The Actuary Magazine October - The New Non-Forfeiture Value
The New Non-Forfeiture Value
by Alan H. Buerger
The secondary market for life insurance is redefining the way policies are valued.
Paradigm shifts dont occur overnight. Yet, somewhere along the line, there comes a convergence of factors that makes significant change inevitable. With regard to the secondary market for life insurance, this tipping point is already in the rear-view mirror.
In the last few years, the secondary market for life insurance has exploded onto the financial planning scene. Clearly, the markets basic premise, the consumers right to resell unwanted or unneeded life insurance, has been validated by the U.S. markets spectacular growth, which some experts estimate could exceed $10 billion in face value by 2007. More importantly, the market and its associated products, such as life settlements, are attracting significant attention from professionals outside of the life insurance industry.
Consider the estate planning community. A recent article entitled The Benefit of a Secondary Market for Life Insurance, in the Real Property, Probate & Trust Journal of the American Bar Association concludes that the secondary market for life insurance is both pro-competitive and pro-consumer. By allowing companies to compete for unwanted or unneeded policies, the secondary market has generated greater consumer choice, a wider range of products and favorable valuations for consumers. But the implications dont end there.
In the June 2000 issue of Bests Review, William Koenig stated, The current environment suggests that if an issuing company does not provide fair value, policy owners will proceed directly to a secondary marketpresumably, a viatical companyto get a better deal. There will be a secondary market for these contracts, and this will not be good for the life insurance industry.
While many in the industry disagree with Koenigs definition of fair value, no one can argue that policy owners have looked to the secondary market for a better deal. In effect, the secondary market has provided consumers with an independent market-based source of non-forfeiture value.
Non-forfeiture laws were developed to protect the policy owners right to access the equity in his or her life insurance. However, existing non-forfeiture values as calculated by insurance carriers ignore several key factors in determining value, including the health of the insured. As a result, they can dramatically undervalue a consumers asset. The secondary market, by contrast, provides a free market environment that offers an independent appraisal of an assets value.
In its simplest terms, a surrender is essentially the sale of a policy back to the insurance company for the cash surrender value. But what if the insureds health has declined since the policy was issued? The same rate class no longer applies and the policy may be worth considerably more than the surrender value. Until recently, if such a policy owner opted out of a policy via a surrender or lapse, the excess value was ceded back to the insurance company. The secondary market gives consumers the option to realize this value.
The consequences are profound. Like other assets, life insurance now has a fair market value. A policys worth can now be defined in terms of its actual value to buyers in a competitive marketplace. In other words, life insurance is now a fully evolved asset on a par with equities, bonds, real estate and other holdings. As a result, there is an entirely new reality to owning life insurance, and policy owners over the age of 60 should have their policies appraised, especially when considering a surrender or lapse.
A New Concept
By redefining the concept of non-forfeiture, the secondary market represents a challenge to the life insurance industry. Even so, Koenig goes on to suggest that the secondary market may, in fact, be good for the life insurance industry. Secondary markets generally strengthen primary markets, and in the years to come, we will come to realize that is the case with life settlements.
The regulatory community agrees. Both the National Association of Insurance Commissioners (NAIC) and the National Conference of Insurance Legislators (NCOIL) recently established new Model Regulation and Model Act positions that for the first time recognize that life producers have the authority under their existing licenses to assist clients with life settlements. In making this change over the vigorous objections of the ACLI, Ernie Csiszar, president of the NAIC, stated that the carriers were simply being protectionist.
As a result, a number of states are in the process of passing provisions that protect the consumers right to know about the opportunities available in the secondary market, and its likely that more states will be moving forward with legislation in the coming year. It is hoped that in this way, the insurance carriers and secondary market companies can begin to come together to protect the interests of the consumer and the investor as the market continues to grow.
Such regulatory action is sending a clear message to financial advisors that secondary market offerings are now within the limits of their fiduciary responsibility. What is the liability of the trustee who allows a thinly funded policy to lapse if the policy had a value in the after-market? asks Jon J. Gallo, JD, co-chairman of the Life Insurance Committee of the Real Property, Probate & Trust Law Section of the American Bar Association.
In an article published in California Broker, March 2003 entitled Will History Repeat Itself? Paul F. Kirsch, Esq. noted that a failure to disclose the material benefits of life settlements to clients could open the door to a new wave of consumer-based litigation. The first such case we are aware of involves a complaint against Paine Webber brought by the trustees of an insurance trust alleging that a Paine Webber broker discouraged the life settlement option (because it was company policy). The implications of these new responsibilities are a major factor driving advisors to demand to be educated about secondary market transactions.
Not surprisingly, the situation has attracted the attention of the capital markets. High-quality institutional capital is pouring into the secondary market, the importance of which cannot be overstated. Not only does institutional backing provide a secure funding source for secondary market transactions, it also provides the highest degree of consumer protection with regard to privacy and confidentiality, as well as a solid foundation on which the industry can grow.
But simple economics provide the most tangible account of the markets momentum. At Coventry First alone, the amount of insurance submitted for purchase in 2003 increased 230 percent to a total of $12 billion. This has enabled policy owners to receive more than $300 million over cash surrender value for their life insurance products that are underperforming or no longer needed.
This growth has led to our ability to introduce additional secondary market productsand even more options for consumers. For example, Settlement With A Paid-up Policy (SWAPP) enables policy owners to transfer the market value of an underperforming policy into a more appropriate level of coverage that is fully paid-up.
Change Is Good
The introduction of market value to the life insurance industry changes everything. It not only makes life insurance more flexible, more powerful and more valuable for policy owners, it also fundamentally redefines the way policies are valued. As the market-based paradigm takes hold, we can expect to see a continued migration toward more equitable and accurate non-forfeiture values in the future.
Alan H. Buerger is chief executive officer for Coventry First.