Introduction

First of all, let’s define a phrase. A “survivor’s option” is a provision, often included in a structured CD or a structured note, that enables the heirs of a deceased holder to redeem the instrument at its par value upon the holder’s death. A provision of this kind may also be triggered upon the determination that the holder is “incompetent.”

Of course, market participants use a variety of different names for this type of provision, including “estate feature.” Some, perhaps those with a more gothic sense of style, use the term “death put.” This article will use these terms interchangeably. (On second thought, this article might not use the term “death put” again after this paragraph.)

The Survivor’s Option and Controversy

These provisions are designed for the benefit of investors, but they are not without controversy. It has been reported that some financial advisers have attempted to profit from the difference between the trading price of a note or a CD and its par value by purchasing the instrument for less than par, and holding it in an account of a person with a short remaining life expectancy. If this practice occurs in significant amounts, an issuer can find itself redeeming a significantly higher amount of CDs than anticipated at the time of issuance. A solution or two to that problem is discussed below.

Do I Need a Survivor’s Option?

The answer is “maybe.” On the one hand, there is no securities law or banking law requirement to have one. However, many distributors of structured products prefer to offer products with these terms to their customers, especially when offering to senior investors. And many individual investors have come to expect the term in the instruments they buy.

Of course, for the avoidance of doubt, if the offering is being made solely to institutional investors for their own accounts, this term is not necessary.

The survivor’s option may make the product more attractive to investors. However, some issuers prefer to avoid including it. Treasury departments prefer the certainty of knowing exactly how long an instrument will be outstanding, and of course do not like to redeem notes or CDs when their cost of funding has risen. Moreover, administering requests for redemption under a survivor’s option involves time, cost and occasional frustration.

Holding Period

Some survivor’s options may only be exercised after the holder in question has held the instrument for a specified period, such as six months. This term is designed in part to thwart the plans of those who, as set forth above, would attempt to sneakily transfer the instruments to the weak or frail in the hopes of turning a profit. In a more restrictive version of this provision, the right may only be exercised by the initial purchaser of the instrument, and not by any transferee in the secondary market.

When Will Payments on the Option Be Made?

A survivor’s option may be designed for the maximum convenience of the investor’s heirs: payment will be made at any time, upon proper exercise. Alternatively, payments may be scheduled for the convenience of the issuer: fixed quarterly or semi-annual dates, or on dates that coincide with interest payments. The “issuer-friendly approach” helps the issuer and any paying agent aggregate any required payments, and may facilitate record keeping.

Payment Limitations

What some issuers give with the left hand, they take away (in part) with the right hand. In order to limit the impact of survivor’s option provisions, the terms of the instrument may limit the investor’s rights to payment. For example:

  • Each note or CD (according to CUSIP) may be subject to a maximum notional amount that may be redeemed.
  • An issuer may subject its entire note or CD program to a maximum notional amount that may be redeemed.

These types of limits may operate on an annual basis, or for the life of the instrument. If the limit operates on an annual basis, redemption requests that exceed the annual limit may be “rolled” into the next calendar year, when the limit “resets.”

Timing Limitations

A survivor’s option may be structured so that it must be exercised within a specified amount of time after the relevant death or incompetence. A fixed period, such as one year, is arguably sufficient for the heirs of the holder to sort out the deceased’s assets. Imposing such a time limitation is also designed to prevent the option from being exercised solely due to decreases in the value of the instrument and/or its underlying asset in the period following the death or incompetence.

“Who’s Death Is It, Anyway?”

If an instrument is held by a single individual, it’s easy to determine whose death or incompetence triggers the survivor’s option. The situation can be a bit more complicated when there are multiple beneficial owners such as:

  • spouses or domestic partners;
  • family members holding jointly; or
  • trustees and beneficiaries.

A well-drafted survivor’s option provision will make it clear whether one, more than one, or all holders of an interest must pass away or become incompetent for the right to be triggered.

A Practice Tip

Different market participants may have different views as to how a survivor’s option should operate, and any limits that should be placed on that option. However, once a note or CD is outstanding, actual redemptions will require an exchange of paperwork, and ultimately, a transfer of funds, between the issuer, the relevant broker and/or the paying agent/trustee for the relevant program. Accordingly, before finalizing any provisions in an offering document, issuers and underwriters are encouraged to make sure that these provisions reflect the actual processes and capabilities of the relevant parties. Once the offering “goes live” and the instrument is issued, the survivor’s option provision will exist for the entire term of the instrument.

Issuers will also prefer to have one standardized form of the survivor’s option provisions. Doing so will reduce the time needed to determine the validity of a proposed exercise, and the required paperwork for doing so. Of course, as time passes, and as investor preferences change, the provision used may change.