by Chris Orestis, Life Care Funding Published July, 2009: New York State Bar Association Elder Law Journal
Life insurance polices are unprotected assets and state Medicaid programs expect any policy with cash value beyond a minimal amount to be surrendered for medicaid eligibility. Those proceeds would then be spent as a medicaid spend down on care before Medicaid eligibility and payments would begin. Instead of surrendering a policy for minimal cash value, the owner could instead receive considerably more through a life settlement. The use of proceeds is without restriction, and could be used to cover out of pocket costs and private pay home health, assisted living or skilled nursing arrangements until spent down.
Assume, hypothetically, that client, 67 years of age and in fair health, has determined that he and/or his wife will probably need Medicaid at some point in the future. Assume also that client has a 20 year whole life insurance policy with 13 years remaining with a cash surrender value of $81,039, an interpolated terminal reserve value of $90,050 (available from the life insurance company by requesting IRS Form 712), and a death benefit of $1,000,000 payable to his wife, and in the event she predeceases him, to his children. Client’s other assets consist of a modest home (valued at $350,000) and other assets totally $125,000. Assume further that client’s family history indicates a shorter than normal life expectancy, but that his wife is likely to live well into her 90’s. Traditional estate planning might suggest that the preferred approach to the above facts would involve Credit Shelter and Gap estate planning or early gifting of the home or other assets to the client’s children to steer clear of the 5 year look back rule, or some combination of the foregoing. But assume that client was concerned about his children’s spendthrift tendencies and creditor issues such as claims by spouses and therefore was unwilling to turn control of his hard earned assets over to his children.
An alternative planning strategy is for the client to gift (assign) the life insurance policy to a trust of which his children are the sole Settlor’s, Trustees and Beneficiaries, thereby removing the proceeds from both his estate and that of his wife’s. Because the policy held in the children’s trust is relatively illiquid (assume the trust requires unanimous consent of all the children to act) and is subject to a spendthrift provision (which defends against creditor claims), the policy is generally protected from the client’s concerns regarding his children as stated above. Assume too that the above trust contained a provision which gave the children a pro rate right of withdrawal if any life insurance policy was subject to a viatical or life settlement, similar to that provided above. Though the gift tax value of life insurance is generally its replacement cost, Treas. Reg. §25.2512-6(a), that cost can vary depending on the type of life insurance involved. In the above circumstances, the value of the whole life policy probably would be its interpolated terminal reserve value ($90,050) at the date of the gift plus the unused portion of the last-paid premium. Now assume that 5 years later client has been diagnosed with aggressive cancer and is not expected to live longer than 4 years, though there is a chance he might fully recover but the treatment is very expensive. Assume further that the proposed treatment will quickly use up most, if not all, of the client’s remaining assets and that husband and wife now need to apply for Medicaid assistance. Assume too that the client’s children have determined that a life settlement will pay out an amount greater than any existing cash surrender value for the current assignment of the ownership of the policy. Assume children in fact liquidate the policy through a life settlement and use the funds to establish a special or supplemental needs trust for parents to supplement said parents’ needs and provide them with luxuries not covered by Medicaid, such as vacations, a leased vehicle, credit cards etc. Not withstanding the unfortunate circumstances described above, an early gifting strategy and a life settlement combined with a special or supplemental needs trust for parents provided for a safety net for the above hypothetical clients. Removing the life insurance policy early, when its value was low, also provided a level of protection from the 5 year look back rule and perhaps some relief from estate taxation.
Medicaid Life Settlements
A life insurance settlement is the sale of a life insurance policy by the owner while still alive to a third party institutional investor. The seller receives a lump sum payment in exchange for transferring ownership of the policy and the final death benefit. The investment entity takes over the premium payments and carries the policy for the remainder of the insured’s life. The right of a policy owner to engage in a life settlement was guaranteed when U.S. Supreme Court Justice Oliver Wendell Holmes ruled in 1911 (Grigbsy v. Russell) that life insurance is personal property and the owner is protected by all the same inalienable rights that any owner of real estate, stocks or any other assets enjoy. This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to sell the policy to a third party. By the end of the 20th Century, Viaticals emerged as an opportunity for AIDS patients to cash out of a life insurance policy while still alive to cover the high costs of care not covered by health insurance. The Life Settlement market became an offshoot of Viaticals and has been growing rapidly ever since, with $13 billion in transactions completed in 2008. In a 2003 study conducted by Conning & Co, they estimated that 90 million senior citizens owned approximately $500 billion worth of life insurance in 2003, of which over $100 billion was owned by seniors eligible for Life Settlements. The Wharton Business School issued a study where they observed, “Life insurance policies are typically assignable, which means that a policyholder is free to transfer their ownership of the policy to another person. A policyholder’s right to assign their policy to someone other than the insurance carrier has existed for some time.” The study also went on to observe that a life settlement, “gives the policyholder the economic freedom to choose between a number of buyers and, in so doing, to receive the fair market price for their policy.” A number of insurance industry organizations such as the National Association of Insurance Commissioners (NAIC), National Council of Insurance Legislators (NCOIL), American Council of Life Insurers (ACLI), National Association of Insurance and Financial Advisors (NAIFA), American Association of Life Underwriters (AALU) and the Life Insurance Settlement Association (LISA) have also recognized the legal rights of a policy owner to liquidate a life insurance policy through a life settlement. Stuart Reese, chairman, president and CEO of MassMutual Life Insurance Company said that if a policy is first purchased with protection in mind and is no longer needed after a period of time, then a contract holder does have property rights and “there is a legitimate Life Settlement business which is consistent with the purpose of insurance.” Q:Is it time to consider cashing in a life insurance policy for its Life Settlement Value? A:If a policy owner has outlived the purpose of a life insurance policy, has decided that it has become an under-performing asset, or has had a life event that requires liquidity– then selling a life insurance policy through a Life Settlement transaction should be considered.
Life Settlement Eligibility
- Age 65 or older (younger ages can be considered based on health) all forms of life insurance can qualify.
- Life Insurance policy with a minimum face value of $50,000.
- Process takes 90 days or less.
- There are no caps on the amount of money that can be raised through a Life Settlement.
- A Life Settlement is the sale of an asset, not a loan, and has no restrictions or requirements to be secured or paid back.
- There are no upfront fees paid by the policy holder.
- The policy owner is no longer responsible for paying premiums once a Life Settlement is complete.
- A policy owner is under no obligation throughout the process. Once a Life Settlement is complete, the policy holder will receive a lump sum payment in exchange for the policy.
Irrevocable Life Insurance Trusts (ILIT)
For clients that no longer need or want to sustain an ILIT, the option of cashing in the policy for its highest possible value through a life settlement should be considered. The trust is the owner of the policy and it can be sold with the proceeds going back into the trust to be administered for the beneficiaries. Through the use of simple amending language to the ILIT; withdrawal provisions could allow for the treatment of the proceeds to be administered as if the still alive insured was deceased. Consider, for example, your typical Irrevocable Life Insurance Trust (“ILIT”). Generally, an ILIT will provide that only upon the death of the Settlor (i.e., the person who established the trust), the trustee will collect the proceeds of any policy on the life of the Settlor and will administer and distribute the assets for the benefit of the beneficiaries. But what if the Settlor is not deceased but the policy has been subject to a life settlement? What if the Settlor survives for many years to come? Can the beneficiaries access the funds in the ILIT as if the Settlor was deceased? Does the Settlor want the beneficiaries to have that access? Regardless of the answer to any of the forgoing, the ILIT should specifically address the issue of life settlements. For example, the ILIT might at some point provide: Notwithstanding any provision herein to the contrary, in the event any policies of insurance on the Settlor’s life are paid prior to the Settlor’s death as a part of any viatical settlement or similar life settlement, the Settlor shall be treated for purposes of administering and distributing the proceeds of such policies as being deceased. Alternatively, the ILIT might provide: In the event any policies of insurance on the Settlor’s life are paid prior to the Settlor’s death as a part of any viatical settlement or similar life settlement, the Settlor shall not be treated for purposes of administering and distributing the proceeds of such policies as being deceased. Alternatively, the ILIT might provide a withdraw opportunity for beneficiaries in the event of a Life Settlement, such as the following: Notwithstanding any provision herein to the contrary, in the event any policies of insurance on the Settlor’s life are paid prior to the Settlor’s death as a part of any viatical settlement or similar life settlement, any beneficiary for whom a trust is being held pursuant to this Trust may request that the Trustee distribute to such beneficiary such amount or amounts of principal, including all of his or her net trust estate; provided, however, that the Trustee shall not be required to satisfy any such request unless all the Trustees then serving (of which there must be at least two (2) Trustees, at least one of whom must be an Independent Trustee, as defined herein) consent in writing to such distribution. This power of withdrawal shall be validly exercised only if exercised voluntarily and shall not include an involuntary exercise. The foregoing are just a few examples of some of the simple drafting considerations estate planners might consider with regard to ILIT’s and life settlements. A life settlement would also be an applicable option in the case of “SILITs” (Special Needs Irrevocable Life Insurance Trusts). Again, the basic idea being that the Settlor (or children) set(s) up an ILIT with early distribution trigger language, allowing the beneficiaries (i.e., the children) to pull life settlement (or cash surrender value) out of the trust and establish a special needs trust for parents if the need arises. Early action before illness is critical. If the parent never needs the benefits of the SILIT, so be it. But if they ever do, the investment in the policy premiums may one day act, with direction of the children, to assist them to live a better life despite the need for public assistance. In short, ILITS really aren’t just for the rich trying to make good use of their annual gift tax exclusion and can work just as well for public assistance planning. The Life Settlement industry provides an important and efficient function to the insurance marketplace–– and it is a practice established by the Supreme Court. This unique financial tool presents estate planners with new opportunities that are only just beginning to be recognized as such. The introduction of life settlements into the estate planning world should cause every practitioner to stop and think about the implications such settlements may have and how strategic planning can (or the lack there of) might impact a client and his or her family.”
Chris Orestis, president of Life Care Funding, a national life settlement company, can be contacted at 888-670-7773 x 2 or firstname.lastname@example.org
Special thanks to Smilie Gregg Rogers, Esq., of Bergen & Parkinson for contributing to this article