When To Hold, When To Fold

Should an analysis argue for a sale, says Weinberg, then the advisor will have to make a second determination (depending on the client's objectives and insurability) as to whether to use part or all of the settlement proceeds to fund a new policy. The size of the settlement–a figure hinging in part on the type of policy to be sold–can help decide this question.

"The type of policy will not affect the analysis, but it will certainly impact the offer the client receives," says Caleb Callahan, a certified financial planner and director of life settlements at Valmark Securities, Akron, Ohio. "Universal life products provide by far the biggest bang for the buck on the secondary market. These policies are worth more to investors."

But Callahan adds that payouts in 2008 and beyond are likely to be less generous than in year past. "Regulation, litigation and realization of returns are all making the investor community more conservative," he says. "And so they're not likely to offer the large sums they paid in 2007 and prior years."

And what if an analysis dictates holding the policy? Assuming also the client needs cash, either to fund the remaining premiums and/or other financial objectives, then the individual should consider several alternatives. One option, observers say, is to exchange the old contract for a reduced, paid-up term policy, thereby eliminating ongoing premiums. The client could also draw down the policy's cash value to pay the premiums or sell a portion of the policy, funding the remaining death benefit at reduced cost.

As a fourth option, a policyholder might agree to split the premiums and policy benefits with a third-party, such as a family member or trust. When the policyholder dies, the third-party recovers its share of contributions to the premiums from the death benefit proceeds, plus a stipulated amount of interest.

Alton Crafton, a chartered financial consultant and president of Advance Financial Designs, Wichita, Kans., says that private split-dollar arrangements wherein a trust is both an owner and beneficiary of the policy are attractive for another reason: They allow the trust grantor (insured) to keep policy benefits out of the estate while also minimizing gift taxes. (Payments made to the trust to fund the premiums can be applied against the annual gift tax exclusion.)

"The advantage of private split-dollar is that only a portion of the gift to the trust–the true cost of insurance–is applied against the gift tax exemption," says Joseph Burgess, a chartered financial consultant and principal of North Star Resource Group, Minneapolis, Minn. "The grantor gets the cash value and the death benefit remains outside the estate. This is a true tax play."

For funding very large policies–those for which premium costs can total hundreds of thousands of dollars annually–the best course of action may be premium financing, experts say. A growing number of affluent clients are turning to this technique–taking out a loan from a bank or other financial institution to cover the premiums for a period of years–to meet short-term cash flow or investment objectives.

For some cash-strapped clients, the goal may be simply be to keep an existing policy in force to cover an estate planning need. More often, however, well-heeled clients will secure a loan to fund a new policy because their estate planning needs have grown; and because monies that would otherwise have been allocated to fund the premiums can be invested in high-yield assets that produce a return greater than the cost of the loan.

Whatever the objective, cautions Ted Bernstein, president of Life Insurance Concepts, Boca Raton, Fla., advisors and their clients need to scrupulously follow certain best practices to avoid either of two outcomes: (1) a pre-arranged life settlement (i.e., a premium-financed policy purchased for the purpose of subsequently selling at a higher price; or (2) a life settlement that is forced on the policyholder because the loan package is onerously structured or fails to include an exit strategy.

"Premium financing done right is about leveraging unused insurance capacity," says Bernstein. "The financing has to be done for the right reason–to fulfill a long-term insurance need–and with carrier compliance and acknowledgement."