What is the FMV of a life policy?


Life insurance is an asset and like any assets, it has many different values. The FMV of a life insurance policy is the amount that an informed third party dealing at arm’s length would be willing to offer to purchase the life policy in question.

Normally to determine the FMV of a policy, a policy owner would hire an actuary to do the valuation. Usually the process would start with a pre-evaluation which is a rough estimate of the FMV. The cost is $250 to $500. This estimate is then used to decide whether there are any benefits in ordering a full valuation which usually cost around $2,500.

Example: John is the policy owner of a T100 with a death benefit of $200,000 where premiums are paid for life and where there are no cash values. He took the policy at age 55 thinking it would be nice if his children could get a little something when he becomes an angel. The premium is $2,500 per year. He is thinking about cancelling the policy because his children are well off and there is no need for it anymore and he could use the premium savings. If he cancels the policy to save $2,500 annually; he will get no cash values from the insurer. Luckily he came across our calculator finding that the same policy would cost him a minimum of $12,500 annually if he was healthy and a lot more if his insurability was bad. The difference of $10,000 between the current premium and replacement premium results in a Fair Market Value of $100,000. Basically if he liquidates the T100, he will be giving away $100,000 to the insurer. Now that he knows about the value of his policy, he can look at various strategies from charitable giving to selling his policy to a third party in order to extract the $100,000 out of the policy for his own benefit.

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Replacement Value

What is the replacement value?

The term replacement cost or replacement value refers to the amount that you or a thrid party would have to pay to replace the insurance you have at the present time, according to your current health of insurability.

The actuarial value is equaled to the Present Value (Future Benefits) – Present Value (Future Premiums)

The replacement value is equaled to the Present Value of the premiums payable for an hypothetical new policy with the same features as the policy you have – Present Value of the premiums payable for the existing policy + Value of any benefits of guarantees offered by your policy no longer available in a new policy (i.e interest rate guarantee of 4% in your current Universal Life policy).

Why is the Replacement Value represents the best approach to determine the FMV?

The CRA defines “Fair Market Value” in paragraph 3(a) of its Information Circular 89-3, Policy Statement on Business Equity Valuations, where it states that: market value is the highest price, expressed in terms of money or money’s worth, obtainable in an open and unrestricted market between knowledgeable, informed and prudent parties acting at arm’s length, neither party being under any compulsion to transact.

CRA adds more information in its Summary Policy Statement (reference number CSP-F02): Fair market value generally means the highest price, expressed in dollars, that a property would bring in an open and unrestricted market, between a willing buyer and a willing seller who are both knowledgeable, informed, and prudent, and who are acting independently of each other.

Some actuaries believe that it is inappropriate to use replacement cost because this would be inconsistent with the CRA definition mentioned above. Their reason is that the third-party would not be able to purchase a new life insurance policy on the life of the life insured. This reason is not valid. The existence of an open and unrestricted market is irrelevant. The Fair market value must be determined in this context which makes the replacement value the better representation of the FMV.

Who does an Insurance Audit?

A Life Audit is very much different than a Life Valuation and includes components usually not included in a Life Valuation conducted by an actuary. This includes:

1. Past review of the history of the policy to determine the effectiveness of how the policy was sold and manage.

2. Determination of the current Fair Market Value of the policy using the Replacement Value approach.

3. Determining the future Fair Market Value under different scenarios allowing you to decide whether it would be more advantageous to enter into a life settlement now versus in the future.

To conduct an audit, the auditor must have a very broad expert knowledge of life insurance. The auditor must also not have any conflict of interests that would prevent him from criticizing objectively the insurer which designed and sold the life insurance policy. Most actuaries would be faced with such a conflict of interest.

4. Click here to understand why you should be careful in using an actuary to get a life insurance audit of your policy.

5. Click here to understand what you should consider before employing an insurance expert in a civil trial against an insurer which could cost you more than $40,000



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