Using Life Settlements to Tap the Value of Hidden Assets

By Lori Friedman

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No corporate assets are more likely to be lost, left unaccounted for, or simply assumed to be valueless than life insurance. Often purchased as an asset of a corporation, it is often used to protect the company’s interest in a key employee or outside director. As corporations evolve, ownership changes, interests diverge, and many life insurance policies can become unneeded.

In the past, the owner of a life insurance policy who no longer wanted to retain the contract had two options: allow it to lapse or surrender the policy. When a term policy lapses, the policy owner receives nothing. When a permanent insurance contract is surrendered, the net cash value is paid to the policy owner.

A new option can tap the hidden value of these policies. Under the right circumstances, life settlements provide value in excess of the cash value built up within these policies. In many respects, it works like found money for a company or individuals who might otherwise simply walk away from a policy rather than continue to pay premiums.

There are limitations to when and for whom life settlements apply. The strategy works best when the insured has less than a 12-year life expectancy, has had a change in health since the policy was purchased, and the policy can be enhanced for the purpose of its sale. In select circumstances, however, life settlements provide a win-win way to receive value in excess of the simple cash value of a policy, while gaining a tax advantage and putting more cash into a business, an acquisition, or an individual’s retirement.

Example. A $35 million hotel holding company decides to acquire a smaller, $12 million operator. The smaller company has two shareholders, both in their late 70s, in failing health, with no effective succession plan. The company owns two $6 million universal life insurance policies, one on each shareholder. The owners’ exit strategy was to use the insurance to purchase the other’s outstanding shares, if one was to die. Each policy has a cash surrender value of approximately $400,000. The sellers each want $6 million in cash from the transaction. The buyer has only $3 million. Where would the balance come from?

A buyer could show the seller that selling the policies under a life settlement would generate $2 million of immediate cash. This is not enough to close the gap entirely, but the remaining $1 million difference could be financed over two to three years. The transaction would not work without the infusion of cash from the life settlement.

Example. The 75-year-old patriarch of a regional family-owned hotel developer retired five years ago, leaving the enterprise, valued at $10 million, to his two sons. His retirement was to be partially funded through an ongoing salary from the company in order to compensate him for serving as chairman and as a consultant to the business. Once the father is out of day-to-day operations, however, the sons begin squabbling and the business begins to fail. Cash flow dries up, and the sons cannot afford to continue funding their father’s retirement.

A $4 million universal life policy that they hold on their father’s life is in danger of lapsing because they cannot afford to pay the premium. The alternative to letting the policy lapse is to sell the policy to a funder for 30% of the face value, recovering $1.2 million to help fund the father’s retirement.

Lori Friedman is president of CFS, Inc., and Innovative Underwriters Inc. She can be contacted at (800) 4-INSURance.




















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