It doesn’t take long while watching TV or listening to the radio to hear a commercial encouraging people to contact any number of companies that will help you access the money of your life insurance before you die. In one commercial a senior couple relates how they purchased life insurance when they were younger to protect their family. Now their family has grown, their youngest son is 40 and they no longer need the life insurance. Other commercials tell how someone who may be chronically or critically ill may, with the help of the life insurance settlement company, access money from their life insurance policy. Just what are these companies advertising? And how can they do what they are suggesting be done? It isn’t rocket science but it is certainly a good deal for the life settlement company. Let’s see if we can make some sense of it.
For years I have seen, offered and have sold, life insurance policies that have an “accelerated death benefit” rider. Life insurance companies recognize this as a benefit to their clients and has not charged them. Because the “accelerated death benefit” is a rider to the policy there are conditions that must be met to trigger the benefit. Typically the triggering condition has been a doctor’s diagnosis of a terminal illness. The length of remaining life suggested by the doctor varies with each insurance company. The benefit that is payable to the insured person is some percentage of the death benefit or a given dollar amount.
So just what is it that these life settlement companies, who are advertising to help you out of your policy, doing? They simply recognize that your policy is a valuable asset. If they can persuade you to sell your policy to them for somewhat less than the insurance company is going to pay in benefits (whether that’s death benefit or the accelerated death benefit rider) they will hold the policy until death occurs. Upon the insured’s death the life settlement company will make a claim to the insurance company, and then realize the gain of their investment. The life settlement companies are in business to make money!
Let us go through a real number example. Assume a man who 75 years old has a $100,000 death benefit life insurance policy which has an accelerated death benefit rider. The rider, in this case pays one half of the death benefit or $50,000. This 75-year-old person has had this policy for many years and is paying $1000 each year for it. The life settlement company evaluates the life expectancy, the present health of the insured, how much each year’s premiums will be and they may offer $30,000 to buy the policy. Let’s say that this gentleman lives 10 more years and passes away at 85 years of age. The life settlement company has now invested $40,000 and receives a check of $100,000 as the death benefit. What is their realized annual rate of return? 10.56%! Not a bad investment! How would you like to get a 10.56% annual return on your money?
The sad truth is that because this policy already had the accelerated death benefit rider, this good gentleman would have received $50,000 had he been diagnosed with a terminal illness. With most contracts there would have been no more premiums required once the accelerated death benefit is triggered. There would have been money to offset the cost associated with a terminal illness. His heirs would have received the remaining $50,000 upon his death, tax-free. If the accelerated death benefit not been needed the heirs would have received $100,000 tax-free. This is far more than the $30,000 the settlement company would offer him, and his family receives the benefit.
Now what about the couple that bought the life insurance to cover their family as they raised the children? Any policy that is of value to a settlement company has either a conversion from term to cash value life insurance option or is already a cash value policy. Since the policy was purchased for the benefit of the family, why not keep it for the benefit of the family? If grandpa and grandma need finances they have options. They can access cash values through loans to supplement retirement income. They can turn the payments over to their children if the premium payments are a burden to them. The children will most likely be the heirs of the death benefit in a tax-free way. In implementing the options mentioned above, grandpa and grandma are blessing their family just like they intended when they bought the policy years ago.
Always remember as a life insurance policy owner, you have an asset, not just an expense. Life insurance is not like home insurance or car insurance. Generations can be blessed financially with the wise purchase and use of life insurance. Sadly, the mainstream financial planners don’t understand and teach these principles. I want every one of my clients to know, understand and live the principles discussed here and in other posts in this blog; like this one.
By Jason I. Henderson, Ph.D.
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