LIFE INSURANCE POLICY VALUATION
The valuation of a life insurance policy is useful for estate planning, divorce, and individual sale. It is also critical for estimating off-balance sheet assets as part of an M&A transaction.
Insurance policies/contracts are illiquid, non-traded assets typically designed to provide benefits for the insured or for the beneficiaries of the insured. Unlike traded securities (such as most stocks and bonds), there is no readily available reference source to assist in establishing an insurance contract fair market value.
The right to receive cash flow distributions represents the most significant economic benefit due to the beneficiaries of the life insurance contract. In valuing this right, The Mentor Group, Inc. calculates the net present value of the future cash flows less the costs to liquidate, that would accrue to the beneficiary. The net present value of the cash flows represents what a purchaser of the future cash flow streams would pay on the date of the value, after taking into consideration the specific facts and circumstances of the life insurance contract. It reflects the theoretical cash distribution that would be received by a beneficiary from withdrawal, loans and death benefit cash flows.
While the value of liquidation rights is important to investors and should be considered in the valuation of any life insurance contract, the fair market value is best calculated through discounting the expected future cash flows to present value, because liquidation of the insurance policy is neither imminent nor certain.
The maximum policy value is the higher of the present value of cash flows or the present value of the death benefit. The rate of return should correspond to a return expected from the insurance company. The actual tables for life expectancy are a key component of the analysis. Unique to The Mentor Group is that we employ a probabilistic modeling of each year’s cash flow, meaning that each year we re-calculate based on the remaining expected life. This approach is the only one accepted by the IRS.
The value of a life insurance policy may be directly affected by the following factors:
- Term remaining on the policy
- Amount of the policy premiums
- Timing of the policy premiums
- Age of insured
- Risk associated with the policy premiums being paid in the future
- Volatility of the S&P 500 and the expected returns of the policy
- Credit worthiness of insurance carrier
- Required rates of returns historically generated by publicly traded common stock
- Amount of cash withdraws or loans expected to be taken form the policy
- Timing of the cash withdraws or loans to be taken from the policy
- Amount of the death benefit
- Timing of the payment of the death benefit based upon the actuarial life tables