Tuesday, July 1, 2014

Discouraging life settlements

Bill Boersma, at his niche blog On Life Insurance, comments on life settlements in life insurance contracts. This thoughtful piece brings up an issue for those who advise clients on personal planning issues. 
  • Many people who have bought whole life or universal life policies years ago now find that it is difficult, as their financial condition has changed, to keep up with premium payments.
  • They may find the need to make the hard decision to discontinue paying the premiums, and taking the current cash value of the policy. If they do so, however, they forfeit the death benefit under the policy, which will often be much higher than the cash value.
  • They will often consult with the agent who sold them the policy about what their options may be.
  • The agent may not tell them, and often is directly forbidden under his agency contract from informing them, that a life settlement is an option.
A life settlement (sometimes called a "viatical" settlement) is an agreement between an insurer and an insured to take an early buyout of the death benefit under the policy, in exchange for which the insurer receives a discount. This is often a very useful alternative for someone who has a terminal illness and pressing financial and medical needs as a result.

An example scenario: Jane Carter has a policy that she has held for the last 12 years, and for which she has paid nearly $250,000 in premiums over that time. The policy obligates the life insurer to pay a death benefit of $1 million to her three children. Unless the policy is paid up, where no further premium needs be paid, she still has to pay the annual premium of $16,500. This was feasible when she was working and earning $140,000 per year, but now she is retired and living on her social security and pension benefits.

Jane has been diagnosed with cancer and the prognosis is grave. She has perhaps 2-3 years to live. The medical expenses have been high, and she is strapped for cash. She does not think that she will be able to afford to pay the premium this year.

If approached, the life insurer may well be willing to negotiate an early life settlement, paying her perhaps $800,000 in satisfaction of her policy. This saves the company $200,000 off the death benefit and puts a significant sum of cash in Jane's hands. Both sides would see a significant gain as a result of such an agreement.

But if the agent she speaks with is not allowed to tell her about this option, she probably will not learn about it. The insurer would prefer that she default on the policy, take the cash value that has built up - maybe $100,000 or so - and go her own way. Her children, on her death, will receive only whatever is left of the cash value, if anything.

Boersma's piece notes a harsh reality: The agent represents the company, not the client, and his loyalties lie with the company. Someone who has a fiduciary responsibility to the client, such as an independent fee-based advisor or an attorney, has an obligation to advise her of the reasonable alternatives. The agent has no such responsibility.