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The value of a life insurance policy
is generally carried on the books as
the cash surrender value – but that
might not be the whole story.
There has been a quiet revolution
going on in the higher-end life
insurance marketplace that has
caused some life policies to be
worth a significant amount over
the cash surrender value in certain
situations. Even a straight term life
policy may be worth a
significant amount of cash!
Accounting professionals, whose
high-net-worth clients often carry
high face value policies, should
know how to access the real
market value of that insurance.
Otherwise they may be
overlooking an asset that can be
turned into hard cash.
Insurance professionals, call them
"life settlements", lifetime
settlements" or "senior
settlements" The terms describe
selling an in-force life insurance
policy for a cash discount on the
face value to a buyer interested in
taking over the policy as an
investment.
Investment companies that have
purchased policies with a
combined face value of over two
billion dollars over the past two
years, call them "high net worth"
settlements. The typical policy
holder is an older executive with a
life expectancy of five years to
decade or more whose health
status ha declined since the policy
was originated.
Knowing when a life insurance policy may be worth
substantially more than its book value is the mark of a
true value-added accounting professional.
An affiliate of CNA Financial
states there are many players in
this rapidly evolving marketplace
where even a term life policy or a
borrowed against whole life policy
can be worth significant amounts
of cash, and universal life policies
can bring in substantially more
than their cash surrender values.
Accountants don’t have to run out
and change all their balance sheets,
yet but knowing when a life
insurance policy may be worth
substantially more than its book
value is the mark of a true value
added accounting professional.
When might a policy be worth
more than a Cash Surrender Value
CSV? There are a few
guideposts to follow in this
new chartered territory.
Here are some indicators of
when to consider selling a
policy:
The cost of renewing a large policy
is growing more rapidly than its
expected benefit.
The insured is over 65 or has a
long-term health condition that
was not present when the policy
was written, and beneficiary would
prefer cash now.
Whenever there has been a change
in ownership that makes "key
man" policies obsolete: a merger,
acquisition, sale of a business,
bankruptcy, dissolution of a
partnership or even a divorce. If a
large life insurance policy is left to
lapse, one could be overlooking a
source of cash.
How much could a policy be
worth? The amount of money that
the policyholder receives for the
policy is calculated based on the
age and relative health of the
insured, as well as the policy’s
costs, duration and cash surrender
value. Most clients have
experienced a decline in their
health status since the policy was
first issued. Each transaction is
evaluated individually. Here are
some realistic examples to give
you an idea of the range of
possibilities.
Example 1: Headliners carried off
a popular chief executive to lead a
new dot.com company, with little
warning. During the post-mortem
review of the benefits and
company assets, the company’s
financial officer indicated that it
carried key man insurance on their
former CEO – a term policy with a
$3.75 million face value and no
cash surrender value. The insured
was in his mid 60s and suffered
from adult-onset diabetes and
related complicating conditions.
The former CEO’s policy had
premiums due of $40,000 and the
CFO had decided to let the policy
lapse. The firm’s accountants
recommended looking into a "life
settlement" and the company was
offered $760,000 pre-tax. Taxes
reduced the policy’s net value to
$614,000. Example 2: A small
manufacturer was operating in
Chapter 11. As part of the process
of submitting operating reports, the
accounting consultant thought she
would confirm the cash surrender
value of the key man insurance
policy. She learned the policy had
been fully borrowed against and
the interim management was ready
to jettison the policy because its
large annual premium was coming
due. She did some fast research.
At the time of review the insured
was a 64 year old whose health
status had declined slightly since
the policy was first issued. The
policy had no cash surrender value.
The $750,000 policy was sold for
$80,000. Example 3: A company
president was retiring from a
closely held family corporation.
The firm held a $3 million term
policy on the retiring president.
Junior and his little brother were
taking over the reins, and had
sufficient life coverage already.
Dad’s company held policy
premium ($12,000 per annum) was
due to increase next year.
The policy was no longer needed
because there was another policy
in place taking care of the heirs.
The company decided to let the
policy lapse because of the nearly
threefold increase in the next
year’s premiums, but the
accounting firm asked, "what
about a high net worth
settlement?" To the company’s
surprise, they were able to sell the
policy for over $600,000. This
was on a policy with no cash
value!
Are the buyers crazy?
Why would someone pay those
kinds of sums for an insurance
policy when the policyholder who
bought it is thinking of bailing out?
There is a solid economic rationale
for buying these "worthless"
policies. the buyer is simply
calculating the present value of the
death benefit, after considering the
outflow for the purchase price and
continuing to pay policy
premiums. The insured’s age, sex,
health and smoking status are
important factors in valuations.
These policies are being treated
just like other financial assets and
are being bought be financial
institutions.
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