Personal Finance

Life Insurance Innovations Include A Valuable 'Out Clause'

In the past, advisors have had few options when discussing life insurance exit strategies with clients, but with life settlements and the new value they present, relationships are strengthened by new planning strategies and greater financial options. Thus, the settlement industry creates unexpected value for consumers and advisors alike, but the potential is largely untapped.

Let’s take a look at how the secondary market for life insurance evolved.

Life insurance has been a core part of American finances since the 1800s. Advisors know a life policy is a valuable financial asset that provides benefits and stability to insureds during their lifetimes and/or to loved ones, businesses or other beneficiaries later.

Often overlooked: Innovation has been a constant since the birth of life insurance and is as fundamental to the industry as it is to electronics or automobiles. As the industry evolved, the requirement for non-forfeiture values (cash surrender values) was added, creating the concept of a whole life policy. Contestable and suicide periods, dividends, waiver of premium, term insurance, universal life and other developments were invented along the way.

Life settlements are simply another important financial innovation in the life insurance industry. Arguably, this may be the most important innovation since universal life.

Among other things, life settlements have changed how consumers – your clients – think about life insurance. Especially about exit strategies for unwanted policies. For years, they had few options but to surrender or lapse. With life settlements the market value of life policies is unlocked; unneeded policies can be assets with real value.

The right of policy owners to assign their policies is the most fundamental right in every life policy. The legal basis for assignments in life insurance, and therefore for life settlements, may be found in the 1911 U.S. Supreme Court case, Grigsby v. Russell. In this landmark decision, the United States Supreme Court set forth the fundamental principle upon which life settlements are based: a life insurance policy is private property, which can be assigned at the will of the owner.

The crux of that Supreme Court opinion sounds prescient, even today: “So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”

Legal precedent has been reinforced many times over in the decades since the 1911 Grigsby decision, including:

  • The passage of the Health Insurance Portability and Accountability Act in 1996 that made many settlements tax-free,
  • The change in Federal Employees Group Life Insurance to provide for assignment in a life settlement,
  • The change in Veterans Group Life Insurance to provide for a way to settle a policy, and
  • The passage of The Tax Cuts and Jobs Act in December 2017 that makes more life settlements tax-free.

The commercial life settlement industry itself can be traced back to the 1980s and the onset of the AIDS epidemic in the U.S. People with AIDS faced an extremely short life expectancy, unprecedented discrimination in access to care and continued employment, and generally few options; often, these individuals owned life policies. It was under these circumstances that the first “viatical” settlements were created.

As medical advancements made progress in the lives of those living with AIDS and other life-threatening illnesses, settlements with people with AIDS became less common. But the life settlement industry emerged, as consumers with other dread diseases sought funds for treatment and living, and seniors with other financial planning-related motivations were offered settlements.

A life settlement occurs when a terminally (less than two years life expectancy), a chronically ill individual or a senior (typically age 70 or over) sells his/her life insurance policy to a third party for consideration - a lump sum settlement or a combination of cash and a retained future death benefit.

A U.S. Government Accountability Office study indicates that life settlements pay almost eight times cash surrender value to seniors. I would just reiterate that every policy and every scenario is unique.

The simple premise that benefits can be “unlocked” from a life insurance policy during the policy holder’s lifetime is the foundation for the life settlement industry.

Today, the life settlement and viatical settlement marketplace is heavily regulated. As of 2018, 45 states and the territory of Puerto Rico regulate life settlements, affording approximately 95 percent of the United States population protection under comprehensive life settlement laws and regulations.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.