Serving Affluent Clients

Connecting the dots between estate planning, philanthropy and life settlements.

July 19, 2007
Sponsored by Advanced Settlements, Inc.

by Sean McNealy and Marlene Frith

As wealth inheritance and retirement take center stage for aging baby boomers, financial advisors and insurance professionals are positioning their practices for this highly desirable market segment. Building a client base of affluent individuals may be the Holy Grail for some financial professionals and wealth managers, but servicing them requires sufficient knowledge of a wide range of products and services, and an understanding of the psychographic variables involving wealthy seniors.

It is worth noting that the common denominator underpinning estate planning, charitable giving and a life settlement transaction is the affluent senior over the age of 70. Therefore, financial professionals serving this demographic market must be capable of connecting the dots with sufficient knowledge in order to deliver an integrated wealth management solution that fits each client’s objectives.

Recognizing the role that life settlements can play in addressing estate planning challenges and maximizing charitable giving objectives is part of the required knowledge base for today’s successful advisors and wealth managers.

From an estate planning perspective, elderly parents of retiring boomers have already passed through the wealth accumulation and wealth preservation phases, and are either presently engaged, or on the cusp of the distribution and transfer phase. Their priorities revolve around who should receive their assets, and how and when those assets should be distributed. Decisions regarding charitable giving, maximizing distributable wealth, and tax considerations are major issues for seniors during the transfer phase. And often the cornerstone of the estate plan is a life insurance policy, the trustee for which may be a family member, a bank trust officer, trust company, an accountant or an attorney.

That said, financial professionals should be aware that there is mounting evidence that trust-owned life insurance policies are not being properly reviewed or managed by trustees. Insurance industry experts estimate that trusts own more than $1 trillion in life insurance coverage. Nearly 40 percent of the life insurance policies sold to these trusts were universal life and variable universal life policies that have not been monitored, and nearly 20 percent of them are on the verge of lapsing, insurance experts say. Supporting this statistic is the number of trust-owned life insurance policies that are settled in the secondary life insurance market. These policies are typically recommended for a life settlement after the insurance agent conducts a review of the policy’s performance and determines it is no longer performing as expected and may require infusions of cash to keep it in force. A review of life settlement transactions which we processed over the past year indicates that more than 40 percent of policies were owned by trusts; approximately 40 percent were owned by individuals; and the remainder was owned by corporations or charitable organizations.

A recent case in point involved a bank trust officer who relied on the expertise of an insurance agent when the agent discovered during an annual review that a $2 million trust-owned life insurance policy would require a substantial increase in premium payments in order for the policy to stay in force. The trustee explained that the grantors were unwilling to spend more money to maintain the policy, and consulted with the agent to identify a solution. The agent recommended they explore a life settlement and subsequently apply the proceeds toward the purchase of a replacement policy. In the end, the parties agreed, accepted a settlement for $460,000, and used the proceeds to purchase a new $2 million policy with lower premium payments. Needless to say, the clients were quite pleased with the solution, and the bank trust officer felt he had upheld his fiduciary duty as a trustee  —  thanks in large part to the insurance agent’s expertise.

Although insurance agents are typically more knowledgeable as it relates to evaluating policy performance and identifying situations where a life settlement may be the most suitable solution, other professionals serving as fiduciaries or gatekeepers to the wealthy are now beginning to recognize the need to expand their knowledge about life settlements, and the importance of interdisciplinary collaboration due to the complexity of life insurance and its role in estate planning.

Charles Ratner, insurance industry expert and prolific author, wrote last year that “Life settlements are having a major impact on estate, financial and insurance planning,” and he cautions “Don’t be surprised to see more life settlements as people realize that their balance sheets and income statements are losing the race against longer life expectancy.” According to industry statistics, the typical life settlement transaction involves a male with an average age of 78, and a life insurance policy valued at $1.5 million.

In terms of psychographic variables and understanding the mindset of their affluent senior clients, financial professionals must not underestimate the importance of philanthropy in estate planning. Affluent seniors are clearly among the most generous demographic group in the nation. In addition to motivating factors such as giving back to society, social reciprocity, and leaving a legacy, involvement with charitable organizations is also a part of the social fabric for many seniors.

The connection between seniors, wealth, and philanthropy is readily illustrated in recent data and surveys. IRS data indicate that almost 18.5 percent of recent estate tax returns reported a charitable contribution, the average of which was nearly $1.3 million. According to a Bank of America study of 30,000 high net-worth households released in October 2006, nearly 98 percent of those surveyed had donated to a charitable organization in 2005, and 61 percent served on Boards of Directors. The Bank of America survey found that the wealthiest 3 percent of American households were responsible for nearly two-thirds of charitable giving. And according to a report issued last year by the Center on Wealth and Philanthropy at Boston College entitled “Financial Resources and Charitable Contributions of Retired Households,” retired households on average own 48 percent more wealth and contribute 69 percent more to charitable causes than do non-retired households.

With those statistics in mind, it is important for the financial professional to understand the client’s charitable objectives, and the best methods to achieve them. For example, during an estate planning review, two things might be discovered: (1) The senior owns multiple life insurance policies, one of which is no longer needed to support the estate plan; and (2) the senior wishes to increase his or her charitable contributions. Rather than donate other assets in his estate to the charity, the senior may want to consider either gifting the life insurance policy to the charity directly, or pursuing a life settlement and subsequently donating the proceeds to the charity.

A gift of life insurance appeals to a variety of donors because it is cost-efficient, provides a tax deduction for premium payments, and because there is no erosion in payout due to administrative fees. For development staff at non-profit organizations with established procedures in place to accept and monitor them, gifts of life insurance can be a plus to their bottom lines as these policies reach maturity. However, similar to the challenges involved in monitoring trust-owned life insurance policies, charities are often ill-equipped to understand the complexities of life insurance and not capable of conducting annual reviews. Thus, donated policies are sometimes surrendered to the carrier, or in some instances allowed to lapse.

It is a well-known fact that life insurance companies rely on policies lapsing, and according to the Insurance Information Institute, in 2005 insurance companies reduced their exposure by $1.1 trillion when nearly 20 million policyholders stopped paying premiums. In comparison, the industry paid death benefits on only 2.2 million policies.

For charities struggling to properly manage insurance policies, one way to leverage such a situation would be for the charity to request the donor’s assistance in pursuing a life settlement, which generally averages three times the cash surrender value. Inasmuch as “cash is king” to most charities, the proceeds could be applied immediately to an endowment or other program to help achieve the donor’s legacy while he or she is still living. And because the senior had already been accustomed to making annual premium payments on the donated policy, the charity could ask the donor to consider purchasing a new policy with comparable premium payments, and name the charity as beneficiary. That way, in addition to receiving an immediate cash infusion for the initial policy while the senior donor is still living, the charity will later receive a full death benefit as well. Of course, it is important to bear in mind when considering a strategy of this nature that there may be obstacles to a senior being eligible for additional coverage, such as changes in health, advanced age, and so forth.

For charitable donors, seeing the results of their largesse during their lifetime not only provides a meaningful experience for the donor, but can also inspire increased giving. More than 58 percent of affluent households surveyed in the Bank of America study indicated that they would give more to charity if they were able to determine the impact of their gifts.

A common question that often arises as it relates to the donation of life insurance policies to charities is whether, for tax purposes, it is more advantageous for the donor to gift the policy to the charity, which later sells it in the secondary market, or for the donor to sell the policy and subsequently donate the proceeds to the charity. Because tax issues vary from individual to individual, it is important that donors of policies consult their tax advisor to weigh the tax ramifications.

Affluent seniors expect state-of-the-art products and services from their professional advisors. Financial services professionals, insurance agents, wealth managers, trustees, accountants and attorneys will be called upon by both baby boomers and their aging parents to help them navigate their way through the wealth distribution and transfer stage of their estate plans. Understanding the demographic and psychographic characteristics of high net-worth individuals, and offering creative solutions to complex problems, will help the best and the brightest come closer to achieving the Holy Grail of the financial services profession.

Sean McNealy is co-president of Advanced Settlements, Inc., one of the nation’s leading life settlement companies.

This article originally appeared in California Broker Magazine, February 2007. Reprinted with permission.