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Betty's Corner

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Life Settlement Offers Explained


Determining a life settlement offer remains a complicated calculation. Each transaction hinges on variables which are never quite the same: Life expectancy, face amount, premium payments and cash value all come into play. Despite the fact that offers can vary widely, and most providers shy away from any generalizations about settlement amounts, a research firm recently published what it believes is the average life settlement amount. Conning Research & Consulting's 2011 study on life settlements reported that the average life settlement value is 20 percent of the life insurance policy face value. This statistic has made some noise lately in mainstream media outlets: Why such a huge discount from a policy's face amount?

At first glance, 20 percent might seem like a grossly unfair cut of a policy's potential value. However, one should compare this value against the average cash surrender value, which amounts to only 10 percent of a policy's face value. One should also remember this 20 percent average value is just that, an average. As anyone in the industry knows, settlement offers vary greatly due to life expectancies and premium costs. Lastly, life settlements serve as an option for those that do not want or do not need life insurance. Almost 90 percent of life insurance policies in America lapse due to unpaid premiums or decision not to renew a policy. The overwhelming majority of policyholders receive little or nothing, after decades of paying premiums. In fact, life insurance companies heavily rely on the high probability that they will not pay out a customer's policy, they reap most of their profit from lapsed, unclaimed policies.

Even after comparing settlements against the alternatives for unwanted life insurance, consumers and agents don't understand why the average discount on the full policy value is 20 percent. Why not 40 percent or at least 30 percent? The life settlement industry suffers from a pervasive fundamental lack of understanding about how much profit is made and how much profit is risked by investors. It's now clear providers need to advocate for more widespread education and awareness regarding life settlements. Reactions to the Conning research average underscore just how little most people understand about how a life settlement transaction is constructed. Even agents who are aware-of or familiar with settlements, may not be able to explain to a consumer why the average settlement value appears highly discounted from the face value of a life insurance policy. All agents should be able to communicate a consistent message about the option of a life settlement to consumers - something, perhaps they cannot do without first understanding for themselves, all of the risks, costs and financial rewards for all parties involved. Therefore, with the intent to clarify confusion caused by contradicting messages, and dispel skepticism on a relatively new option for unwanted life insurance, we deconstruct how a life settlement provider reaches an offer.

To better understand the costs of a life settlement offer for a provider, let's evaluate a common example. Below is an illustration of provider costs for a settlement offer for an 80-year-old with a 10-year life expectancy and $1 million policy.

In this example, the settlement provider offers $200,000 to the policyholder (this reflects the Conning 20 percent industry average). If the life expectancy remains accurate, the total cost for the settlement provider equals $632,000 after 10 years. But if the policyholder outlives the predicted life expectancy by just four years, the total cost at year 14 equals $1 million. With the cost now equivalent to the policy's pay-out, the provider breaks even on the settlement. If the policyholder outlives the life expectancy by eight years, the total cost at year 18 equals $1.5 million. As you can see, the provider takes substantial risks. If the seller lives past age 98, then the provider loses $500,000. What exactly do settlement provider "costs" cover? Costs comprise: the offered settlement amount (in this example, $200,000), premium payments - providers pay policy premiums for the rest of the policyholder's life, underwriting costs, medical evaluation costs, administrative fees and tracking costs.

With these risks and costs in mind, the average life settlement value of 20 percent of a policy's face value is placed in its proper context. The variables influencing a settlement offer, costs, profit and risks are not black and white. They are complicated transactions as numerous factors influencing a settlement offer. The discount off the face value reflects the costs and real risks involved in a life settlement, but those costs and risks fall on the provider, not the policyholder or the agent. Life settlements are not for everyone, but for those who no longer need or want life insurance coverage, a settlement is likely the smartest option for the policyholder and the agent. Funds from a settlement can drastically alter a client's financial situation. Even for seniors who currently enjoy a financially prepared and comfortable retirement, a settlement returns more funds to the policyholder than a cash surrender or lapsed policy.

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