Life insurance used to be a waste of money for those who no longer needed a policy or could not afford it, but not anymore.
For those over the age of 70, a new market has been created a secondary market on life insurance. Now policyholders can pay only the premiums for a multimillion dollar policy, hold onto it for two years and turn around and sell it for a hefty profit.
“I have always felt that it was ridiculous that while there existed a secondary market for stock, real estate, automobiles, jewelry, etc., there was never such a market in life insurance,” said Barry Kaye, author of the two all-time bestselling books on life insurance and estate planning. “Now all of a sudden it exists, therefore making every policy possibly more valuable.”
Smart Business spoke with Kaye about life insurance policies and the growing popularity of the secondary market.
What does a secondary market mean in life insurance?
In the past, if you no longer needed a life insurance policy or you couldn’t afford it, you would drop it. You might receive a minimal amount of money from the insurance company based on the cash surrender value.
With the new secondary market, you may possibly be able to sell your policy. This makes your policy a better asset, and certainly worth much more than previously. Assuming you’re over 70 years old, you might get 10 to 25 percent of the death benefit, depending upon your age, current health and the amount of the policy.
How does a policy qualify for the secondary market?
It’s the man who qualifies, but the policy has to be on someone with the right age, the right health and the right premium. If the age is too young or the health is too good or the premium is too expensive, it won’t work. The barometers are 72 to 85, but ideal the age is 77 to 81. Health should be decent and it should be a standard or preferred policy.
How can you take advantage of the new secondary market?
This market requires a great amount of inventory in order to function in the best interest of the public. In many situations, people between 72 and 85 would purchase a policy. Under the law, they would have to retain it for two years, and then they could sell it into the secondary market.
A perfect example would be a 75-year-old purchasing (pro rata for more or less) a $10 million policy for approximately $600,000 of premium covering the first two years. At the end of that period, they could possibly receive 20 percent of the face value for $2 million. This would result in a profit of approximately $1.4 million.
This could be used to recover any losses in investments or to provide a nest egg for retirement or to purchase a new life insurance policy to pay estate taxes. As this became more popular, banks and funding companies offered to loan the money to the insurance on a nonrecourse basis, which paid the entire premium for the first two years, including interest and fees.
In this manner, there was no outlay, yet a potential tremendous profit at the end of the period.
Who buys these policies in two years?
Coventry, Berkshire Hathaway, pension funds, hedge funds and many other institutions. We never sell policies to individuals. They are then securitized and rolled up in trusts, similar to second trust deeds. These institutions buy these policies because they get an excellent return when they purchase them from people with a 10-to-12-year or less life expectancy.
How can this program benefit charities?
One example is a policy that was purchased for $7.5 million on a 75-year-old man. The actual premium outlay for two years was $550,000. The policy was sold at the end of two years for $2.4 million, thus returning the funder, who lent the money to the insured, the original $550,000.
This left the insured with a profit of $1.85 million, which he was able, after paying capital gains tax, to give to charity at no cost whatsoever. Furthermore, the entire contribution, based on qualifying, and his tax bracket, produced an approximate tax savings of $600,000.
Why would a company pay $2.4 million for that policy?
The institution that purchases the policy knows that ultimately the insured must die, which guarantees their return. They pay the premium based on life expectancy, which is 85 years of age. In this case that would be eight years, plus what they paid him, and that still amounts to less than half of the $7.5 million that they will eventually receive.
Barry Kaye is an author and industry leader on life insurance and estate planning. For more information on the secondary market for life insurance, contact him at (800) 343-7424 or e-mail him at [email protected].