An estimate of a life insurance policy’s value is important information, but other factors should be weighed
For many life insurance policyholders with the opportunity for a life settlement, the only important question is usually “how much is mine worth”? To get an answer, they may go to a life settlement provider and get an appraisal, which would give a dollar value to their policy.
That’s a sensible way to get information for financial planning purposes or tax reasons. But as two experts warned in a recent piece on ThinkAdvisor, relying solely on estimates can be a mistake.
According to Robin S. Weinberger and Peter Katz of Life Insurance Settlements Inc, estimates from brokers and provides generally do not qualify as a valid appraisal for tax purposes. And life settlements can also fall short for financial-planning purposes since it only offers a guide as to the worth of a policy on the life-settlement market or, in the case of providers, an estimate of what the individual offer is willing to offer.
“[L]ife settlement value and cash surrender value are not the only way to measure a policy’s worth,” the article said. While free appraisals may be used by life settlement providers and brokers as marketing tools to foster interest in life settlements, financial advisors must take other information into account.
The piece noted that getting quick cash isn’t a good reason to enter into a life settlement transaction. But there are many examples of valid ones, such as when a policy is no longer needed, when it is no longer affordable, and when an immediate necessity such as medical expenses must be paid for.
For policies that are likely to be terminated, policyholders may want to get a life-settlement appraisal to see if they have a better option than surrendering their policy. The report noted three primary factors in determining a policy’s life settlement value:
- The insured’s life expectancy;
- The cost to carry the policy; and
- The rate of return (discount rate) that the purchaser desires.
“In today’s market, the compounded rate of return that buyers seek, at least for pricing purposes, generally exceeds 15%,” Weinberger and Katz said. Since sales proceeds are also reduced by transaction costs and possibly income taxes, a policy owner who maintains their policy would likely see a return of investment that exceeds 15%. “This does not make a life settlement a bad deal when compared to surrendering a policy, but it is likely not a good deal when compared to keeping a policy,” the piece said.
Life settlements also do not consider the potential human benefits of the death proceeds, which can be used as income for a surviving spouse, funding for a grandchild’s education, paying off debt, and taking care of estate or inheritance taxes, to name a few.
“To help your clients make good decisions, it is important to point out the limitations of these appraisals so as to not underestimate the true value of a life insurance policy.” the piece said. “Inevitably, such analysis leads to the conclusion that a life settlement is an alternative to surrendering a policy, not an alternative to keeping it “
