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 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. 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, 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 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 of 15 years or less. According to 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 an otherwise dormant asset. * Fund new, more cost-effective life insurance coverage. …