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Life insurance valuation: Key factors to consider

August 4, 2021 Article 3 min read
Authors:
Steven J. Gibson Wealth Management

When transferring a life insurance policy, valuation is crucial. But the answer to the question, “What’s the value of my life insurance policy?” isn’t always straightforward or consistent. Consider these factors.

Business professional working from home using their laptop computer.To achieve a range of financial goals, it’s not uncommon for an individual or entity to transfer a life insurance policy. It might be from a company to an employee at retirement, from company to owner upon sale of the business, from individual to trust for estate planning purposes, or even selling a policy from one trust to another. These are just a few examples and, regardless of the reason, the policy being transferred must be valued for income, gift, estate, or generation skipping tax purposes. But answering the question, “What’s the value of my life insurance policy?” isn’t always straightforward or necessarily consistent, and depends on the transaction details.

Fair market value and the life settlement market

Ultimately the answer should be “fair market value” (FMV) which is the price at which the property would change hands between a willing buyer and willing seller, neither being under any compulsion to buy or sell and having reasonable knowledge of the relevant facts. The fair market value approach works well for assets that have daily valuations or that are regularly bought and sold on a secondary market where the transaction has transparency and visibility. This is where life insurance policies have their limitations.

The life settlement market that would work for the willing buyer/willing seller definition of FMV typically limits its focus to purchase policies where the life expectancy is 15 years or less. The process can also be cumbersome, and buyers won’t put forth much effort unless they believe the seller will likely sell the policy.

What happens in other situations when we need to value a life insurance policy that’s changing hands?

The answer depends on many factors, including the facts and circumstances surrounding current and future policy ownership, policy age, and certain policy characteristics. These factors can help direct us to particular Internal Revenue Code sections and revenue rulings for guidance. One of the more common valuation methods referenced in the tax code is interpolated terminal reserve (ITR) value. ITR is used under certain circumstances when gifting a policy, and it’s also referenced when distributing a policy out of a corporation.

One of the more common valuation methods referenced in the tax code is interpolated terminal reserve (ITR) value.

The ITR value

ITR refers to a value calculated by the insurance carrier based on the policy’s reserve value at the point in time the policy is transferred. If you’re trying to determine the ITR before an actual transfer for planning purposes, you can request the current value and use that as an approximation until the actual transfer takes place.

The use of ITR by the IRS dates back to the 1960s when the most common insurance was annual renewable term and whole life. The calculations were relatively standard between insurance carriers for these two products. Since then, we’ve seen the creation of many new insurance products, including universal life, variable universal life, indexed universal life, guaranteed universal life, and many others.

Even term life insurance has an ITR that must be considered before gifting or transferring out of a corporation. Don’t fall prey to the misperception that because term insurance has no cash value, it’s worth nothing.

ITR caveats

ITR use relies on the carrier’s interpretation of which reserve the ITR references. This is because insurance carriers have tax reserves, statutory reserves, and AG 38 reserves. Combine this with how the carrier applies the interpretation to newer products, and you could have different reported values for two similar products issued by different carriers.

You could have different reported values for two similar products issued by different carriers.

ITR is only appropriate for certain policies during certain transactions. Language in the Internal Revenue Code states that the ITR method may not be used when, because of the unusual nature of the contract, current-value approximations are not reasonably close to the full value. This can be problematic when dealing with ill or terminally ill insureds on a contract. In many other situations when ITR is not the appropriate method, we have to use other methods to calculate fair market value.

Suppose you’re considering the transfer of a life insurance policy into a trust, distributing a policy out of a business, or transferring a policy to satisfy a debt. In that case, the issue of valuation is complex, and it can be helpful to seek professional guidance. Have questions? Feel free to reach out.

Securities are offered through Valmark Securities Inc. member FINRA and SIPC, an unaffiliated securities brokerdealer.

The material contained in the herein is for informational purpose only and is not intended to provide specific advice or recommendations for any individual, nor does it take into account the particular investment objectives, financial situation or needs of individual investors. Consult your financial professional before making any investment decision. The information provided has been derived from sources believed to be reliable, but is not guaranteed as to accuracy. Valmark Securities supervises all life settlements like a security transaction and its’ registered representatives act as brokers on the transaction and may receive a fee from the purchaser. Once a policy is transferred, the policy owner has no control over subsequent transfers and may be required to disclosure additional information later. If a continued need for coverage exists, the policy owner should consider the availability, adequacy and cost of the comparable coverage. A life settlement transaction may require an extended period to complete and result in higher costs and fees due to their complexity. Policy owners considering the need for cash should consider other less costly alternatives. A life settlement may affect the insured’s ability to obtain insurance in the future and the seller’s eligibility for certain public assistance programs. When an individual decides to sell their policy, they must provide complete access to their medical history, and other personal information.

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