@Drop cap Minion:More and more senior citizens are seeking ways to make their leisure years more comfortable — or simply to make ends meet. Many are looking to liquidate or tap at least a portion of an asset that historically has gone untouched.
For example, two seniors asked recently if it were preferable to take a life settlement on their life insurance policy or to pursue a reverse mortgage. The answer depends on a variety of individual preferences, plus a person’s age, health, policy value, estate needs, home value and future housing needs.
A life settlement is the sale of an existing life insurance policy for an amount greater than the cash surrender value. Insurance policies are a saleable asset like a stock or bond. It is a financial option for seniors 65 and older who no longer need or want their current insurance policy.
Who would be a prime candidate for a life settlement? Typically, a surviving spouse whose children are now financially secure, a company that no longer needs to insure a key executive or seniors who are no longer able to pay the policy’s premiums.
Reverse mortgages were created as a safety or security net for people who wanted to stay in their homes and generate income. It has now become more of a valuable strategic planning tool for seniors as savvy borrowers use it to offset investment losses, etc.
Life settlement was created by wealthy executives as a secondary market for multi-million dollar company insurance policies, according to Eric Bachman, chief executive of Golden Gateway Financial, which facilitates both reverse mortgages and life settlements. That “product of privilege” has now moved toward a more mainstream product for anyone who has outlived their policy. The two began as products on opposite ends of the market, but have both moved toward the middle.
Deloitte Consulting was one of several companies to determine that the best return on a life insurance policy was to allow the policy to run to its full term. (Read its report at http://tinyurl.com/bukfjd.) The estate, typically the survivor’s spouse, children, other family members or charity, received the funds from the policy. However, that common plan does little to solve an immediate need or want. But be careful. There are an increasing number of states that have outlawed the practice of life settlements on a policy initiated by investors, known as STOLI (stranger originated life insurance).
A reverse mortgage historically has enabled senior homeowners to convert part of the equity in their homes into tax-free income without having to sell the home, give up title, or take on a new monthly mortgage payment. Reverse mortgages are available to individuals 62 or older who own their home. Funds obtained from the reverse mortgage are tax-free. The Federal Housing Administration, a component of the U.S. Department of Housing and Urban Development, insures the nation’s most popular reverse mortgage — known as the Home Equity Conversion Mortgage, or HECM.
Before needing financial assistance last year, insurance giant AIG had a significant stake in the Rex Agreement, a company that offered homeowners a lump-sum payment now in exchange for a portion of future equity in the home. It was an intriguing option for savvy investors who believed they could realize a greater return on investments than on home appreciation.
AIG also was heavily involved in premium finance life policies, another life insurance wrinkle that is mistakenly linked with a life settlement. Very few, if any, companies who work with life settlements will now deal with “premium life finance” programs because of litigation risk. A premium finance life insurance policy typically is purchased by wealthy persons over the age of 70 in good health with “significant” assets.
For example, a fit, 74-year old man who rides his bicycle 100 miles a week has assets of $4.2 million (including a home that surprisingly climbed in value). He purchases an insurance policy with a $4 million face value amount. The premiums for this life policy are $130,000 a year and are financed. After about two years, the man sells his policy for $800,000. After all commission costs, expenses, interest charges and legal fees, the man pockets $297,328.42.
How is this possible? First and foremost, the purchaser must be in excellent physical health and, consequently, fewer than 25 percent of people over 70 qualify for such a policy, insurance companies report. The premium finance company (the organization that loans the purchaser the money to pay the premiums) will charge interest between 8 percent and 12 percent to finance the premium loans. The premium finance company will require your personal promissory note in the amount of the premium loans.
Typically, after two years of premium payments, the policy is bundled with others and sold to an insurance company, large bank, hedge fund, pension fund, or private equity company for about 20 percent of the $4 million face value, or $800,000. The purchasing company or fund assumes the responsibility of continuing the premium payments. After the premium finance company is repaid, and after brokers are paid a fee for arranging the policy sale, the original purchaser nets about $300,000.
Maybe this is why AIG needed help.
Tom Kelly can be reached at www.tomkelly.com
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