New life insurance market.

• Author: Tsotsos, Bill
• Position: LifeSettlements

Imagine a world where buyers are willing to purchase your car at substantially more than its trade-in value--and you get to choose the highest bid. No advertising, no haggling, no expense to you. Science fiction? Nope. Such a world exists--not for car owners, but for owners of life insurance policies intended for lapse or surrender. These owners can receive a cash settlement--while they are still living.

The life settlement industry has created a secondary market for acquiring life insurance policies from qualifying policyholders, who receive an offer guaranteed to exceed the cash value. In 2002, life settlement providers paid approximately $340 million to acquire policies with an aggregate cash value of $94 million.

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Policyholders qualifying for life settlements are generally older than 65; have deteriorating health, but are not terminally ill; and have "ascertainable and limited" life expectancies between two and 15 years. Qualifying policies are at least two years old, pay death benefits between $100,000 and $5 million and are issued by a life insurance company with an "A" rating or higher.

AN EVOLVING INDUSTRY

Relatively new, the life settlement industry evolved from "viatical" settlements, which responded to the needs of terminally ill policyholders. Viatical settlements enable an insured to receive benefits, prior to death, to pay for the costs of care. Life settlements, also known as senior settlements, do not involve a terminal illness (less than 24-month life expectancy) but a determinable life expectancy based upon the insured's age, health and lifestyle.

The policy's market value is the net present value of the death benefit, factoring in the policy's duration and carrying costs. Other factors affecting the market value include the type of life policy, the policy's cash value and any loans against the policy.

A life settlement transaction creates a two-tiered taxable event. The first tier is the difference between the cost basis and cash surrender value, taxed as ordinary income. The second tier is the excess of settlement proceeds over the surrender value.

The IRS has not provided specific guidance, however, whether this is considered to qualify as a long-term capital gain. The tax treatment of a viatical settlement is markedly different. The IRS considers these tax-exempt accelerated death benefits.

WHEN TO SELL--OR BUY?

Life settlements are a viable option when policy premiums are no longer affordable...