Pros and Cons of Selling Life Insurance Policy
Selling a life insurance policy is an important decision, and as a life settlement broker I always tell clients: if you need the coverage and can afford it, by all means you should hang onto the policy. The thing is, when policy owners get older it’s not uncommon for seniors to have trouble affording the premiums, and realistically they probably don’t need the coverage as much as they once did either. I’ve personally done two life settlements for my own family members, so I have both a personal and professional perspective on the subject matter. Reviewing the pros and cons of selling life insurance policy would be a good way to help you make an informed decision.
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Over the years, many of us have purchased life insurance — whether it was to protect family or a key employee or as a vehicle to provide liquidity for estate taxes. As life evolves and laws change, it is essential to review whether your policy has outlived its intended purpose. The old strategy of “buy and hold” no longer applies to the ever-changing world, especially with the development of a sophisticated and robust buyers’ market for life insurance policies. It may be prudent to consider selling your policy. (1)
Let’s get the cons out of the way first as that list is fairly short. The most obvious downside to selling the policy is that you no longer have the coverage. The “what if I die this year?” question no longer includes the death benefit to your loved ones as part of that answer since you would be taking a reduced cash payment now instead of upon death, unless you select a reduced death benefit settlement. The reality is, if you’ve lived over 70 years by now you’ve certainly found a way to manage life threatening risks at this point, and the probability of you passing away in the next year or even next few years is highly unlikely, and the underwriter knows this when they look at actuarial data based on your age, health concerns, and overall well being that’s been documented in your medical records. If you happen to have a risky medical procedure coming up, most people would wait until after to sell their policy for peace of mind, and feel comfortable letting it go based on their current well being.
I suppose another con is that the life insurance policy provides the discipline for putting away money that you want to leave to your loved ones that is tax free, but we've learned that this usually doesn't work out as planned. In fact, an independent study found that 85% of universal life policies do not end up paying the death benefit either due to the policy lapsing or being surrendered. This tells us that the insurance company has a pretty good idea who is likely to live a long life, and eventually those people reach the stage where they don't want to pay the premiums anymore, and doing a life settlement is likely to get significantly more than the surrender value and definitely more than lapsing. You can decide to keep the policy another year, or maybe you can get more now if your policy still has some cash value in it.
Life insurance is a great tool to avoid your family or business partners from experiencing economic devastation if you were to pass away unexpectedly. And while this does happen on rare occasions, life insurance is not intended to be a get-rich-quick-scenario or else the insurance companies would go out of business. Once you reach retirement age, the need for the coverage may be dwindling while your cost of insurance is increasing. It’s possible you purchased this policy before 2008 when inheritance tax laws were unreasonable, so the policy provided an estate planning tool to avoid your family from paying hefty taxes, but the tax laws have dramatically reduced this burden, so this strategy may not be as important to you as it once was.
When you consider how only 15% of policies are staying in-force until death, perhaps selling it before you sink even more money into it might be your better option, which leads me to the Pros of selling a life insurance policy.
Here’s a list of Pros, and I will divulge further on each subject:
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You are relieved from the financial burden of paying future premiums
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You can enjoy living benefits with the cash settlement you receive now
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You can invest your money elsewhere in something where you have more control
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You can distribute wealth while you are still living
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You may be able to afford the long term care you need if you don’t have LTC insurance
The first pro is often an overlooked one. When we purchase a home or vehicle with a loan, we owe payments on it, but we also enjoy that tangible good while we’re paying for it. On the other hand, a life insurance policy also requires large payments to keep the contract in force, but there is no tangible asset until the insured passes away. And oftentimes when the insured gets older, those premiums can become very expensive. It’s not unusual for a senior to be making annual premium payments of $20k - $50k or even more. When you write that check to the insurance company there’s a part of you that might think - “well, I don’t know how many more of these payments I can afford, but I don’t want to let go of this policy”. Others may think “gee, I’ve been paying these premiums for years. I can’t let it go now, we have too much money into it already”. It's not that this type of thinking is wrong, but you should probably start considering a life settlement if you're already having doubts on being able to afford the policy much longer.
When you receive an offer, part of interpreting that offer is also factoring in the amount of premiums that you will not have to pay next year, and all the years after. So if you’re paying $50k a year in premiums, and you get a settlement offer for $150k, technically your savings account will have $200k more in it now than if you had kept the policy another year. Factor in the year after, and you will have $250k more than you would have if you had kept the policy. No, there won’t be a death benefit paid to your loved ones upon your passing, but we’ve already determined that this scenario only works out about 15% of the time.
The reason I do this exercise with clients is because it’s easy to get married to the death benefit amount and not factor in how much it costs before the benefit gets paid. It’s not unusual for seniors to invest over $600k into a $1MM life insurance policy over 30 years. Yes, with simple math you can see a $400k return on investment there, but when you factor in how long your money was tied up in this policy before it paid, it’s actually not a great investment when the insured lives a longer life.
Life insurance can provide much-needed cash for loved ones you leave behind when you die. That financial safety net for those who depend on you for support is the primary reason to buy a policy.
But life insurance also can provide cash for you while you’re living—that is, if you have a cash value life insurance policy. (2)
The second pro is enjoying living benefits. Affording retirement can be hard, even with social security benefits and whatever savings you’ve accumulated. Most Americans have not saved enough to fund their ideal retirement, and if you’re paying expensive premiums into a policy that has no tangible benefit until you pass, you’re shelling out money that you can’t afford to spend, which is why eventually these policies lapse. Having living benefits might be a better option for many. Even families with accumulated wealth might own multiple homes, but when the budget gets tight, cutting that expensive check for another year of life insurance coverage may make it the asset to let go. The homes continue to accumulate value while the death benefit on the policy stays the same. And, they can be enjoyed today by you and your loved ones while a death benefit may not get paid for many more years.
The third and fourth benefits are the ability to invest that money elsewhere. Going back to the idea that you “could” pass away in the next year, it’s probably very unlikely unless you've been diagnosed with a terminal illness. And going on mortality tables and thinking the policy will be a get-rich quick-contract, it’s probably not going to work out that way. Perhaps you’re better off investing the life settlement payout and the premiums you would have paid towards something else. Let the multi billion dollar investment fund pay out large premiums for years to make modest returns on your contract instead.
Perks of Selling Your Life Insurance Policy
The value of real estate has gone up significantly over the years as millennials leave the big cities and try to purchase their first home. Perhaps helping a child or grandchild make a down payment on a home might be a better investment for your loved ones in the long run anyway. If they have to wait for years before you pass away to be able to afford a home, the market value will likely have gone up so much that they would have been better off with the reduced benefit amount today that afforded them the home now than waiting for a larger amount down the road. This is of course market speculation, but long term the real estate market increases in most areas, and buying a home in a sensible community is likely to grow in value in just a few years.
The same concept can be applied to affording a vacation home. Perhaps the settlement provides a down payment on a vacation home that can also be a rental property. Use the property when you like, and rent it out while you’re not there. Pick a property in a place that gets multi-season visitors, and you may turn your property into a business, creating retirement income for years to come.
Maybe you prefer to put the money in a safe annuity that protects you from market fluctuations while growing your money long term. Even a kitchen remodel if your home is outdated could increase the value of your home when your loved ones go to sell it. There are many practical places where you could invest your money that don’t need to wait until your passing to be fruitful.
The 5th pro applies to the many Americans who have not planned for long term care. 70% of Americans aged 65+ are expected to require long term care in the future and yet few have planned for this significant expense. This can mean anything from home care to adult day health care and even skilled nursing, all of which can be fairly expensive. Long term care insurance has turned out to be very expensive as well, which is why so many don’t have it. If you don’t have coverage and you or your parents are having trouble living independently, it’s possible that your life insurance policy could receive a large settlement that could help afford the care that you need. Depending on how long you’re in care, whatever is not spent on care will still go to your loved ones.
When reviewing an appraisal or offer, the amount in which one receives is largely dependent on the insured’s life expectancy and their cost of future premiums. An investor is crunching these numbers to figure out how much the policy is going to cost to keep it in-force before the death benefit is paid, and their return on investment is made.
When someone is 70 years old and in good health, they might be surprised to find that offers for their policy may only be 5% - 10% of the death benefit. This is not because the investor thinks you’re likely to pass away in the next couple years, but rather they think you’re likely to live until age 90. It also means that whatever amount of money they paid you today to buy your policy, they will not likely get it back for another 20 years. In order for that to make sense from an investment standpoint, they need to calculate an annual interest rate that’s on par with the stock market, which can range from 8% - 12%.
Things To Consider When Selling Life Insurance Policy
When we bring a case to market, we really need two things:
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An in-force illustration with minimum level premiums to age 100
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The last 5 years of medical records
The medical records are reviewed by underwriters to come up with a prediction on how long the insured is likely to live. Of course nothing is in-fact, and the insured may live longer than predicted or shorter, but an investor must have a reliable prediction which can be applied across many policies, some of which will be profitable while others may end up a loss.
With universal life policies you might be able to get away with paying a minimum premium of $6500 this year, but each year will get increasingly more expensive. When we level out the premiums it might look more like $10k a year to keep the policy in-force to age 100.
Many policy owners only look at the next year’s premium, and don’t consider the long term costs if they were to keep paying. Doing this exercise while we review it with investors gives clients a chance to look at the bigger picture and decide if the settlement amount is enough for them to be happy taking it while considering the future costs of keeping it.
If the underwriter determines a 10 year life expectancy is probable, and premiums are $15k a year, right away the investor knows they’ll likely have to spend $150k in premiums over the next 10 years just to keep the policy in-force. If the death benefit is $200k, that doesn’t leave much room to pay a settlement and make a return on investment. If the death benefit is $500k, suddenly that leaves a lot more padding, and the investor might offer $120k.
While $120k sounds like a lot less than $500k, keep in mind the time value of money, and how the costs of this investment approach $300k by the 10 year mark. With the investor tying up capital for 10 years, they need to make interest on this money each year that it is invested, and also have to bake in the possibility that the insured lives longer than expected. So in a nearly $300k investment over 10 years they profit just over $200k. That’s not a bad investment, certainly not for a deep pocketed fund that has a billion dollars to buy and manage policies. For an individual, perhaps you’re better off freeing up $15k a year and taking $120k to invest it either for personal needs, or for legacy purposes.
Life settlements first started in the 1980s during the AIDS epidemic when people were given a terminal diagnosis and needed access to cash for medical treatments. When medicine improved for HIV, and people are living much much longer today, the need for senior settlements have been growing in popularity.
In the early 2000s, only policies over $500k were considered with life expectancies of 5 years or less. After a decade or so of buying and selling policies it was determined that the life expectancies that were projected were too short, and people were living a bit longer than expected, making most of these investments a loss, and investors walking away from the sector. Once life expectancies had been lengthened for accuracy, the market started to come back and has grown tremendously with policies now being considered over $100k and life expectancies up to 20 years. Now that the market has been maturing for over 20 years investors have gotten better at predicting profitability, and more and more capital enters the market because of it.
Each Case Is Unique
Every case is unique as not all life insurance policies are created equal. Some people pay significantly more for the same amount of coverage as someone else simply due to their health at the time of application, how long they’ve had the policy, the carrier they went with, etc. When it comes time to apply for a life settlement, again the health is considered as a determining factor for future costs of the policy. Two identical people of the same age and death benefit amount may receive different offers as one person may had the policy a lot longer and is paying lower premiums because of it.
There’s a wide variety of investors these days, and it’s always recommended to get more than 1 offer to ensure you’re not taking a low-ball offer. Working with a life settlement broker will get your case in front of many investors to seek out the most motivated buyer. The life settlement market is indeed a marketplace, so one buyer may have lost several deals recently because they weren’t bidding high enough and are more aggressive on your policy, and vice versa. That’s why going to one life settlement provider is not likely to yield the most money for the seller.
If you’re on the fence about considering to sell life insurance policy, start with an appraisal to see if the numbers are even interesting to you. If they are, you can apply for offers without the obligation to accept one. And when interpreting the offers, we recommend looking at the bigger picture to help you decide if the pros outweigh the cons to sell it or keep it.
Zack Taylor
4 years in life settlements