Exempt Magazine

Hardly a day passes without someone approaching a charitable organization with the insurance industry's latest fundraising concept. In this case, it's life settlements.

"This is just another tool in your toolbox," said Reginald Jackson, a Redlands, Calif., financial advisor, asset manager and certified financial planner.

A life settlement entails the sale of a life insurance policy to an institutional buyer for an amount greater than its cash surrender value, but less than the death benefit. This process ordinarily involves a life settlement broker, who puts the policy up for bid before potential buyers. The purchaser either resells the policy or holds it until maturity to collect the death benefits.

Since there is no central collection source for data on the secondary markets that purchase life settlements, it's unclear actually how widespread the practice is among charities and donors. The settlements are cited on numerous university planned giving sites. But not many universities have handled such an arrangement, even though they have told donors about them. For example, information is on the site at Purdue University but its general counsel said the school has not yet handled one.

And while life settlements sound attractive, donors and charities must clearly understand the potential pitfalls if the transactions are not done correctly.

"The connection between life settlements and charitable organizations is just beginning to reach the radar screens of planned giving and development executives," said Marlene Frith, director of marketing and national accounts for Advanced Settlements, Inc., an Orlando, Fla., firm specializing in life settlements. "However," she continued, "our organization has transacted life settlements for a variety of charities with a very significant total face value. These charities have ranged from academic foundations to community foundations to religious organizations."

For many cash-thirsty charities, the temptation to utilize this concept to turn long-held life insurance policies into an immediate source of funds is appealing. Insurance executives contend that charities and individuals utilizing the life settlement arrangement can reap three to four times the policy's cash surrender value.

From a charitable giving standpoint, life settlement presents the opportunity to turn life insurance into cash now, said Jackson, who spoke on the topic at a recent fundraising event.

He explained that a donor could sell a policy that was no longer needed through a life settlement arrangement and donate all or some of the proceeds to charity. A charity could use the same process to sell a policy it owns.

Since most life settlements involve donors at least age 65 to 70, they are in the mainstream of major- and planned-giving prospects. Jackson suggested that this is simply another option to put before these prospects in certain situations.

Although a physical exam is not required to complete a settlement transaction, the insured must sign a release form permitting the life settlement company to request medical records for the past five years. Consequently, a nonprofit exploring a life settlement on a policy it holds must have the permission and cooperation of the insured, who is ordinarily the donor of the policy.

Policies can be universal life, whole life, second-to-die and even term policies, if convertible, Frith explained. "Group policies may also qualify if portable and convertible," she added.

Life settlements are generally for individuals and charities facing special circumstances that might make this technique a viable option to less appealing alternatives. "Life settlements are most commonly used in situations where the life insurance is no longer needed as determined by the insured and their advisors, or is a last-resort option in severe financial situations," explained Sarah B. Kaplan of the Kaplan Financial Group in Bethesda, Md.

"In a charitable donation situation, it is most common to see life settlement transactions where life insurance is no longer needed by the insured or the insured's estate. If the transaction is not suitable for the insured, serious legal and ethical dilemmas can arise," she cautioned.

More specifically, according to Advanced Settlements, a charity might wish to explore a life settlement on a policy if:
· It is struggling to pay the premiums;
· The policy is at risk of lapsing or being surrendered;
· The insured donor has expressed an interest in converting the policy into cash to benefit the organization now; or,
· There is a concern that the death benefit is in jeopardy because of the carrier's rating status.

There can be pitfalls to these types of arrangements, the least of which is the reaction of a donor when asked for five years worth of medical records. For example, NASD, the private sector regulator of America's securities industry, has issued an "investor alert," advising seniors to proceed with caution when considering life settlement arrangements.

"Life settlements can be a valuable source of liquidity for people who would otherwise surrender their policies or allow them to lapse -- or for people whose life insurance needs have changed," NASD reported. However, NASD also stated that "they are not for everyone," citing their potentially "high transaction costs and unintended consequences. And if you decide a life settlement is generally right for you, it can be hard to tell whether you are getting a fair price."

NASD advised that anyone considering a life settlement -- and this presumably would include a charity -- should work with a reputable broker, consider ongoing life insurance needs, less costly alternatives, obtaining a fair price for the policy and determining the financial implications.

Regulation of the life settlement industry falls within the purview of each state's insurance department, Frith explained. Right now, 27 states regulate life settlements. Individuals and charities should check on the regulations in their states. Federal securities laws might also apply.

Charities and donors should also obtain professional advice before agreeing to a life settlement to determine the legal, financial and tax consequences to the nonprofit and donor.

"One of the greatest concerns regarding life settlements is the suitability of the transaction for the donor," Kaplan said. "We strongly urge the donor to seek legal and financial counsel before agreeing to any life settlement arrangement."

For charities that choose to work with a third-party insurance or financial professional in pursuing a life settlement transaction, it is important to consult with those who are knowledgeable about life settlements, have the appropriate licenses, and who have a proven track record in handling these transactions.

Charities should discuss what commissions, compensation or fees the financial professional might receive if they are involved in the life settlement transaction.

Jackson also suggested charities review their gift acceptance policies to determine whether life settlement agreements would even be permissible. If not, the policies would have to be amended before proceeding, he said.

Frith acknowledges that the complexity of executing a life settlement agreement may be daunting to charities.

"Because the product is still in the early stages of its life cycle, and because life insurance is a complex topic, some charities do not have a full understanding of how the product works or the value it could bring to their organization," Frith said. "Lack of knowledge may result in charities having misgivings about considering it as a solution." E

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Michael Patterson is associate vice president of planned giving for the Arthritis Foundation and is based in San Antonio, Texas.