The past two years have not been overiy
kind to the life settlement market.
The economic crisis of 2008 dried up much
of the capital of the institutional investment
community, resulting in the life settlement
universe being cut by nearly half. Then the
Internal Revenue Service issued an often-confusing ruling last August that attempted
to clarify the tax treatment for life settlements.
Adding to that were major changes in the actuarial tables in late 2008, extending life expectancy by as much as 10-25 percent.
And lastly, the predatory image of life
settlement brokers coercing seniors to take
out and subsequently sell their policies was
amplified by a high-profile lawsuit filed by
former New York State Attorney General Eliot
Spitzer against Coventry, one of the country’s
largest life settlement brokers, accusing it of
bid-rigging to keep seller prices down.
After a rough patch, life settlements are returning to the investment horizon
BY BILL CARLINO
insurance policies to a third party when they
can no longer afford the premiums or otherwise don’t need the policies is a sounder
investment than the insurance carrier’s cash
surrender value, which is often a fraction of
the policy’s death benefit.
Opponents argue that the industry is unregulated and thus ripe for fraud, although 40
states now have some form of life settlement
regulation through state insurance boards.
Most recently, New York, Illinois and California have established regulations on the sale
side of life settlement policies, requiring buyers of life settlement policies to be licensed.
“Do you know of any other industry in
which the buyers have to be licensed and
not the sellers?” asked Doug Head, execu-
tive director of the Life Insurance Settlement
Association in Orlando, Fla., a 130-member
trade group, who estimated that the market,
if they sell it to a third party, the owner’s basis
is not equal to the full amount of premiums
paid, but instead the cost basis consists of the
cumulative premiums paid into the insurance
contract plus a subjective “cost of insurance”
or “provision of insurance” figure (see “Life
and taxes,” at left, for an example).
An owner buys life insurance on his
own life with his family as beneficiary.
He pays $64,000 in premiums over
eight years, then surrenders the policy
for $78,000. During the eight years, he
pays $10,000 in “cost-of-insurance”
charges. If he surrenders the policy,
he has $14,000 of ordinary income
($78,000 cash surrender value minus
$64,000 in premiums).
However, should he sell to an
A NEW MODEL
investor for $80,000, the owner now
has $26,000 in taxable income. That
includes $14,000 in ordinary income
($78,000 CSV minus $64,000 premiums
paid) and $12,000 long-term capital
gain income ($80,000 sale price minus
Under Rev. Rul. 2009-13 the IRS
analyzes the transaction as “the sale
or other disposition of property,” and
inserts an “adjusted cost basis,” rather
than “investment in the contract.”
Therefore, the seller’s basis in the
contract must be adjusted to reflect the
hypothetical $10,000 cost of insurance.
Thus, the adjusted cost basis then
drops from $64,000 to $54,000. There-
fore even though the seller received
just $2,000 above the CSV, the total
gain is $26,000 ($80,000 sale price
minus adjusted basis of $54,000).
LIFE AND TAXES
Daniel Powell, chairman and chief executive
of Los Angeles-based investment concern
Christian Stanley, echoed Head’s optimism
about future growth in life settlements, but
said that the industry model itself remains a
large part of the problem.
“There’s a lot of potential, but [the life set-
FINANCIAL REFORM ENACTED
tlement industry] is archaic. They’re still us-
ing the same buy-and-hold model they have
for years,” said Powell. “As a result, there’s not
enough new money coming in and the poli-
cies that have been purchased are just sitting
in someone’s vault waiting to mature.”
Powell said that his firm has created a new
financial vehicle, a “Life Shares” mutual fund
comprised solely of reverse life insurance
policies. “What we’ve done is turn it into a
securitization business,” he said. “Everyone
should know what they could sell their policy
for, just as you would your house or your car.
You should have it appraised. You and your
accountant need to sit down and figure out
WASHINGTON, D.C. — President Obama
has signed the sweeping financial regulatory reform bill into law. The bill contains
a vast array of provisions, including the
creation of a Bureau of Consumer Financial Protection and the ability to close
down failing financial institutions.
The act also expands the authority of
the Public Company Accounting Oversight Board to regulate auditors of brokers and dealers by providing them with
standard-setting, inspection and disciplinary authority regarding broker-dealer
audits. It also allows the PCAOB to share
information with foreign auditor oversight
authorities, and exempts smaller public
companies with a market cap of under
$75 million from Sarbanes-Oxley Section
404(b) audits of management’s assessment of internal controls. CPAs and tax
preparers are exempted from regulation
by the Bureau of Consumer Financial Protection, and CPAs may be called upon to
assist in audits of the bureau by the U.S.
KPMG BUYS GT’S
SUPPLY CHAIN PRACTICE
NEW YORK — Big Four firm KPMG has acquired the supply chain advisory services
practice of Grant Thornton LLP in order
to expand its restructuring capabilities.
Financial details of the transaction were
not disclosed. The acquisition is expected
to strengthen KPMG’s existing restructuring services practice. The transaction also
includes Grant Thornton’s Vontik software
system, and the addition of 23 professionals to KPMG. KPMG will also take
over existing Grant Thornton projects at
several Fortune 500 companies.
Yet with roughly $1.5 trillion of in-force life
insurance either lapsing or surrendered on
an annual basis, life settlements — the sale
of an existing policy to a third party via the
secondary market in exchange for a one-time
cash payment — are slowly inching their way
back onto the investment landscape.
“We’re seeing more institutional buyers
re-entering the marketplace,” reported Amy
Garvartin, director of advanced markets for
Melville Capital, a life settlement broker in
Scottsdale, Ariz. “But there’s a lot of misconceptions out there about life settlements and
YEA OR NAY
Proponents of life settlements contend that
allowing the sick or elderly to sell their life
which was once valued at roughly $16 billion,
has been winnowed down to somewhere
between $6 billion and $8 billion. “There’s
a potential for a lot of investment here,” he
opined. “But you also have to realize that it’s
not a short-term investment. Now I think the
market is more reflective of moderate growth
with better-informed investors and sellers.”
However, Head said that last year’s IRS rul-
ing on the tax treatment of life settlements
may spark some investor reluctance.
PROCEED WITH CAUTION
However, not everyone is as anxious to wade
into the life settlements market.
“I’m skeptical of them,” said Glenn S. Daily,
a fee-based insurance consultant in New York
who provides reviews of life settlement offers.
“I work off the presumption that the policy-
holders are giving up too much money. In a
case I did last year, the insured was 85 years
old and the son was the owner of the policy.
We reviewed the policy as an investment, but
if she lived a long time, he could lose money.
He only got two offers and knew he was leav-
ing a lot of money on the table.”
Dave Mickelson, a chartered financial
consultant, accredited estate planner and
principal of Mickelson Capital Consulting in
Oceanside, Calif., maintains that every case is
different and requires a professional to assess
the risks and rewards: “When it’s all said and
done, you need to have a financial planner
look at the situation. ... There’s never a simple
answer. But it’s not rocket science.” AT
IRS ASSET SEIZURES DECLINE
WASHINGTON, D.C. — The number of
assets seized by the Internal Revenue
Service’s Criminal Investigation Division
fell in 2009 and 2008, according to a new
report from the Treasury Inspector General for Tax Administration. During fiscal
year 2009, the CI Division seized 1,624
assets, a 13 percent decline from the
previous year, and a 28 percent decline
from the six-year high in FY 2007. However, the decline in the number of assets
seized can be partly attributed to the decrease in the number of illegal source and
narcotics investigations initiated during
that period, and the loss of experienced
special agents in recent years.