Not Sure You Want to Continue Paying on that Life Insurance Policy?

Life insurance policies often are purchased well in advance of when the proceeds are needed. For example, people buy a life insurance policy that will, upon their death, inject cash into their estate so that the heirs don't have to sell assets, such as a business, to pay estate taxes. Or, the bread-winning spouse will buy a policy that will provide security for the non-working spouse in the event the working spouse dies prematurely.

Life insurance policies can also be bought to cover contingent business risks, such as "key-man" risk. Similarly, partners might fund a buy-sell agreement with a life insurance policy. The policy will then provide the surviving partner with funds to buy the deceased's interest.

As time passes, things change. Insured persons end up worrying more about having the necessary cash to live rather than how much will remain after they die. Non-working spouses pass and render useless the policy intended to provide for him or her. Key-man risk exposures pass and partners come and go on their own - outside of the buy-sell agreement.

When life insurance policies are no longer wanted or needed, you have four options:

1.    Cancel the policy/let it lapse (i.e., stop paying the premium)

2.    Exchange the policy for a new one with different, more appropriate characteristics;

3.    Sell the policy to an investor; or

4.    Do nothing (keep paying the premium).

As with any decision, an accurate understanding of the facts is necessary to make the optimal choice. Here, you must understand a little about the economic, financial and tax elements of life insurance.

One of the unique features of life insurance is that the death benefit is received tax free - as long as the premiums were paid with after-tax dollars and the beneficiary has an "insurable interest." Most any policy will originate with an insurable interest.

The evolution of the secondary market for life policies, viatical or other, has put policies into the hands of people or companies that have no insurable interest. These investors buy policies and name themselves as beneficiaries. The policy proceeds are then paid to them upon death. However, the tax benefits are not passed to the new owner. So, policy payouts are taxed as income.

Let it lapse? Millions of life insurance policies lapse each year. Insurance underwriters plan on this and their costs are thereby substantially reduced. The policyholders pay premiums and the underwriter never has to pay a death benefit. This, then, allows the underwriter to charge less for all policies because a death benefit must be paid on only a fraction of the policies.

The smartest financial decision regarding a life policy is a function of the monies required to keep the policy in place, the life expectancy of the insured and the death benefit (face value) of the policy. Life expectancy can be estimated. The death benefit and premium payments required are stated in the policy itself. Life expectancy, however, can be more difficult, but there are experts, called actuaries, who project such things. Contact your life insurance agent for assistance.

Exchange for a new policy? Let's assume that your policy is a $1,000,000 whole-life policy that requires five more years of $3,000 per month premium payments and has a current cash value of $100,000. If your primary motive is getting out of the monthly payments - but you would like to retain some death benefit coverage - contact the underwriter and ask him for options. If you are willing to contribute all or a portion of your cash value, you could simply use your cash value to pay the premiums or exchange the policy for one that is "paid up" (no more premiums required). The results might be a lower death benefit but an end to further financial obligation.

Sell it to a third party? Insurance policies, whether term, whole or universal life, are assets. They have value. The value depends on the term, the face amount (death benefit), the financial contributions that remain and the life expectancy of the insured. Another important financial criterion is the tax status of the beneficiary. In the case of a financial buyer, death benefit proceeds are taxable. So, the price that they will pay to purchase your policy will be sufficiently low to compensate them for the taxes that will be due as well as a fair rate of return.

Do nothing (i.e. continue paying the premium)? If the insured is aged or ill, the policy may have substantial value that exceeds the reasonable estimate of future premiums that will have to be paid. And, given the favorable tax treatment of the proceeds relative to that of a third-party buyer, the value of the policy, if kept in place, is far greater for the insured and/or insurable interest beneficiaries than to the investor. Therefore, an investor cannot afford to pay a price that approaches the built-in value to the originating insured/beneficiary. So, the best alternative typically is to find a way to keep the policy in place. For example, the beneficiary might be willing to take over payment of the premiums, based on his financial interest.

Where to find a third-party buyer for your life policy? Talk to your trusted financial and tax advisors. Keep in mind that investors in life policies and life-settlement brokers will be interested in the following factors that drive policy value:

• face value of the policy;
• estimated mortality of the insured;
• loans against the policy;
• cash value of the policy;
• rating of the insurance carrier;
• type of policy and prevailing interest rates;
• and premium payments required to keep the policy in force.

In conclusion, the sale of your life insurance policy might seem like an easy "win" at first. However, a life insurance policy is a unique and complex financial instrument. Before you act, gather the facts and consult knowledgeable advisors. One poor decision could wipe out years of prudent investment.