Life Settlement News

What about the Taxes?
The tax community needs to focus on how to compute gains and the tax basis for sellers of life insurance policies, according to a report by the Insurance Studies Institute. The IRS has yet to provide formal guidance on the subject of policy sales under a life settlement. Case law suggests that the proper tax treatment is a bifurcated approach for the proceeds of a life settlement even if the policy was premium financed. Gains recognized between the tax basis and the policy’s cash surrender value would be deemed ordinary income. What gets capital gains treatment would be the gains recognized above the cash surrender value (or above the tax basis of a policy with no cash surrender value).
Any gain that is recognized through the discharge of a non-recourse premium finance loan should be treated as ordinary taxable income. This is because no part of the loan debt represents an increase in the policy’s market value.

The tax code is not clear on the proper tax basis calculation for policies sold as life settlements in the secondary market. In its guidance, the IRS has provided conflicting views. It applied an approach that is similar to what is mandated under the tax code for policy surrenders. While not formally overruling this approach, IRS has argued, in private letter rulings, for having a policy’s basis reduced by the cost of insurance. “Why should the tax basis of a life insurance policy be forcibly reduced by cost of insurance any more than the tax basis of real estate or equipment be forcibly reduced by depreciation that has not otherwise been expensed against taxable income?” the authors ask. The report stresses that the multi-billion dollar life settlement market represents an important and growing revenue source for federal and state governments. For more information, visit www.InsuranceStudies.org.

Variables Can Skew Investment Performance
Investors in settled life insurance policies need to understand the effect of underwriting and mortality assumptions on investment performance, according to an analysis by Phoenix Life Solutions. The study’s authors see a potential risk in life expectancy estimators’ use of industry-standard valuation mortality tables when assessing life expectancy by age and sex categories. Recent experience of life insurance companies shows that Americans are living longer than the tables’ estimates. “Life settlements portfolios are a relatively new asset class, so their short-term results are not necessarily predictive of their long-term experience. Investors who don’t fully understand the factors that were used to determine the life expectancy estimates of life settlement portfolios could face significantly different returns on their investments than anticipated,” said John K. Hillman, president and chief executive officer of Phoenix Life Solutions.
For more information, visit www.phoenixwm.com/public/products/pls/index.jsp and at www.milliman.com.