buy the policy and the seller accepts. * A closing occurs with all documents signed. * The funds are deposited in an escrow account until the change of beneficiary and ownership is recorded. * When the policy transfer is official, the funds in escrow are wired to the insured. Payment structures. Payment terms are generally flexible to meet the seller's needs. The most common payment methods include lump sum Lump sum A large one-time payment of money. , installments (to defer taxes) and annuities. Case study. An 82-year-old woman sold a policy on her life for $900,000 that had a face amount of $5 million but a nominal cash surrender value of just $2,500. Without the sale, she would have walked away from almost $698,000. PROFESSIONAL DUE DILIGENCE Research; analysis; your homework. This term has caught on in all industries, because it sounds so "wired." Who would want to do analysis or research when they can do due diligence. See wired. It's important for CPAs to understand both the market and the players clients are dealing with. Life settlements are unregulated and involve substantial sums of money. Not all transactions are fair. A Texas man was indicted INDICTED, practice. When a man is accused by a bill of indictment preferred by a grand jury, he is said to be indicted. for buying policies from AIDS patients without paying theN. On the flip side Flip side In the context of general equities, opposite side to a proposition or position (buy, if sell is the proposition and vice versa). , The Los Angeles Times Los Angeles Times Morning daily newspaper. Established in 1881, it was purchased and incorporated in 1884 by Harrison Gray Otis (1837–1917) under The Times-Mirror Co. (the hyphen was later dropped from the name). reported the arrest of several AIDS patients who concealed their condition to get insurance coverage with the intent of selling it in the aftermarket. Indeed, sophisticated buyers are sometimes wary of policy sellers who are HIV HIV (Human Immunodeficiency Virus), either of two closely related retroviruses that invade T-helper lymphocytes and are responsible for AIDS. There are two types of HIV: HIV-1 and HIV-2. HIV-1 is responsible for the vast majority of AIDS in the United States. positive. With recent advancements in AIDS drugs, the life expectancy of these individuals is such that investors often receive little or no profit. CPAs should use these due diligence guidelines to help judge the deal and the buyer. * Gauge the market by obtaining offers from two or three companies. * Check with your state attorney general's office or insurance department for any complaints against the possible buyer. * Verify that the buyer has the money to buy the policy readily available. Reputable companies usually have cash on hand. * Select or insist on a buyer who uses a reputable, independent financial institution to hold the money in escrow until the change of ownership closes. * Make sure terms of the contract specify timely payment from the escrow agent--generally no more than two or three business days after change of ownership. * Determine and disclose to your client the possible tax consequences of the transaction and implications for public assistance benefits as a result of the sale. * Consult legal counsel regarding probate and estate considerations arising from the transaction. By definition, life settlements remove life insurance benefits from the original beneficiary's estate. * Determine the buyer's process of administering policy investments. Some buyers contact the insured on a monthly basis to verify that he or she is still living; needless to say, some clients may find this distasteful. TAX IMPLICATIONS To the individual policy sellers, life settlements usually involve three layers of taxation: * Zero tax--up to the owner's basis, since it is a return of capital. * Ordinary income--from the basis to the policy's cash surrender value. * Long-term capital gains--from the higher of either the cash surrender value or the federal income tax basis to the net settlement proceeds, since this is a capital asset. WHAT'S NEXT? By putting some research and thought into the disposition of unneeded life insurance policies, CPAs can help clients and employers realize extraordinary value from the growing secondary market. The exhibit below includes a list of resources where CPAs can get additional information on the legal, ethical and tax implications of selling life insurance policies. NEIL ALEXANDER Neil Alexander (born 10 March 1978 in Edinburgh) is a Scottish born professional football goalkeeper, currently playing for Ipswich Town. Club career Alexander started his career with Stenhousemuir before moving to Livingston in 1998. , CFP 1. CFP - Constraint Functional Programming. 2. CFP - Communicating Functional Processes. 3. CFP - Call For Papers (for a conference). , is founder and president of Alexander Capital Consulting, LLC (Logical Link Control) See "LANs" under data link protocol. LLC - Logical Link Control , in Los Angeles Los Angeles (lôs ăn`jələs, lŏs, ăn`jəlēz'), city (1990 pop. 3,485,398), seat of Los Angeles co., S Calif.; inc. 1850. . His e-mail address See Internet address. e-mail address - electronic mail address is nalex@alexcap.com. Sources of Additional Information * Federal Trade Commission 600 Pennsylvania Avenue Pennsylvania Avenue is a street in Washington, D.C. joining the White House and the United States Capitol. Called "America's Main Street," it is the location of official parades and processions, as well as protest marches and civilian protests. , N.W. Washington, D.C. 20580 www.ftc.gov * Coventry Financial--a policy buyer www.coventryfinancial.com * Legacy Benefits Corp.--a policy buyer www.legacybenefits.com * Viaticus division of CAN--a policy buyer www.hinetworth.com * American Council of Life Insurers The American Council of Life Insurers (ACLI) is a Washington-based lobbying and trade group for the life insurance industry. ACLI represents 373 insurance companies that account for 93 percent of the U.S. life insurance industry's total assets. 1001 Pennsylvania Avenue, N.W. Washington, DC 20004-2599 www.acli.com * National Association of Insurance Commissioners 444 North Capitol Street Capitol Street can refer to three separate streets in Washington, D.C.:
* National Association of People with AIDS The People With AIDS (PWA) Self-Empowerment Movement was a movement of those diagnosed with AIDS and grew out of San Francisco. The PWA Self-Empowerment Movement believes that those diagnosed as having AIDS should "take charge of their own life, illness, and care, and to minimize 1413 K Street, N.W. Washington, DC 20005 www.napwa.org * National Viatical vi·at·i·cal adj. 1. or vi·at·ic Of or relating to traveling, a road, or a way. 2. Of or relating to a contractual arrangement in which a business buys life insurance policies from terminally ill patients for a percentage Association 1200 G Street, N.W., Suite 760 Washington, DC 20005 www.nationalviatical.org * North American Securities Administrators Association The North American Securities Administrators Association (NASAA), founded in Kansas in 1919, is the oldest international investor protection organization. NASAA was created to protect consumers who purchase securities or investment advice, and their jurisdiction extends to a 10 G Street N.E., Suite 710 Washington, D.C. 20002 www.nasaa.org * Viatical Association of America 1200 19th Street, N.W., Suite 300 Washington, DC 20036 www.cais.com/viatical * Your state attorney general * Your state insurance commissioner |
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