Introduction: In answering our questionnaire, you have asked not only whether this policy might potentially be sold for more than its limited cash value but also whether it might be worthwhile to keep the policy and continue to fund it in light of what may be the reduced life expectancy of the insured.

     In this initial review, we cannot give a definitive answer to either question without one or more medical evaluations to determine the insured’s probable life expectancy. However, we can suggest some guidelines for evaluating the pros and cons of either course of action based on the information given.

     Determining a policy valuation in the secondary market: The perceived value of a life insurance policy will vary with the nature of the owner. An existing owner will likely have relatively conservative expectations for a policy consistent with the investment rate of return of the underlying assets supporting the cash value of the policy. However, an investment entity that purchases the policy will do so with a business purpose. The life settlement industry is relatively new, and the profitability of it is somewhat uncertain. Given the degree of risk involved with investing in an asset class that has a limited history of demonstrated investment returns, such as life insurance policies, most industry observers suggest that investors will seek a rate of return objective of at least 12 percent to compensate for this perceived risk.
     The beneficiaries of a policy will normally receive life insurance proceeds free of income taxes. However, the purchaser of a policy in a life settlement transaction may owe taxes on the policy proceeds it eventually receives in excess of the purchase price plus the subsequent premiums it invests, depending on whether or not the policy purchaser is a tax-exempt entity, such as a pension plan. If the purchaser owes such taxes, the prospective tax cost will reduce the price it is willing to pay while still seeking its targeted profit margin.

     Possible life settlement value of this policy: There is a distinct possibility that this policy would be valued in excess of its cash value by a purchaser in a “secondary market” (life settlement) transaction. An underwriting analysis of the insured’s current medical condition could well conclude that his probable life expectancy makes this an attractive investment for an institutional investor that holds many policies with insureds having a similar medical profile to the insured.
      Whether it is a good investment for the current owner of a single policy with these characteristics is a different question. As discussed below, given the small amount of remaining cash value in this policy and the rising premiums necessary to sustain it over future years, there could be a considerable risk that the insured will live to the point that the policy will produce a very low or negative rate of return. Most of those with the medical profile of the insured may not live to the point that continuing to fund a policy of this kind would become a poor (perhaps even worthless) investment. But some of them probably would, and that is a risk that would need to be quantified. As a practical matter, the increasing outlay necessary to maintain the policy after a certain point would likely lead to a policy lapse if the insured “lives too long.” This is a risk that an investor of multiple policies under the same circumstances could afford to take by spreading the risk over several policies, while the owner of a single policy of this kind may not want to assume such a risk

     The importance of life expectancy in determining a policy’s value: The potential investing entity in a life insurance policy needs a good analysis of the possible life expectancy of the insured and the future premium commitment necessary to realize the policy’s eventual death benefit. As a general rule, for there to be a very good likelihood that a policy will have a life settlement value in excess of its cash value, the health of the insured needs to have declined to the point that the underwriting class of the insured, if applying for a new policy, would be two gradations below the category in which the insured was placed when the original policy was issued.
     The possible life expectancy of the insured is equally important to the current owner of the policy in determining whether to retain it. A life insurance policy becomes more valuable if the health of the insured has declined. If a policy purchaser can make a handsome profit on the policy after paying more than the cash value for the policy plus the subsequent premiums – and perhaps after also incurring taxes on a portion of the death benefit – the policy should be even more attractive, one would think, as an investment for the current owner, since the beneficiaries would receive the proceeds free of income taxes. However, if, as in this case, a policy has little cash value left in it, it is essentially a term insurance policy with steeply increasing premiums at older ages. There may be an unacceptable risk for the owner of a single policy of this kind that the insured will live so long that the continuing premium investment will produce an unacceptably low return, or perhaps a negative return, or even an infinitely negative return if the policy lapses because of unaffordable premiums. Again, that may be a risk that an investor in multiple policies of this kind can afford to take and still achieve a healthy profit margin, because the losses from some of these policies will be offset by gains from other policies where the insureds die well before their anticipated life expectancies. Assuming the same risk may be imprudent, however, for the owner of a single policy betting on the duration of a single life.
     In the attached spreadsheets (not included in this sample report), you can see what the rate of return would be for the current owner in each possible year of death for the insured out to age 90. These assume the “investment” of the initial cash value or possible life settlement amount in the first year and the stream of annual premiums shown and then the receipt of the eventual death benefit. The returns looks attractive (5% or greater) until age 84, 82, and 80 assuming, respectively, no life settlement offer in the first case and then forgone life settlement purchase offers of $100,000 and $200,000 in each of the next two spreadsheets.
     With the results of a life expectancy evaluation, however, we could determine risk of an unacceptably low, negative or even worthless return if the policy is retained and whether it would be worthwhile or unwise to accept that risk in exchange for a possibly high return if the insured dies within the most likely range of life expectancy.
     With such a life expectancy report, we could also determine a range of what an investment entity might pay for this policy in order to meet its profit goals for investments in all such policies. That would provide a benchmark against which to gauge the merits of any life settlement purchase offers that may eventually be made.

     Initial findings and recommendations: Our initial conclusion is that, in light of the apparent decline in the insured’s health since the time the policy was issued, there is a significant possibility that the policy could have a meaningful life settlement value in excess of its cash value. This potential should be fully explored before the owner surrenders it. A life expectancy evaluation will enable us to provide a range of the possible life settlement value of this policy.
     That same life expectancy analysis will enable us to specify the potential reward for the current owner in maintaining the policy and also to quantify the risk that the policy could become a poor or worthless investment if the insured lives beyond his anticipated life expectancy.

     Possible Next Steps: We suggest the following next steps with which we could assist:

     First, have us order a life expectancy evaluation. This will cost $400-$500 and somewhat more if there are multiple evaluations. We suggest paying this cost even though many life settlement brokers will absorb it as a cost of doing business. You should be able to recoup it in a negotiating any eventual brokerage commissions or fees if you do sell end up selling the policy. Paying this cost out-of-pocket for now will be helpful in maintaining an independent and open-minded about the possible desirability and feasibility of keeping the policy rather than selling it.
     A life expectancy evaluation only involves a release of the insured’s medical records. Unlike an application for new life insurance, it does not require a medical exam.

     Second, once the life expectancy evaluation is complete, engage us in an additional analysis of the pros and cons of selling the policy, if it does have life settlement value, versus retaining it or pursuing alternative measures such as selling an interest in half the policy and retaining the rest. We will perform this review noting the probabilities, potential benefits and risks with each possible course of action for $500.

     Third, if a life settlement appears to be the best alternative, ask us to help identify a broker with the knowledge and experience to have access to all of the potential reputable investors in life settlements and the insight and integrity to stay clear of those who might be unsavory.
     Our assistance in negotiating the broker’s commission, if you do attempt to sell your policy, rather than approaching a broker through a life insurance agent, such as the one who sold the original policy, will considerably reduce the commission because brokers tend to pay much or most of the commission to life insurance agents who refer life settlement cases to them.

     If you like, please call to discuss our findings and suggestions and the additional ways we can help you determine the right course of action with this policy.