Determining Fair Market Value For Life Insurance Policies

Life insurance policies are an asset, and like other assets, they have a fair market value. This value is required when a policy is transferred, for example, in a pension distribution or a sale. The fair market value of a life insurance policy is a calculation that determines the current value of the insurance policy. This calculation takes into account the insured's current age and health, future premiums due, and coverage provided. It is important to determine the fair market value of a life insurance policy to ensure that the policy is not sold for less than it is worth and that the appropriate amounts are used for taxation purposes.

Fair market value vs cash surrender value

A life insurance policy is an asset with a unique set of characteristics. When a policy is transferred, sold, or gifted, it needs to be assigned a value. This is where the concepts of fair market value and cash surrender value come into play.

Fair Market Value

Fair market value (FMV) is the price at which an asset would change hands between a willing buyer and a willing seller, with neither party under any compulsion to buy or sell and both having full knowledge of the relevant facts. In the context of life insurance, FMV is determined by exposing the policy to an open market of qualified potential buyers and sellers, allowing market forces to determine the value. Several variables influence the FMV of a life insurance policy, including the death benefit, the cost of premiums, and the life expectancy of the insured.

Cash Surrender Value

Cash surrender value (CSV) is the sum of money an insurance company pays to a policyholder when they voluntarily terminate their policy before its maturity or the occurrence of an insured event. It is the savings component of permanent life insurance policies, particularly whole life insurance. The CSV changes over time based on premiums paid, interest earned, insurance charges, and carrier-imposed fees. It is important to note that CSV does not reflect the true value of a life insurance policy, as it is often lower than the fair market value.

FMV vs CSV

The main difference between FMV and CSV lies in their calculation and the parties involved. FMV considers the open market value of the policy, taking into account supply and demand. It aims to determine the price that a willing buyer would pay to a willing seller. On the other hand, CSV is calculated based on the premiums paid, interest, and fees associated with the policy. It represents the amount the insurance company will pay to the policyholder upon voluntary termination of the policy.

When considering options for a life insurance policy, it is essential to understand both FMV and CSV. FMV provides a more accurate representation of the policy's value on the market, while CSV represents the immediate cash payout from the insurance company. By exploring alternatives, such as working with a life settlement company, individuals can often obtain a higher value for their policy than the CSV offered by the insurer.

Face value

The face value of a life insurance policy is the amount that your beneficiaries will receive after you die. It is also referred to as the death benefit or the face amount of the policy. The face value is the primary factor in determining the monthly premiums to be paid.

The face value of a life insurance policy is the sum of the death benefit and the value of any additional riders you may choose to add to your policy. Riders are additional benefits that can be included in a plan. For example, some riders stipulate that the face value doubles if the insured dies from a specific type of accident. If you do not add any additional benefits, the face value may be equal to the death benefit alone.

The face value of a life insurance policy can be found in the policy's statement of benefits. The initial face value is the amount of the death benefit purchased when the policy is issued, and it is stated on the policy itself. The face value can be influenced by factors such as medical history, age, number of dependents, income, and financial goals.

It's important to note that the face value of a life insurance policy is different from its cash value. The cash value is a separate savings component of a permanent life insurance policy that the policyholder can borrow against or withdraw from. Taking out cash value reduces the face value of the policy.

Determining the face value of a life insurance policy involves considering the death benefit and any additional riders. By adding up the value of the death benefit and the value of any riders, you can calculate the face value. If you have borrowed against the cash value of a permanent life policy, subtract the outstanding loan amount from the total benefits to determine the death benefit and, subsequently, the face value.

Cost of premiums

The cost of premiums is a significant factor in determining the fair market value of a life insurance policy. It is the amount of money that a buyer will need to pay in annual premiums to keep the life insurance policy active. The cost of premiums is influenced by the face value of the policy, which is the amount paid out to beneficiaries following the insured person's death. The higher the face value, the higher the premiums will be. Face value can increase or decrease over time, depending on how the policy is managed. For example, if the insured person does not withdraw cash from the policy, the face value may increase. Conversely, if they take out loans or withdraw cash, the face value will decrease.

The premium rate for a life insurance policy is determined by considering mortality, interest earnings, and the expense factor. Mortality tables provide life insurers with an average life expectancy for each age group, helping them estimate future payouts. Companies also invest premiums in stocks, bonds, and other assets, assuming interest earnings. The expense factor covers operating costs, including salaries, agents' compensation, and rent.

When determining the fair market value, the cost of premiums is essential for buyers to consider. Buyers will evaluate the sum of the cost to maintain the policy and the expected return on investment. If this sum is lower than the policy's death benefit, the difference will be the purchase price offered by a life settlement company. Obtaining life settlement quotes allows clients to explore their options and receive a fair price for their policy.

Life expectancy

The age and health status of the insured individual are key considerations in determining life expectancy. These factors can influence the likelihood of future health issues and the potential timeline for policy payouts. For instance, an older person with underlying health conditions may have a shorter life expectancy than a younger, healthier individual.

Actuarial calculations and models are used to estimate life expectancy and the associated financial implications. These models take into account mortality rates, survival probabilities, and the time value of money. They help calculate the expected cash flows and the present value of future benefits.

Additionally, life expectancy can influence the investment returns on the policy's cash value. Policies with longer durations may offer more opportunities for investment growth, affecting the overall value of the policy.

Policy type

Universal Life policies are a form of permanent life insurance that offers flexibility in terms of premium payments and death benefits. Policyholders can adjust their premiums and coverage amounts to suit their changing needs. This type of policy often includes a savings component, allowing policyholders to accumulate cash value within the policy. The cash value can be accessed through loans or withdrawals, separate from the death benefit.

Whole Life insurance, another type of permanent life insurance, is characterised by level premiums and a guaranteed death benefit for the insured's entire lifetime. It also includes a savings component, allowing the policy to accumulate cash value over time. Dividends from this policy can be used to increase the death benefit or can be taken as cash value.

Variable Life insurance is a type of permanent life insurance that provides both a death benefit and an investment component. Policyholders can invest their premiums in a variety of investment options, such as stocks, bonds, or mutual funds. The value of the policy, and consequently the death benefit, fluctuates based on the performance of these investments. Variable life policies often come with higher risks and potential rewards than other types of life insurance.

Term Life insurance, in contrast to the previous types, provides coverage for a specific period or term. It does not accumulate cash value and solely focuses on providing a death benefit if the insured passes away during the policy term. Term life insurance policies typically have lower premiums than permanent life insurance policies due to their temporary nature and lack of cash value accumulation.

When determining the fair market value of a life insurance policy, it is essential to consider the unique characteristics and marketability of each policy type. The type of policy impacts the premiums, death benefit, and potential cash value associated with the policy, all of which are crucial factors in calculating its fair market value.

Frequently asked questions