You should know if your clients should sell their insurance policies

Susan J. Bruno, CPA/PFS, of Beacon Wealth Consulting in Rowaton, Conn., maintains that sometimes CPAs are afraid of what they don't know, so they avoid it. That instinct, she warned, can often be hazardous to a client's financial health.

Bruno is on a crusade to educate CPAs about life settlements, the proper sale of a life insurance policy to an investor when the client is better served by forsaking steering a death benefit to heirs to gain an immediate infusion of cash.

Life settlements are sometimes confused with abusive or potentially fraudulent "STOLI" (stranger-originated life insurance) transactions. In those deals, large life policies are sold to elderly people who had no genuine need for the coverage, with the promise that the contracts will be immediately bought back by an investor and create a windfall for the insured.

Life settlements are also sometimes confused with viatical settlements, the sale of a life policy when the policyholder is in dire financial straits and has a very short life expectancy, typically due to a terminal illness.

"I think it's a borderline fiduciary responsibility for CPAs to know whether a life settlement is an option for a client," said Bruno. After describing a recent case in which an elderly client sold a long-held insurance policy, instead of simply letting it lapse, she asked: "Imagine if this guy had let the policy lapse and later learned that he could have sold it. He goes to his accountant and says, 'Are you kidding me? You didn't tell me I just gave up a valuable asset in my portfolio?'"

No CPA would want to be put in that position, she said.

So what kind of clients might benefit from pursuing a life settlement?

Bruno recently handled a case involving a client in his early 80s who had been dutifully paying premiums on a $500,000 face amount universal life policy with a limited cash value. When the policy was originally purchased by the client many years ago, illustrations (based on higher prevailing interest rates at the time) projected a substantial cash value by today.

That cash value could have been used to cover premiums, or paid to the client upon surrendering the policy. But because the underlying interest rate was variable and had declined - consistent with bond market yields - that scenario had not come to pass, and the client was still paying $35,000 in annual premiums. He asked whether he was better off simply letting the policy lapse.

His CPA knew he might have a third alternative - a life settlement - and referred the case to Bruno. Ultimately, the client received an offer of $180,000 for the policy - an offer he decided to accept.


Another situation that might give rise to a life settlement, Bruno said, involves "key man" life insurance in a business context. "A lot of times the policy will be dropped when the key man retires, but the owner [of the policy] may be sitting on a gold mine," she explained.

The point, Bruno said, isn't that life settlements are always the smart way to go - but they may be, at a minimum, an option for suitable clients to consider, assuming that they can find an attractive offer.

"At this point, there is somewhat of a standoff of return expectations of sellers versus buyers," said Michael Fasano, of Fasano Associates in Washington, D.C., a life settlement underwriting concern. "But pools of capital are beginning to accumulate, and there will be heightened demand for life settlements," he predicted.

Investors, including banks and hedge funds, were shell-shocked by losses on other investments in 2008, and stayed on the sidelines until earlier in 2009. Many were also rattled when an upward adjustment in standard mortality tables used by actuaries undermined models used by institutional buyers to price their life settlement offers.

But investors are beginning to put those disruptions behind them, according to Scott Kirby, co-president of Advanced Life Settlements, a broker based in Orlando, Fla.: "Investors think of life settlements as somewhere between bonds and equities" on a risk scale. "It is a safe asset class. People will die."

Fasano, meanwhile, anticipates that life settlement investors, who have traditionally targeted policies with face amounts of $500,000 and above, will become more interested in policies as small as $250,000 - if they can bid on them economically. His firm furnishes life expectancy forecasts on individuals seeking to sell their policies. Those reports are purchased by brokers and presented to prospective investors.

Life expectancy is a key variable used by investors to determine whether to bid on a life policy, and if so, how much.

Fasano said that investors used to only be interested in buying policies whose owners had a life expectancy in the five-to-eight-year range. "Most of the buying now," he said, "is done at 12 years or less."


Amy Gavartin, a marketing executive with Melville Capital, a New York-based life settlements broker, said that she has seen "an influx of policies on the market."


Jean-Luc Bourdon, CPA/PFS, of Walpole Financial Advisors in Goleta, Calif., attributes it to recent hard times. "As retirement savings portfolios have lost value and real estate has lost value, a 'Plan B' has to be devised - which is where life settlements can sometimes fit in," he advised.

Bourdon is working on such a plan for a client in his 70s who owns a $3 million life policy. His health has taken a turn for the worse recently, making the policy potentially attractive to an investor.

"CPAs should suggest that all senior clients have their life insurance policy appraised to determine the fair market value of the policy," advised Daniel Powell, chairman and chief executive officer of Christian Stanley Inc., a high-volume life settlement clearinghouse specializing in the securitization of trust-owned life insurance assets. "Even if the client does not necessarily want to exit the life policy, it's critical that the fair market value of the life insurance policy be determined."

The fact that life settlement investors' payoff comes only when the original owner of the policy dies leads Gavartin to stress that CPAs should only steer clients to life settlement brokers who work with institutional investors, not private parties. "You wouldn't want Tony Soprano buying your policy," she quipped ominously.

But life expectancy isn't the only variable investors consider.

Noted Advanced Life Settlements' Kirby, "I have an 85-year-old whose policy I can't sell because the premiums are too high." The higher the ratio of premiums to death benefit, the less attractive the policy.

Other considerations include the type of policy involved. For example, standard whole life policies are not typically valued as highly as universal or variable life contracts. And the only term policies that investors consider are convertible policies; investors would buy them only after they have been converted to a permanent policy.

Often the most attractive type of policy, Gavartin said, is a joint survivorship policy with one spouse already deceased.

Also, policies with a significant cash value build-up tend to be less attractive to investors, she added. Indeed, the owner of a life policy with a high cash value might be better off simply surrendering the policy and collecting the cash value. (Melville Capital's Web site,, features a worksheet that quantifies key variables, leading to a "settlement probability" score.)


The tax implications of selling a life insurance policy are a natural focus of CPAs in helping clients sort through this issue. A revenue ruling (2009-13) issued in May and which takes effect August 26, provides some clarification.

In the ruling, the IRS "confirms its somewhat controversial position set forth in prior private letter rulings that the holder's basis is not equal to the full amount of premiums paid, but instead must be reduced by that portion of the premiums paid expended for the provision of insurance," according to a summary of the ruling by the law firm O'Melveny & Myers. "The IRS does finally confirm, however, that a portion of any gain can be capital in nature upon such a sale," the summary stated.

Another important planning consideration that CPAs can sort through is the existence of trusts, Bruno explained. For example, if a life policy has been transferred to an irrev­ocable trust, "You'd better make sure that the spouse is the beneficiary of that trust," she said, because otherwise, the sale of that asset to a third party might not provide the intended benefits.

In advising clients on the possible sale of a life insurance policy, Bruno believes that it's important to involve the policy's original prospective beneficiary. "I require that the beneficiary sign off, so there is no surprise," she said. "You don't want them to be counting on a policy, and then they find out that mom has sold it to someone."

Bruno has been questioned about the wisdom of her cautious approach. "Some would say, 'That's just one more gatekeeper.' I say, 'I don't care, it's what's right.'"

Meanwhile, lawmakers aren't convinced that everyone will do what's right. For example, proposed legislation in Maine and Washington states would require life insurance companies to advise policyholders that life settlements are a possible choice for those considering surrendering their policies.

And Congress has taken notice of the growth of life settlements and is exploring the federal government's role in overseeing these transactions. At a Senate Select Committee on Aging hearing in April, Securities and Exchange Commission Chairman Mary Schapiro testified that life settlements may soon come under the jurisdiction of her agency.

Committee chair Sen. Herbert Kohl, D-Wis., commented that "selling one's life insurance policy is a complex transaction, fraught with possible pitfalls."

That is precisely why Susan Bruno believes CPAs need to be involved: "CPAs will raise the bar in terms of integrity," she said.

(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.

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