Fiduciaries: Don’t Ignore the Secondary Market for Life Insurance
Your clients probably don’t know their life insurance could be worth tens of thousands of dollars on the secondary market. The secondary market for life insurance is where life settlements and viatical settlements happen — these are transactions that sell life insurance policies to third-party investors. Despite the compelling financial benefits of reselling life insurance, many policyholders aren’t even aware that a secondary market for life insurance exists. Unfortunately, that knowledge gap can be costly for any policyholder who ends up surrendering life insurance back to the insurer.
As a fiduciary advisor, you can help fill that knowledge gap, while encouraging your clients to understand the true value of their financial assets. Read on for an explanation of the secondary market for life insurance, how it differs from the primary market, and the benefits eligible policyholders can expect to receive from the sale of their life insurance.
What is the life insurance secondary market?
The secondary market is where existing, in-force life insurance policies are bought and sold. There are two types of transactions available on the secondary market: viatical settlements and life settlements. Viatical settlements are available to terminally ill policyholders, while life settlements are available to senior policyholders who’ve not been diagnosed with a terminal condition.
The Supreme Court established the legality of reselling life insurance in the 1911 case of Grigsby v. Russell. But it wasn’t until decades later that a true secondary market for life insurance began to take shape. Sadly, the AIDS epidemic in the 1980s played a role. Too many terminally ill policyholders needed cash to fund their treatments and prolong their lives. They increasingly sold their life insurance to generate funds quickly. Investor demand grew at the same time. This era was a turning point for the secondary market.
In the years that followed the AIDS crisis, investors and policyholders warmed to the idea of reselling insurance even in the absence of a terminal diagnosis. That gave rise to the life settlement side of the secondary market, which serves policyholders over the age of 65 who are not terminally ill.
Difference between the primary and secondary market for life insurance
The primary market for life insurance is where insurers initiate original policies. In other words, when your client fills out an application with an insurance company to obtain a new life insurance policy, that transaction happens in the primary market. The buyer is the policyholder, and the seller is the insurance company. Typically, the policyholder and the insured are the same person. If they’re not, the policyholder must have an insurable interest in the insured — meaning the policyholder would suffer a financial loss if the insured were to pass away.
In the secondary market, the buyer is an investor, and the seller is the original policyholder. The policies that change hands in the secondary market are already issued and in force. Unlike the primary market, the buyer in a secondary transaction doesn’t need an insurable interest in the insured. When the secondary market transaction closes, the buyer becomes the new policyholder, but the insured does not change. When the insured passes away, the insurance company pays the death benefit to whomever the buyer has named as beneficiary.
How does the secondary market for life insurance market work?
The secondary market for life insurance gives policyholders the opportunity to liquidate their coverage for far more than the policy’s cash surrender value. That’s why it’s appropriate to advise your clients about the secondary market for life insurance — particularly when they’re already questioning the usefulness of their policy going forward. An insured who no longer wants or needs the coverage is an ideal candidate for a life or viatical settlement.
Your clients can sell their life insurance directly to a buyer or work through a broker. The direct buyer is motivated to pay as little as possible to gain ownership of that policy. For that reason, direct sales often result in lower selling prices. A broker, on the other hand, will market the policy to multiple buyers and drive up the price with a bidding auction.
The selection of the broker is important, too. A single point of contact — either an experienced broker or life settlement company with a wide network of buyers — will serve your client best. The right broker working alone can actually secure a higher sales price than multiple brokers working at the same time. Submitting the policy to multiple brokers requires a lot of paperwork on your part, but it also adds inefficiencies to the bidding process. A single broker is well aware of the highest bid on the policy and can manage the negotiations with that number in mind. When multiple brokers are involved, no one broker is sure how the bids are coming in. That leaves all of them disadvantaged in the ongoing negotiations.
Once you refer your client to the broker or life settlement company, they’ll manage the process of underwriting the policy and setting up the auction. The broker will negotiate and collect bids, and then present those bids to your client. If your client accepts an offer, all parties involved complete the closing paperwork. Your client then receives the cash payment, less the broker’s commission and any escrow and other service fees.
Benefits of selling a life insurance policy on the secondary market
For clients who no longer want their life insurance or death benefit, a life or viatical settlement can be a transformative financial strategy. The benefits include:
- Large cash payment. A secondary market sale gives your client the flexibility to cash in on the cumulative investment made in life insurance premiums. The cash payouts can be substantial, too. Your clients can use the money to cover living expenses, pay for healthcare, repay debt, top up emergency savings, or in any other way.
- No more premiums. Once the transaction closes, the new buyer is responsible for paying all future premiums on that policy. If you have a client who’s struggling to keep up with premium payments, it’s worth evaluating whether that policy is even necessary. Selling it on the secondary market can be one step towards reshaping your client’s budget and downsizing living expenses.
- Higher payout than a surrender. Your client can surrender the policy back to the insurance company instead of selling it. The insurer can complete this transaction quickly but the cash proceeds will be far less than the policy’s worth on the secondary market. An eligible policy could sell for as much as 60% of the death benefit — which would be several times more than the surrender value.
- Creates liquidity to adapt to changing circumstances. Life insurance is a long-term asset. A policy your client purchased 25 years ago may no longer be the best match for his or her finances. Reselling the life insurance on the secondary market can create the liquidity necessary to shift wealth into other assets, such as a smaller insurance policy, an annuity, or traditional securities.
As a fiduciary advisor, you don’t need to be a life settlement expert to discuss a secondary market strategy with your client. The Harbor Life Settlements team can support you in this conversation. Reach out to us and we will provide a free estimate on the value of your client’s policy in the secondary market. We can also answer your client’s questions and concerns. Once the client is ready to move forward, we’d underwrite the policy and work through our premier partner-broker to secure the highest sale price possible.