With people living longer and the cost to maintain life insurance policies on the rise, LifeTrust3D has received more questions about Life Settlements and Policy Maturity Provisions. To address this growing need, Tate is releasing Chapter 9 of his recently released book … the Best Policy.
Life Settlements & Maturity Provisions: What You Need to Know
Tate,A Thank You Letter Provided by a Client
Well it looks like you have pushed the sale past the finish line. Thank you and your team for getting this done in a professional and excellent manner. It is very rewarding for me to see my children enjoy some extra money instead of them waiting until I’m gone. I appreciate your service.
These are the kinds of notes that really hit home and help me remember what’s important—helping families. This one was sent to me by Michael, a client who reached out to me last year with a request. “I’m going to live another fifteen years,” he said. “I want to see my kids enjoy the funds I set aside for them while I’m living, as opposed to waiting until I’ve died. I no longer want to fund $50,000 annual premiums for my life insurance.” After working with Michael and reviewing all the options, it was clear that a life settlement was the best option for him.
Life settlements are on the rise. It is important that trust officers understand them, as they may be the best course of action for certain clients.
A life settlement is the sale of an existing life insurance policy on the secondary market to a third party for a sale price that exceeds the policy’s cash surrender policy. In other words, an investor group purchases a policy from the policy owner and takes over making premium payments on the plan until the insured person dies. At that point, the investment group collects the death benefit. For reasons I’ll explain in a moment, life settlements tend to involve insureds over sixty-five years old with some health impairment. Life settlements used to be considered taboo, but now they are much more accepted for insureds and grantors no longer able or no longer willing to continue making premium gifts.
Why would an insured person want to sell their policy? Remember, as I’ve stated throughout this book, the life insurance landscape has changed drastically in the last twenty years. Lower interest rates, increasing cost of insurance charges, and changes in the estate tax laws have left some insureds asking whether they really need as much life insurance today as they did in the past—or if they even need life insurance at all. Even if they want to maintain their life insurance, are they willing to fund the increased premiums many would have to pay in order to fund and sustain policies that have underperformed and now are projected to lapse before the insured dies?
When policy owners receive the dreaded letter from their insurance carrier that premiums are increasing— sometimes more than doubling—they begin evaluating their options. For older insureds, a life settlement may be an alternative to funding higher-than-anticipated premiums. I’ve outlined some cases of these types of older policy owners in previous chapters: Gary, Mary, and Janet, for example, all struggled to pay premiums greater than what their retirement cash flow could support.
Remember, too, the 2018 Tax Cuts and Jobs Act now allows individuals to exclude over $11 million from their taxable estate ($22 million for a married couple) through the year 2025. This significantly reduces the number of estates subject to estate taxes at this time. Many poli- cies we now see being considered for a life settlement were originally purchased in the early 2000s, when the exemption was between $1 and $3.5 million. Those policy owners feel they no longer need to protect their estates, do not want to pay their premiums anymore, and want their loved ones to benefit today, while they are alive and can see the smiles on their families’ faces.
My client Michael owned two $500,000 life insurance policies totaling $1,000,000. He was used to funding a total of $20,000 annually, but after his estate planning attorney referred him to us for a policy review, the premium necessary to sustain $1,000,000 to age 100 increased to $50,000 annually. Surprised by the outcome of the review, he wanted to take some time to reflect on the purpose of his life insurance.
After consulting with his attorney and investment advisor, he knew he could afford the increased premium required to maintain viable policies. However, he came to the conclusion that he preferred to use the $50,000 annu- ally to make lifetime gifts to his children and grandchildren so he could see them enjoy his good fortune. He decided to sell the policies in the life settlement marketplace through Colton Groome Insurance Advisors. In addition to the $50,000 of freed-up annual cash flow, the net sales proceeds from the life settlement totaled $300,000.
Michael took his family on a huge vacation, flying out of state to see his grandkids play football and see the smiles on his family’s faces. That’s what I call a win! Stories like Michael’s, and the relationships we build with our clients, make my work gratifying.
Okay, so now we know why some policy owners want to sell their policies for cash, but why would an investment group want to buy someone’s life insurance policy? Some investor groups, known as life settlement providers, are looking for assets that do not correlate to the stock market. Bluntly, mortality meets that criterion. Life settlement providers understand that the inherent internal rate of return (IRR) within life insurance policies can be favorable in the right set of circumstances. Simply stated, the purchase price + premiums paid is projected to be substantially less at the insured’s life expectancy than the life insurance death benefit proceeds. Investment groups seek out policies on people over sixty-five years old with a health impairment. They generally want to purchase policies with a life expectancy of less than twelve years.
To understand how this works, let’s consider another recent client of mine: Celeste. She was seventy-eight years old and she owned three $1 million life insurance policies, with a total value of $3 million. She received a letter from the insurance carrier notifying her that her cost of insurance charges (COI) had increased substantially. The COI increase meant Celeste’s premium payments had doubled from $100,000 to $200,000 a year. That $100,000 annually was already hard for her to swing, and now they wanted $200,000? Like many older Universal Life policies, Celeste’s policies had no meaningful cash value. A policy surrender would have meant that after funding $100K per year for close to fifteen years, she would receive nothing back from the carrier upon a policy surrender. Surely there had to be another option.
Through the life settlement marketplace, we were able to sell two of Celeste’s policies for $400,000 each and one of them for $300,000. Celeste and her family—burdened by an exorbitantly high premium and unable to surrender their policies for any meaningful cash value—ended up getting $1.1 million. Although it wasn’t quite what she’d paid in over those fifteen years, it was much more than $0. She and her family were grateful for the outcome.
The investor group or life settlement provider that purchased Celeste’s policies did the following calculus to determine a purchase price for her policies: They did a full medical work-up on this seventy-eight-year-old woman, and calculated her life expectancy based on her health. They then factored the premium outlay they would need to pay—$200,000 for every year Celeste would live. They concluded that it was worth buying the policies at $1.1 million and paying that yearly premium in order to get a $3 million return on investment. An entire competitive bid process among multiple life settlement providers went on behind the scenes to negotiate an offer as high as $1.1M for these policies.
You can see why these investment groups want to purchase policies with a life expectancy of less than twelve years. They want returns of anywhere from 8 to 12 percent. Insurance carriers generally do not like life settlements.
Think about Celeste for a minute: She paid $100,000 for fifteen years, spending a total of $1,500,000. If she surrenders her policies for a few thousand dollars, the insurance carrier wins. They never have to pay a life insurance claim, and they have received $1,500,000. They count on policies lapsing when they price them. Now, a life settlement provider with deep pockets steps in to purchase a set of policies that would have never resulted in a death claim. How dare they!
A secondary market reduces the percentage of cancelled and surrendered policies, known as the “lapse ratio.” Traditionally, carrier actuaries price “lapse ratios” into their products. They know that a certain percentage of policyholders will fund premiums for a long time, then cancel or surrender their policies for cash. With the growing life settlement marketplace, their lapse ratios may not be materializing as the actuaries anticipated. Due to this, we are seeing certain insurance carriers now offer “enhanced cash surrender value options” to policyholders, enticing them to surrender some of the most efficiently priced life insurance policies in the marketplace.
Carriers look for ways to protect themselves and their stockholders when they know they’ve priced certain products too low. This becomes even more evident in a low-interest rate environment. Therefore, they offer to buy back policies that may have a cash surrender value of $150,000 for a premium of, say, $225,000. That way, they get these underpriced policies off their books (kind of like banks do for bad debt) while also taking a $1,000,000 liability off their books (the death benefit of the policy they are buying back).
Generally, if a carrier offers to purchase a policy back from a policyholder, that means it is priced too low. Don’t take their bait—hold on to these policies if at all possible! To be clear, life settlements are generally viewed as a last-resort option when the alternative is to surrender the policy or allow it to lapse due to inability to fund the neces- sary premium. There are very specific circumstances that warrant the selling of a policy on the secondary market. Ideally, a well-monitored policy would be adjusted to maintain an affordable premium and appropriate death benefit. Nobody wants to surrender a policy for next to nothing. Life settlements can be a last resort that help your clients recoup value on a problematic policy.
With a life settlement, you are looking to help a policy- holder make the most of a life insurance policy that no longer works for their situation. But what if the policy seems to be in great shape and is in force to “maturity,” and then suddenly, at age ninety-five, ninety-eight, or one hundred, the life insurance benefit reverts back to its cash value? The life insurance benefit you thought you had could vanish. That’s the kind of contractual provision that makes a trustee wake up in a cold sweat. But it’s not a nightmare—it’s a maturity provision.
Maturity provisions are the single most important thing I work to educate people about when I speak at trust conferences and with our clients.
In the 1980s and 1990s, it was commonplace for insurance carriers to include maturity provisions at age ninety-five, ninety-eight, or one hundred. Policyholders were told that if they outlived these provisions they would “beat” the insurance carrier and get paid a handsome reward for doing so. It was reasoned that the cash value of their policies would be equal to or greater than the original death benefit. Part of the value would be created by the policy owner’s premium contributions, but the majority of the value would be created by the insurance carrier’s assumed earnings within the policy.
If only reality lined up with theory. As you know, interest rates changed, the cost of insurance increased, and dividends decreased. These provisions were seldom discussed, since after all, who was going to live that long? If they were discussed, many agents would position policy maturity as a reward for outliving your life insurance. It was kind of like finding a pot of gold at the end of the rainbow, so it didn’t seem to be an issue on the surface. Then came the perfect storm: increased life expectancies combined with significantly lower-than-projected cash- value accumulation. Today, maturity provisions (with many but not all policies) are not the pot of gold at the end of the rainbow, but the lump of coal with which parents threaten misbehaving children around the Christmas season.
In the 1990s, maturity provisions were highly theoretical. Very few Americans were living into their late nineties. According to the Wall Street Journal, in 1980 there were 32,194 centenarians in America. By 2010, there were 53,364 Americans living past age one hundred.* Last week, a woman in my home state of North Carolina turned 109. People are living longer. Maturity provisions are a real issue today.
The Furious Case of Mr. Lebbin
If you want to understand the human cost of maturity provisions, consider Gary Lebbin. The first time I heard Mr. Lebbin’s story, I literally got sick to my stomach. (It is currently being litigated—see Lebbin v. Transamerica, US District Court, Southern District of Florida, Case No.
Mr. Lebbin was born in 1917 in Berlin. He fled Nazi Germany in 1938 and ended up penniless Baltimore, Maryland. Mr. Lebbin worked hard and made a name for himself in the paint industry—eventually owning over fifty retail paint shops in the Baltimore-Washington area. He married the love of his life and started a family. He is the best of America.
Mr. Lebbin turned one hundred years old in 2017. Shortly before his birthday, he received a letter from his life insurance carrier, Transamerica, notifying him that his life insurance policies (two of them totaling $3.2 million in death benefits) had matured. Instead of his beneficia- ries receiving the life insurance benefits at his passing or receiving a sizeable cash value, the contractual maturity provision in Mr. Lebbin’s policy stated that the maturity value would be equal to the cash value at age of maturity. This amount was far less than the $1.6M premium that was funded during his lifetime.
By the letter of contract law, Transamerica had the right to terminate coverage, but Mr. Lebbin and his family felt they had been misled. The policies were labeled “universal life”—surely they should cover him for his whole life. He had paid over $1.6 million in premiums during his life.
The Lebbins sued Transamerica. As of publication of this book, the case remains in court. It garnered much attention, including an article in the Wall Street Journal. If you are a trust officer, it’s likely that you have a Mr. Lebbin in your portfolio of policies. Maturity provisions
today are not as much of a concern for newer policies, as they are now designed to extend to age 120. Certain policies issued in the 1990s are a different story, however. Believe me, you do not want Mr. Lebbin’s situation occur- ring on your watch. If you have such a situation, you want to discover it as soon as possible. This is why policy monitoring is so vital. If you catch a maturity provi- sion early enough, you have options such as a policy exchange, surrender, or restructure. The longer one waits and the older the insured, the more limited are the options available.
I cannot stress enough how important it is for trustees and policyholders to seek out the maturity provisions in policies.
Here is some sample contractual language by policy type. This is by no means an exhaustive listing. My goal is to help trustees understand what to look for when requesting maturity provisions from carriers.
Examples of Maturity Provisions from Different Policy Types:
- Whole Life: “Benefit will mature or expire on the policy anniversary 2-17-2059” (Insured’s age 98)
- Universal Life: “This product is designed to mature on the anniversary date closest to the younger insured’s age 98. The maturity date for this policy is August 21, 2023. If the policy matures by the passing of both insureds prior to the maturity date, then the policy proceeds will be the death benefit. Inversely, if the policy matures by age then policy proceeds will be the cash surrender value.”
- Variable Universal Life: “Final premium payment date is the policy anniversary nearest the younger insured’s 95th birthday. No premiums may be paid after this date. The death proceeds after the final premium payment date will be the policy value less debt.”
Since I originally published this book, it’s become clearer to me that life settlements and maturity provisions are two vitally important elements of life insurance that trust officers must understand. A life settlement is a last resort—designed to help a policyholder get something out of a difficult situation. Meanwhile, maturity provisions can put a policyholder in an equally difficult situation. The job of a trust officer is to help their clients identify obstacles ahead and work to avoid them when possible. Our job at LifeTrust3D™ is to support trust officers, period. We do the background work and heavy lifting so trust officers can do what they do best: be proactive in addressing these difficult situations sooner, rather than waiting until it’s too late. The more time we have to collaborate with the trust officer prior to future issues arising, more options are available to the client. It is when we are faced with short time horizons, such as policies lapsing in the near future or finding out about a maturity provision two or three years prior to its occurrence, that policy remediation alternatives are limited.