Before Surrendering Life Insurance, Consider the Secondary Market.

Help your clients avoid unnecessary taxation by making life insurance integral to their multi-generational strategies.
Posted by: Marc L Lowell Category: Think Ahead

Chances are you have clients with a life insurance policy they no longer need or can no longer afford. Maybe they’re retired and have no dependents. Perhaps they have other plans for financially supporting their loved ones. And maybe they need the funds for other expenses. When any of these occur, most people think about surrendering their policy. They are paid the cash surrender value (CSV), which is the amount the insurance carrier pays to the policyholder if he or she decides to terminate the policy before it matures, minus any surrender charges.

But surrendering the life insurance policy may not be the best option, and, fortunately, it’s not the only option. History created an environment that led to the formation of a secondary market for life insurance. It emerged in the 1980s during the AIDS crisis when terminally ill policyholders sold their life insurance policies to generate funds that would help pay for their healthcare. The idea was popular with both policyholders and investors. Today the secondary market primarily serves policyholders over the age of 70 who are not terminally ill.

Although many people don’t know their life insurance can be sold on a secondary market, the fact that one exists should come as no surprise if you think of life insurance as a piece of property such as a house or a car. These are items you can sell if you no longer want or need them. Life insurance is no different. If it’s no longer useful to the policyholder, it may be time to sell.

Here’s how it works.

Policies that sell in the secondary market are already in force. He or she sells to a buyer for a negotiated purchase price.  The investor is not an individual but an investment entity such as a hedge fund that becomes the new policyholder and beneficiary.  Upon sale, all future premium payments will be paid by the buyer who receives the death benefit upon policy maturity.

The seller receives the sale proceeds.  There is an income tax consequence based upon the sale price as compared to a total of all premium payments made over the life of the policy.  In most circumstances, the gain and/or loss will be capital in nature.  Understanding the income tax consequences of the policy sale prior to closing is extremely important as the income tax may be material to the transaction.

Surrender or sell: which is best?

When faced with a decision about taking the cash surrender value or selling the policy on the secondary market for fair market value (FMV), how does a policyholder know which is best?

Let’s start with an understanding of fair market value, which is a function of how long buyers in the marketplace think the seller will live. It involves obtaining medical records and working with companies that can provide life expectancy reports. Generally, the shorter the policyholder is expected to live, the lower the premium and the higher the purchase price. Conversely, the longer the policyholder is expected to live, the higher the premium and the lower the price.

The benefits can be significant. When someone sells their life insurance policy on the secondary market, it generates a cash payment that can be used for other needs, such as long-term care and other healthcare expenses. It may also be an opportunity to invest the proceeds elsewhere. When an insurance policy is no longer wanted or needed, selling it can be an impactful investment strategy. On the other hand, not selling it could turn into a lost opportunity.

Work with a life insurance expert.

The process of selling life insurance on the secondary market can be complex, and that’s why it’s important to work with a seasoned life insurance expert. These individuals take policies to the open market, working with policyowners in an ethical and honest fashion. They understand the secondary market and how to expose the policy to qualified buyers. And they can provide an objective appraisal of the policy’s value.

Policyowners may be tempted to approach a singular buyer, but this only limits the competition. A direct buyer naturally wants to pay as little as possible for the policy, so direct sales often yield lower prices. Other sellers may approach a life settlement broker who markets the policy to many buyers, which increases the competition and drives up the price. Although the latter course is the preferred option, an even better route is to work with a knowledgeable and experienced life insurance expert.

Seeking the guidance of a life insurance expert can be beneficial for a number of reasons. First, this person understands the marketplace, knows how to position the sale, and is knowledgeable about which products are in demand. But it’s also important to work with someone who understands the tax consequences, given that the sale could result in a big capital gain or a big capital loss carryover. Beyond that, the seller should work with a professional who also knows what to do with the proceeds.

Although the majority of the policies bought and sold in the secondary marketplace are whole life, variable, and index, a term policy can also be sold. At the end of the guarantee period, the premiums are expensive and past the conversion, but if someone is ill and their life expectancy is short, there likely will be a buyer for the policy.

Talk to your clients.

Many insurance agencies discourage their agents from talking to their clients about the secondary market, and many simply aren’t aware that it’s an option. But when evaluating existing life insurance, keep in mind that surrendering the policy is often not the best alternative. Don’t let the insurance industry tell your client what they will give them for their life insurance policy. Your client could get significantly more in the secondary marketplace, and you could help them create enormous value.

Above all, work with a life insurance expert who knows how to maximize the policy’s value, understands the tax consequences, and is adept at migrating the proceeds into other products that meet your client’s needs. If you have a client who needs assistance in this area, please call us for more information.

About the Author


Marc L Lowell

After graduating from The University of Florida with a degree in Finance, Marc entered the financial services industry and began the two-year process of becoming both a Chartered Life Underwriter and Chartered Financial Consultant.