When a life insurance company wants to buy back a policy

I recently received another message from a life insurance company wanting to buy back from the policy owner a life insurance policy that was issued years ago. Such offers happen periodically, but this is the first time I have seen it from this operator.

In these situations, the insurance company offers the policy owner more money than the current cash value to surrender the policy. This approach often surprises the policy owner and he starts asking questions. The first is “Why would they do that?”

These situations usually involve Guaranteed Universal Life (GUL) policies. GUL policies have a guaranteed premium and a guaranteed death benefit and often have little, if any, cash value, especially compared to more traditional policies. My guess is that if a policy owner has, for example, a more traditional $1 million policy with a cash value of $300,000, they are more likely to consider surrendering it to use the cash value for alternative purposes than if they were $1 million GUL policy with $50,000 cash value. A non-cash GUL provides no incentive to surrender other than the promise of non-payment of future premiums.

Benefit to the carrier

It is a matter of economics and what would be in the best interest of the financial health of the insurance company. Some of the policies they issued in the past year proved to be “too good of a good deal” for customers. Let’s say there is a $5 million insurance policy with a cash value of $300,000. Given the age of the insured, the provisions regarding how much money the insurance company has to cover claims, and other factors, the company would like the customer to surrender the policy for $300,000 because that would be much less than the future liability funding of 5 million dollars. But the customer doesn’t want to give up, so they offer more than monetary value as an incentive. Economically, it’s simply better for the insurance company to try to get that liability off the books.

If the economics dictate that it is better for the carrier to buy the risk and the liability, it appears that target policies may be those that may be in the best interest of policyholders to maintain. I’ve seen quotes for quite a few different GUL policies, but when you calculate the internal rate of return (IRR) on the present cash value and the current premium to the future death benefit, the lower the cash value, the higher the IRR. This comparison does not make the IRR for the entire transaction from policy issue to death benefit payment necessarily better, but from the midpoint to the end, a GUL policy with a lower cash value generally provides a greater IRR than a traditional policy with a higher monetary value.

When evaluating the quote, the policy owner should review the original purpose of the policy. Do they still need it? Is the reason they originally took out life insurance still valid, or if things have changed, is there a need for an alternative current? If they decide they want to take advantage of the offer, it is important for them to understand the potential tax consequences of canceling the policy. A great offer can result in a gain that is taxed upon rejection.

Life Settlement?

The first thing I advise a client who receives such an offer is to think about it this way: “If the insurance company wants it because it’s a better deal for them to buy the death benefit today, maybe someone else would interested as well.”

I’ve done this before. In several cases, it turned out that the life insurance market eventually decided that the policy was also attractive. In fact, they thought it was more attractive than the insurance company and ended up making a higher offer. In the end, the policy owner got more, a third party got the deal they wanted, and the insurance carrier ended up leaving the policy on the books.

Bill Boersma is a CLU, AEP and licensed insurance advisor. More information can be found at www.OC-LIC.com, www.BillBoersmaOnLifeInsurance.info, www.XpertLifeInsAdvice.com or email at [email protected] at 616-456-1000.

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