The controversy about "life settlement" policies--ways that people can buy rights to life insurance policies--has kicked up again around the country.
Here's Saul Friedman's May 5 Act Two column on the subject:
Only in America could some twisted mind figure a way to make big bucks on your death. I’m not talking about funeral homes, cemeteries or casket-makers. I’m talking about a growing and questionable new industry called “life settlements,” or “senior settlements.”
Here’s an extreme example, as relayed to me by a Long Island elder lawyer friend. One of his retired clients--we’ll call him Mr. Doe--is now in his 70s, in fair health and living in Florida. Recently he was approached by a life settlements agent with a strange and tantalizing proposition.
If Doe would qualify for and take out a new life insurance policy of $1 million, then designate the agent as beneficiary, Doe, would receive $100,000 cash, with no strings attached, and never have to pay a premium. When he dies, the designated beneficiary would make a profit of $900,000–minus the premiums paid.
Doe jumped at the offer, said the elder lawyer, for the money was a windfall that made his life more comfortable. “It sounds like it should be illegal, but it’s not, in Florida or anywhere else that I know of,” said the lawyer.
“When he asked me, I couldn’t see anything wrong, although he may have a huge tax bill.”
There may be other financial consequences, which we’ll get to. But this extreme case, which may become more commonplace unless the law steps in, illustrates how most life settlements work. Most of this information comes from a February “investor alert” from the National Association of Securities Dealers (NASD), which sees these life settlements as investor instruments, which need regulation.
Until now, an older person who can no longer afford the premiums on a whole life policy he or she has held for years, can either let it lapse (which insurance companies like) or surrender it for its cash value. A third alternative is a “life settlement,” in which the policyholder gives up the death benefit and names as the new beneficiary a life settlements agent, who pays the policy holder more than the cash value but less than the face value–the death benefit.
It seems like a gamble, but the agent/beneficiary is armed with actuarial tables and may even see the policyholder’s health record. The policy holder, however, may take bids to sell his policy for the highest cash price.
The agent may in turn re-sell the policy to an investor. And since the original policyholder’s death is inevitable, sooner or later, the policy is like money in the bank.
The “life settlement market,” as it is called, grew out of the AIDS epidemic of the 1980s and the very practical “viatical settlement” market in which investors or agents paid cash for the life insurance policies of AIDS patients who faced almost certain deaths and needed cash for medical and living expenses. That market ended with drugs that indefinitely prolonged the lives of HIV-positive people.
According to NASD and other sources, life settlements involve policyholders who are not terminally ill, have a life expectancy of two to ten years, with death benefits on the policy much higher than on viatical settlements. One study cited by NASD estimated that existing policies sold in 2005 were worth $5.5 billion, and the potential market is more than $100 billion.
As you can see, life settlements may be attractive not only to the policyholder who needs cash, but to institutional investors who purchase policies as they do stocks and bonds and for finders and brokers who handle such transactions.
Almost inevitably where such money is involved, competition among brokers and potential investors will lead to abuses, swindling the unwary elderly out of their policies with the lure of cash, by not informing them of the consequences, such as that they are losing the death benefit that would have gone to a surviving spouse.
There are other, more complicated possible consequences. Although the cash value of a life insurance policy is counted as an asset when applying for Medicaid, the cash payment from a life settlement probably would be higher than the cash value and could affect a person’s eligibility for the program. And, of course, the cash payment could be taxable and have a negative impact on one’s income tax bill.
Let me interject another alternative if you need cash. If you over 62, have sufficient equity in your home or condo, a reverse mortgage is much safer, for it’s well regulated and even if you get the maximum loan, it won’t eat up the entire value of your home. Also the proceeds are tax exempt and you don’t have to pay it back until you leave the home for good or die, in which case your heirs will still have your life insurance death benefit and the home, if they pay off the reverse mortgage.
While selling one’s death benefit may be a good deal for someone who needs cash for living and has no beneficiaries, there are some caution flags, says NASD. How do you know if your getting the best price for your policy? You may have to shop your policy. What do you know about the reputation of the firm or broker that promises payment? There may be steep or hidden transaction fees; find out in advance. And at the moment, life settlements are an entirely unregulated industry and in this life you don’t get something for nothing.
Finally, let’s go back to that anecdote at the beginning. As one financial scam investigative web site (www.quatloos.com) says, “Some bad guys in the life settlement market can’t leave well enough alone...they look to basically ‘grow’ future life settlements by arranging slick-sounding deals to encourage people who don’t even have much life insurance yet to buy life insurance with the idea that later they will sell it...In these arrangements, known as SOLI (‘stranger-owned life insurance’), life insurance truly does become a pure investment with policies grown like so many fields of corporate bonds awaiting future harvest.”
Thus, says Quatloos, most life settlements “end up in pools owned by large financial institutions and hedge funds...but there is some concern that particular life settlements could end up in the hands of seedy elements...there is simply no guarantee who will end up owning the policy” that Mr. Doe sold..
Said Steve Leimberg, a Pennsylvania financial adviser: “How well would you sleep at night knowing that your life insurance is owned by Tony Soprano and his rate of return will depend on how quickly you die?”
--Noel Rubinton
