How to Handle Life Insurance Needs for Your Elderly Relatives

A recent cancer diagnosis has forced an evaluation of my Dad's finances. As we shake down the numbers, a huge monthly life insurance premium jumps out as one of the first items to address.

Just what we need right now, facing a major health care crisis -- $800 a month in premiums with 10% annual increases. Dad's been paying on this policy since he was in his early 50s -- now he's 73 -- and has put big bucks into it, easily over $100,000.

Seems like a complete rip-off.

Sure, the prospect of a $250,000 payout is nice for the heirs. But do we need the policy? What "protection" is it really providing? Are there better ways to use the premium dollars, not to mention the value tied up in the policy? Is my Dad's effort to do something good for us really a bad decision?

I set out to answer the question and that quest led me through some interesting choices, including an obscure corner of the insurance world known as life settlements. Life settlements allow you to sell the policy -- and get rid of the premiums -- to an investor for a calculated lump sum.

Hold, fold or sell
The first question: do you need the policy? Should the benefit stay intact for you or any other beneficiary? Or are the premium dollars better spent elsewhere? That, in itself, isn't a simple decision, but knowing the options will help you make it. Here they are:

• Keep the policy. You and other heirs will get $250,000 -- perhaps soon in my case. So if cash flow allows, $800/month might not be a bad investment. Dollars spent for the last 50 years are water under the bridge. But there may be better ways.

• Let it lapse. So you think $800/month is too much right now? Not surprising. That's what the insurance company wants you to think. Why? Because they're betting you might let the policy lapse. Many holders, perceiving that they already received their value, will let the policy lapse or cash it out for what may be a modest cash value. The insurance company wins. In fact, it bets on an expected number of lapses to make profit goals and keep premiums down for new policy buyers. Not on your back, though. It's probably not your best option, unless your policy is a variable life type and has built up substantial cash value.

• Sell the policy -- accelerated benefit. Depending on the policy, you may be able to go direct to the insurer for a so-called "accelerated benefit" -- if the insured has a life expectancy of 12 months or less. Ostensibly, the insurer recognizes you might need the money up front for medical expenses, etc. But it also realizes it will have to make a death payout soon, so a paid-sooner-but-diminished death benefit might make sense for it too. It can be a win-win -- but look at the numbers carefully.

• Sell the policy -- life settlement. Life settlements let you sell the policy to an investor, either directly or through a broker. The investor gets the promise of an eventual death benefit, but pays the premium and absorbs any changes in cash value for variable policies. You get cash now, and get out from under the premium.

Settlements -- what you can expect
Roy Shellhammer of RTG Consultants, a Florida life settlement adviser and broker, gave some great tips on the subject. Life settlements aren't always the answer, but they "provide another option," says Shellhammer. And as far as what you'll get, he'll tell you: "Every situation is different." And indeed it is -- life settlement investors use a complex formula driven by age and health to determine what you might realize.

You can go to a broker like Shellhammer to learn the alternatives and get started. "Normally it takes four to six weeks to go through the process, which includes a no-cost medical review and an evaluation of the terms of your policy." But clearly Shellhammer could explain the choices and give you a ballpark range pretty quickly.

Now the big question -- what can you expect to realize? The answer, of course, depends on how long the settlement buyer thinks the insured will live. "Most life settlements assume a maximum life expectancy of 16 to 17 years. For these situations, you might expect 18% to 27% of face value."

But for situations like my Dad -- I asked him about a three-year life expectancy -- the percentage of face value climbs to the 50 range. He also noted that if you qualify for an accelerated benefit from your insurer, the amount would likely be larger.

Other FYIs
Not surprisingly, there are a few other life settlement "facts" to be aware of:

• Taxes. Life insurance benefits are generally income-tax free. But what about a settlement? According to Shellhammer, the amount of a settlement benefit in excess of premiums paid in is generally taxable as a long-term capital gain.

• Type of policy. Most forms of "permanent" insurance -- whole life, universal life, variable universal life -- can be settled. Term policies can be settled too -- but only if they're convertible to permanent insurance, which many are.

• Time in force. Insurance rules are clear that policies can only be purchased by someone with an "insurable interest" in the insured's survival. You can't buy a policy on just any person anywhere. But can a life settlement investor own a policy on my Dad? The answer is yes: Insurance is an asset that can be transferred so long as bought legitimately in the first place, and so long as it meets the policy's "no contestability" period -- usually 2 years.

So this "primer" scratches the surface. It's a strategic decision involving "due diligence" with family members and lots of numbers. And yes, it's probably best to have an impartial financial adviser in the loop.

You'll have to go over the numbers and decide what to do with the settlement. Should saved premium dollars be used for long-term-care insurance or other medical costs for the aging parent? According to Shellhammer, it could even make sense to look into a new life policy -- things have changed since the 1950s.

And, says elder-law attorney and elderlawanswer.com founder Harry Margolis: "Don't take the first offer you see. Life settlements depend on a lot of factors. For any proposal you get, there might be a better one out there."

So if you have aging parents with life policies, especially parents with health issues, you have some tough decisions to make. The life settlement option may help with at least one of them.