Consumers who have purchased a permanent life insurance policy — such as whole life or universal life — are familiar with a distinctive number on their regular account statements from their insurance carrier. Unfortunately, many people are confused about what this number truly means...and even worse, many of their financial advisors are unaware of important information they need to place its value in its proper context.
Understanding Cash Surrender Value
The number I am referring to is Cash Surrender Value (CSV). Cash surrender value refers to the funds that will be due a policyholder should they choose to surrender, or "cash in" their policy. With permanent policies, it's the savings component that's built up by paying premiums above the cost of the insurance in the earlier years of the policy.
In other words, CSV is the cash that an insurance company will pay to a policy owner for terminating the policy and relinquishing his beneficiaries’ claims to the benefit that they would have received upon the insured’s death. The amount of this cash payout will change from year to year based on premiums paid, interest earned, the cost of insurance charges determined by the life insurance company, and other various carrier-imposed fees.
Receiving the cash surrender value can be very tempting if the policy owner no longer wishes to continue making annual premium payments. It is a guaranteed and immediate cash transfer into a designated bank account - sign some papers, terminate the policy and the carrier will issue the CSV check.
The problem is that cash surrender value has no correlation to the only way of properly evaluating the value of a life insurance asset – Fair Market Value (FMV). Most consumers associate this metric with other assets, such as houses cars, but rarely apply such association to a life insurance policy.
Understanding Fair Market Value
Fortunately, FMV has a common understanding because it is a mainstream term that is clearly defined by the Internal Revenue Service. According to the IRS regulations, “[T]he fair market value is the price at which (1) the property would change hands between a willing buyer and a willing seller, (2) neither being under any compulsion to buy or to sell, and (3) both having reasonable knowledge of relevant facts.”
So how does this definition apply to the challenge of determining the FMV of an asset like a life insurance policy? It means that the policy needs to be exposed to an open market consisting of qualified potential buyers, as part of a no-pressure and no-obligation process, and that both the owner and prospective buyers have full knowledge of the facts related to the policy and its value.
The FMV of a life insurance policy is determined by the current market conditions of supply (number of policy owners seeking to sell their policies) and demand (number of investors interested in buying policies), but there are a few common variables that influence how much cash a policy is worth to prospective buyers:
If an investment fund can earn an attractive return on the purchase of a policy, it will offer to buy the policy for an amount that is greater than the CSV; in some cases, the payout could be multiple times higher than the CSV offered by the insurance company.
How Do You Know the True Value?
So how is the true market value of a life insurance policy determined in order to learn whether the CSV or the FMV is the best financial option?
The only practical way to arrive at the FMV for a life insurance policy — based on the three considerations contained in the IRS definition above — is to work with a professional firm who has a duty to act in the policy owner’s best interest and will gather and present relevant facts about the asset to buyers and sellers. With life settlement transactions, the only duty as described above, according to state regulations, is fulfilled by a licensed life settlement broker.
Life settlement brokers take policies to the open market of qualified and licensed life settlement providers and share information to policy owners in an honest and ethical manner. The FMV of any policy is determined in real-time as the competitive marketplace determines what the policy is worth, from the first bid to the final bid.
Before a policy owner even explores the market, the prudent course of action is for him or her to receive an objective appraisal of the policy’s value. Crossroads Financial Group can prepare a no-cost, no-obligation pre-market pricing valuation for each insurance policy, leveraging more than 20 years of experience in the industry. This confidential assessment provides immediate insight into whether the policy is likely to command offers and whether the FMV is likely to exceed the CSV.