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The FMV_Life App has been designed as a tool for financial advisors in order to give them the ability of doing a quick estimation of the Fair Market Value (FMV) of an insurance policy. Currently advisors are unable to provide any information regarding this value because it is not in the interest of many insurers. However the fiduciary duty of the insurance advisors requires that they inform their clients of this value. Breach of such fiduciary duty, by not disclosing the FMV of an insurance policy, could have severe consequences on the career of a financial advisor and financial situation of a client.
What is the FMV?
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.
The FMV_Life App replaces the pre-evaluation which will save time and money to the client. The FMV_Life App provides an estimate of the value of the death benefit. However it does not include the value of any other guaranteed benefits such as interest guarantee, paid up additions… The values of such guarantees should be determined through a full evaluation.
Do I have to do an evaluation of the policy by an actuary if I want to use the FMV of my policy?
The answer is negative. An actuary provides an actuarial evaluation of the policy. That evaluation may be different than what the FMV truly is. An actuary may not know what a third party will offer you for your policy. However we recommend that such a valuation takes place as it easier for the policy owner to justify an FMV, if it has been used in a transaction resulting in a tax benefit, if the policy owner can refer to a rigorous analysis.
Why is the FMV of my policy important?
Because policy owners are unaware of the FMV, they are unable to choose the best form of settlement for their policies. As a result in the USA alone, policy owners mostly made of seniors lose $112 billion in life insurance benefits every year.
What is a life settlement?
There are many definitions of a life settlement. This has created a lot of confusion. Insurers have simplified a life settlement to the notion of a Viatical life settlement to discredit any form of settlements outside of the forms of settlement they offer through the life policy contract. We believe it is wrong and that to protect consumers we have to change the level of discussion in order to view a life settlement from a comprehensive perspective.
A life settlement is the disposition, wholly or in part, of an interest in the property of a life insurance policy in favor of a third party for or without any forms of considerations.
There are two main types of life settlements and they are contractual life settlement and non-contractual life settlements.
Contractual Life Settlement
A contractual life settlement is the disposition of an interest in a policy, wholly or in part, under one of the provisions found in the life policy contract. In this case the third party who receives the interest in the policy is the insurer. There are 3 main types of Contractual life settlement;
1) Cash Value Settlement: This is the liquidation value of a policy whereby a policy owner liquidates his death benefit position in exchange for the cash value of the policy (CSV). We could state that in exchange of the CSV, the insurer regains the property of the death benefit. Usually the liquidation value (CSV) is inferior to the FMV and this is why liquidation is very profitable to the insurer.
2) Loan Settlement: Most life policy contract allows the policy owner to take a policy loan against the cash value of his policy without having to liquidate his death benefit position. Interest will accrue against the loan as per the interest rate stated in the contract. This rate would be currently a lot higher than current interest rates. Depending on the Adjusted cost base of a policy, this loan may be taxable contrary to a loan made under a non-contractual life settlement.
3) Living Benefit (Disability and Critical illness): The Disability benefit is the payment of the CSV tax-free when the insured is faced usually with a total disability or a critical illness. The living benefit is different. When an insured is faced with an illness that has significantly decreased its life expectancy, the policy owner could request an advance on the death benefit. This option was a response by insurers to justify their opposition to Viatical settlements. Sadly insurers have not honored their promise and have made the qualifications extremely difficult to meet in order to qualify for a living benefit. It is obvious!!! Insurers would prefer that the policy owner takes the CSV instead of offering an advance on the death benefit.
Non – Contractual Life Settlement
A non-contractual life settlement is a settlement obtained outside of the contract with a third party that is usually not the insurer.
1) Leveraged settlement: This settlement involves using the life policy to secure one loan or series of loan by assigning the policy as collateral. The third party is a lender which is usually a bank. Sadly the banks are only willing to consider the FMV of a policy and only loan on the CSV of the policy. This type of settlement is usually used to create additional retirement income.
2) Corporate settlement: This is a very important type of settlement and involves a transfer of ownership of a life policy between an individual and a corporation. The tax liability or tax benefit is based on the FMV of the policy and this is why an evaluation of the policy is highly recommended for this type of settlement. Usually there is a tax liability upon the transfer of a policy from a corporation to an individual and a tax benefit when the insurance is transferred from an individual as a tax free rollover to a corporation. An individual considering between cancelling the policy to get the CSV or the rollover will select the rollover if the tax benefit of getting the money out of the corporation equaled to the FMV of the policy less tax paid on the disposition of the policy is greater than the net after-tax value of the policy.
3) Family settlement: This should be the most common type of life settlement and the fact it is not illustrate that advisors are not conserving life policies. Prior the cancellation of a policy, the policy owner should have a discussion about the FMV of his policy with his family to see if the members of the family are willing to take over the policy by continuing paying premiums even if the cash value is withdrawn. The knowledge of the FMV permits to do a straight Internal Rate of Return analysis of paying the premium versus the FMV of the policy. This type of settlement can also be done on a Split Dollar basis as described below.
4) Charitable settlement: This type of settlement involves the donation of the life policy to a charity. Revenue Canada now allows the transfer to be done at Fair Market Value instead of at Cash Surrender Value. The financial decision of proceeding with the donation will depend whether or not the value of the Charitable tax credit is greater than the after-tax value of the CSV.
5) Reverse loan settlement: This loan takes its origin from the Reverse Mortgage. The third party is usually a private lender who will accept to do a loan based on the death benefit and life expectancy of the insured. The policy is assigned as collateral and the policy owner retains the property of the life insurance. For provinces where this is considered trading and where trading is prohibited, this type of loan is still available. However the policy will not be directly assigned and a claim will instead exist against the estate. Since there is no change of ownership, there is no disposition and therefore the amount received is not taxable or reduced by taxes.
6) Viatical settlemet: This is an arrangement whereby the policy owner is selling his life insurance policy to third part that is in the business of buying such life policies. There is a change ownership and will trigger a disposition of the policy which may result in taxes. Also the amount of the FMV above the proceeds of disposition will also need to be included in the income of the policy holder. As a result, from a tax perspective it is the least advantageous. A policy owner would proceed with such settlement if the net after-tax amount received is greater than the net after-tax cash value
7) Split dollar settlement: This type or arrangement involves the splitting of a life insurance policy into two benefits, the death benefit and cash surrender value benefit with one of the benefit owned by the current policy owner and the other benefit transferred and owned by a third party under a rental or ownership agreement. Popular at issue of a policy, this type of settlement can also be put in place at anytime in the life of a life policy. This type of arrangement could be combined with a family settlement or corporate settlement. For example, a policy holder would transfer on a rollover basis the death benefit of his policy to his investment corporation in exchange for the FMV but would retain the ownership of the CSV and the ability to further invest into the policy on a personal basis if for example the policy had an interest rate guarantee of 4%.