Life Settlements: Five Lessons for Agents and the Case for Optimism
Cynthia Poveda

With attention focused on troubled equity, bond, and mortgage portfolios, barely noticeable to many is that fact that the life settlement market struggled last year.

There is little doubt that financial advisors and their clients have embraced life settlements. Life settlements were only a fringe curiosity a decade ago. Since then, the industry’s annual transaction volume has grown to more than $12 billion by some estimates. Advisors aggressively sought the liquidity afforded by life settlements on behalf of their clients. Forward-thinking institutional buyers were eager to add in-force policies to their portfolios. They were attracted by the defined payout, easily calculated servicing costs, and underlying viability of the asset.

But recently, advisors have watched relative offers for clients’ policies plummet, assuming they could get any offer at all. In extreme instances, offers were pulled before they could even be presented to the policy owner or strict take-it-or-leave-it offers were extended with very short deadlines for acceptance. Not surprisingly, deal flow receded and confusion and indecision replaced the rampant confidence that was so apparent in the market a year ago. As collateral damage, relationships at every point of the settlement process were severely strained between funder and broker, broker and advisor, and advisor and client.

What Happened?

The credit markets, which began to tighten in the fall of 2007, have had a profound, game-changing effect on the settlement industry and its processes.

Buyers’ lines of credit were frozen, reduced, or not renewed as liquidity concerns heightened. At the same time, hedge funds came under pressure from declining asset valuations elsewhere in their portfolios, leading to an exacerbation of deflation due to capital withdrawals. Other settlement investors chose to simply exit the market for the near term while waiting for a more accommodating credit environment.

All this would have made settlements difficult enough, but industry participants are also contending with a dramatic rule change that is affecting the process at a more primary level. In mid-September, 21st Services, a widely-utilized life expectancy company, adjusted its underwriting methodology, resulting in statistically significant increases in expectancies on the order of 20% or more. Applying the longer projection suggests a longer investment horizon than originally anticipated, which drives prices down.

Five Lessons for Agents

When properly applied, a life settlement can be a valuable, flexible component of a financial plan. With that in mind, here are five points to remember when exploring the life settlement option on behalf of a client.

Lesson One -- See the Big Picture and the Long-Term

While it’s probably normal to be distracted by negative circumstances in the broader markets, advisors would be wise to not lose sight of the big picture and the long-term view. The credit market issues and related concerns do not detract from the intrinsic appeal of the life settlement transaction.

Settlements often remain a very good option for assisting clients in meeting their financial goals or obligations, when their needs regarding their current policy have changed. Potential benefits from a settlement include a cash payment higher than cash surrender value, relief from premium obligations, access to immediate cash for current expenses, and the ability to transfer assets to more suitable, possibly better performing investments or insurance policies.

Lesson Two -- Life Settlements Provide Options

There are likely as many reasons for executing a life settlement transaction as there are individual financial planning needs. Changes in personal priorities, estate planning matters, or even business circumstances can lead to the decision to settle the policy. Typically this decision results from some combination of a desire to discontinue making premium payments, replace the current policy, or use the proceeds for another purpose.

Recent clients have needed to fund long-term care programs or address family medical emergencies. Still others wanted to accelerate their charitable giving arrangements, ensuring that their chosen beneficiary is able to meet operating or capital improvement plans as desired. Last year, for example, a faculty member from a Midwestern university was able to initiate the endowment of a department chair for the school, thanks to the proceeds from his settlement.

A settlement broker should be able to provide detailed case studies that will illustrate how a settlement transaction can benefit the client. 

Lesson Three -- Manage Expectations

Clients, especially in the context of a complicated financial transaction like a life settlement, need to have their expectations managed properly, then reasonably met.
Pre-qualifying, the process of determining if a particular case is a good candidate for a settlement, as determined by certain criteria pertaining to both the policy itself and the underlying insured, is the initial step in managing client expectations. This preliminary analysis is important in determining if the policy is likely to sell.

To ensure that the client is not expecting an offer out of line with the realities of the current market, the settlement broker should run an insurance valuation report, which estimates the marketability and value of the policy in the secondary market. These reports can typically be provided within 24 hours of receiving the necessary policy and insured information.

It is also critical to select a broker with an experienced negotiation staff. This ensures that the policy is shown to potential buyers most likely to present acceptable offers.

Lesson Four – Don’t Procrastinate

A common complaint from agents is that life settlements take too long to complete. And while a settlement can sometimes run upward of three months, there’s much an advisor can do to move the process along.

As is the case with the entire life settlement process, communication between the broker, advisor and client is critical to successfully closing a transaction. Bear in mind that to ensure the protection of all parties involved, ownership of the policy does not transfer and funds are not dispersed until every required document is signed and notarized, and all necessary items are submitted and reviewed. This means that clients must be continually updated regarding what documentation is needed to move the process forward.

Because a closing package will typically contain around 100 pages of documentation, it helps to have a designated point person on the agent’s staff, who can gather required documentation and signatures and keep the process on track.
The bottom line: An agent involved in a settlement is better off procrastinating on almost anything else. Settlement-related requests should be a front-burner priority.

Lesson Five -- Don’t Go it Alone. Please.

Regulatory oversight of the settlement industry continues to grow. About 40 states have implemented some form of regulation, and about two dozen are considering either modifying those laws or are implementing life settlement regulations for the first time in 2009.

The increased attention is beneficial to the industry, because it discourages and limits specious activities by marginal players. This provides a higher comfort level for both buyers and sellers and should lead to healthy growth in the industry for years to come.
But it also means that attention must be paid to the expanding details associated with every settlement case.

Licensing parameters must be respected, transparency and disclosure requirements should be strictly adhered to, and client suitability and buyer due diligence should be given the highest priority.

But these obligations should not discourage agents from pursuing good settlement cases. An experienced settlement broker, with dedicated case managers and full time legal and compliance staff, can ensure that the process runs according to law. So don’t go it alone.

What’s Next?

Looking forward, there are reasons for optimism. Interest in the life settlement transaction continues to grow. As we anticipated with the start of the new year, more activity among buyers is evident. Initial activity has focused on “sweet spot” cases – those with policy face value under $3 million and life expectancies under 10 years – but we expect interest to broaden.

New capital coming to the market appears to be truly “new-to-the-industry” money, which is obviously positive. However, new buyers are usually tentative and allow themselves a couple of months to get familiar with market levels.  Most in the industry are looking toward the late second quarter of 2009 for significant improvement.
In any case, in this environment, it is crucial to work with an experienced broker who can help an advisor inform clients as to the marketability and potential value of a policy.

The key is to be prepared when the recovery reaches full momentum.
––––––––––
Cynthia Poveda is executive vice president at Life Settlement Insights, a Cleveland-based life settlement brokerage. She can be reached at 877-574-4321, or e-mail Cyndi.Poveda@LSInsights.com.