Qualified Appraisal

Due to the lack of guidance from the IRS regarding the determination of fair market value of a certain policies, and the vast inconsistencies in methodologies amongst life insurance companies, an owner of a policy may argue that the fair market value is more accurately represented by a qualified appraisal that uses the “willing buyer, willing seller” standard. The “willing buyer, willing seller” approach is found in Treas. Regs. §§ 20.2031-1 and 25.2512. The Treas. Regs. provide that “[t]he value of the property is the price at which such property would change hands between a willing buyer and willing seller.” Therefore, a qualified appraisal using the “willing buyer, willing seller” approach is an alternative valuation method, which may be used to justify a lower sale price than the IRS Form 712 calculated.

Secondary Market Valuation (SMV)

Determining fair market value of a life insurance policy may no longer need to be a guessing game. The policy can be valued similarly to other pieces of property in the secondary market for life insurance. The secondary market for life insurance can produce an alternative value than the insurance carrier will provide. All types of policies can qualify, including term, if the policy fits the current purchase parameters.

A regulated and institutional framework has developed over the past decade to formalize the “willing buyer and willing seller” in a transparent platform. Policy owners and their advisors are no longer forced to rely on outdated rules for calculating fair market value. There is a proven methodology and process to determine a life insurance policy’s value based upon the current health of the insured and by analyzing the details of the life insurance contract and premium streams.

Revenue Ruling 59-60: A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases.

• In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science.
• A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance.

The methodology to estimate the fair market value of a client’s life insurance policy is outlined in a process known as the Secondary Market Valuation (SMV). This process employs standardized industry practices and analytics, which consist of a combination of analyzing the insurance contract, policy values, required capital outlay (premiums), database comparatives, and the life expectancy of the insured. The process is simple to follow and easy to integrate into an existing planning process. The insured and policy owner complete the appropriate forms and disclosures, and current information is obtained and reviewed to determine the potential value of the policy and the options that might exist.

Some of the common fact patterns for advisors and their clients participating in the Secondary Market are in situations such as:

• Determining the fair market value of the contract
• Transferring a policy from one entity to another
• Completing a business valuation – including insurance or annuities
• Valuing a Convertible Term Contract for a buy/sell or key-executive
• Split Dollar rollouts
• M&A or bankruptcy transactions
• Exit-Planning recommendations

The process to evaluate a policy begins with contacting the insured and policy owner to sign the state regulated forms that provide the proper authorization to begin the valuation process. The following items and steps are required to build and facilitate the bidding process. The critical steps include a collection of the last five years of medical records, acquisition of independent life expectancy reports from licensed providers, review of database comparisons for reference, and engage the licensed buyers/capital markets to facilitate the bidding process.

The most attractive policies to institutional buyers are those that were issued standard or preferred and there has been a change health since issue. Ideal policies were issued by highly rated insurance carriers, with very low credit risk or volatility, and have a manageable carrying cost or future premium streams. This is important due to the illiquid nature of the asset itself. Buyers in the current market require returns similar to other alternative investments, as they are committed to a longer duration and have to maintain considerable capital commitments and reserves.

This life insurance asset and Secondary Market for Life Insurance is known globally as “Longevity Risk.” Top-rated insurance carriers performed better than banks during the Credit Crisis of 2008-2009 and both domestic and global funds became attracted to the non-correlated aspect of this asset class. It is not tied to the equity markets or other traditional markets. Sophisticated institutional buyers such as pension plans, reinsurers, private equity, municipalities, and others have realized that they could deploy large amounts of capital, while benefiting from an aging population, in short, an aged population has more predictable mortality. Many experts feel this investment strategy continue to attract global investors as it qualifies for a higher standard known as “socially responsible investing,” which is grounded by an approach that focuses on maximizing both financial return and social good.

Conclusion

Life insurance policy valuation remains a complicated topic fraught with antiquated Treas. Regs. and vast inconsistencies amongst life insurance companies. The result is no ascertainable standard for consistency in valuation methods. Therefore, a policy owner may, instead, wish to rely on a qualified appraisal that uses the “willing buyer, willing seller” standard to determine fair market value. The secondary market, for which there is no better example of “willing buyer, willing seller,” may provide a viable option for clients engaging in financial and/or estate planning transactions where determining the fair market value of a policy for tax reporting purposes is required. However, the secondary market is typically only available to policies that meet specific criteria, such as insureds who are over age 65. For younger insureds, or others for which the secondary market is not available, a qualified appraisal by an independent appraiser who specializes in life insurance valuation may be the better means for reporting purposes if the value reported by the carrier on Form 712 is not an appropriate representation of the policy’s fair market value.

IRS Required Statement: Pursuant to recently-promulgated U.S. Treasury Department Regulations, we are now required to advise you that, unless otherwise expressly stated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.