Why would they do this? What are the advantages/disadvantages of accepting this offer?
I recently received another communication from a life insurance company looking to purchase back from the policy owner a life insurance policy issued years earlier. Offers like this happen periodically, but this is the first time I’ve see it from this carrier.
In these situations, the insurance company offers the policy owner more money than the current cash value to surrender the policy. This approach often take the policy owner by surprise, and they start asking questions. The first is “Why would they do this?”
These situations typically involve guaranteed universal life (GUL) policies. GUL policies have a guaranteed premium and a guaranteed death benefit and often have little, if any, cash value, especially relative to more traditional policies. I imagine that if a given policy owner had, for example, a more traditional $1 million policy with $300,000 of cash value, they would be more likely to think about surrendering it to use the cash value for alternate purposes than if it was a $1 million GUL policy with $50,000 of cash value. A GUL with no cash value provides no incentive for surrender except for the promise of not paying future premiums.
Benefit to Carrier
It’s a matter of economics and what would be in the best interest of the financial situation of the insurance company. Some of the policies they issued in the past year turned out to be “too good of a good deal” for clients. Let’s say there’s a $5 million life insurance policy with a $300,000 cash value. Given the insured’s age, regulations regarding how much money the insurance company has have on hand to cover claims and other factors, the company would want the client to surrender the policy for the $300,000 because that would be much less than funding for the future liability of $5 million. But the client doesn’t want to surrender so they offer more than cash value as an incentive. Economically, it’s simply better for the insurance company to try and get that liability off the books.
If the economics dictate it’s better for the carrier to buy off the risk and obligation, it seems the target policies may be the those that might also be in the best interest of the policy owners to maintain. I’ve seen offers on pretty disparate GUL policies, but when you calculate the internal rate of return (IRR) on current cash value and ongoing premium to future death benefit, the lower the cash value, the higher the IRR. This comparison doesn’t make the IRR on the entire transaction from policy issue to death benefit payout necessarily better, but from a midpoint to the end, a lower cash value GUL policy generally provides a greater IRR than a higher cash value traditional policy.
When evaluating the offer, the policy owner should be reconsidering the original purpose of the policy. Do they still need it? Is the reason they originally secured life insurance still valid, or if things have changed, is there an alternate current need? If they do decide they want to take advantage of the offer, it’s important for them to understand potential tax consequences of surrendering the policy. A great offer may result in gain that would taxable on surrender.
The first thing I advise to a client who gets such an offer is to think this way about it: “If the insurance company wants it because it’s a better deal to them to buy out the death benefit today, maybe someone else would be interested as well.”
I’ve done this before. In a couple instances, it turned out the life settlement market ended up thinking the policy was attractive too. In fact, they felt it was more attractive than the insurance company did and ended up making a higher offer. In the end, the policy owner ended up with more, a third party obtained the deal they wanted and the insurance carrier ended up with the policy staying on the books.
Bill Boersma is a CLU, AEP and Licensed Insurance Counselor. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.com or email at firstname.lastname@example.org of call 616-456-1000.