Life Insurance Settlements: A Bad Deal?
Posted: March 9th, 2010 | Author: Joe | Filed under: Insurance | Tags: Insurance, Life Insurance, life settlement | 5 Comments »Did you now that you can sell your insurance policy to a 3rd party and receive an immediate lump sum?
I never knew this existed until I came across The Trade-offs of Selling Your Life Insurance in SmartMoney magazine.
The process is called “life settlement”, and it works like this…
Would you take cash for your life (insurance)?
For example: Meet Bob, a 68 year old retiree with a million dollar life insurance policy. Bob has some health issues, and not enough money to pay for the care he needs to stay a live a few more years to see his grand kids grow up a little more. Enter a life settlement agent, we’ll call him agent Smith.
Agent Smith offers Bob $400,000 for his life insurance policy. For Bob, it looks like a win-win scenario: he gets the money he needs today, in exchange for a policy that he may not even be able to pay the premium on and that wouldn’t help him anyway since he’d have to be dead to get the money, and his wife has already passed away.
If Bob lives another 5 years, then the investors get their $1 million, which works out to be $120,000 per year (before taxes and premiums are subtracted). For those of you playing at home, that’s a 30% annual return!
So, who owns Bob’s life?
At this stage in the game you may be wondering (as I was): That sounds great, but who owns Bob’s life?
The short answer is: whoever holds Bob’s life insurance policy has become the beneficiary.
So, most likely it’s the investment bank, pension fund or hedge fund since wall street is packaging multiple life settlement policies together into single bonds.
What’s the risk?
For Bob, there is no risk. The risk is assumed by the investors, and the risk is that Bob will live longer than expected. The longer Bob lives, the less return the investors make.
Who wins?
The earlier Bob passes away, the better the monetary result for the investors. So, if Bob dies early, the investors win.
The brokers and agents for the life settlement companies win because they make a commission and earn a fee for the transactions.
Who loses?
The direct losers here are Bob’s children, since they will now not see a dime from the insurance upon his death.
But what if Bob had no children or family to leave behind?
Fair enough. In that case, the insurance company loses since there is now no chance of Bob defaulting on his premium and since the hedge fund, pension fund or investment bank that now owns his life insurance policy will likely outlast Bob, the insurance company is guaranteed to have to pay the original death benefit of $1 million.
In a less direct way, the rest of life insurance customer lose out because to cover the increase in death claim payouts, the insurance companies have to raise premium prices.
Why it’s a bad deal.
I think life settlements are a bad deal because they target the elderly and seriously ill, they potentially increase the cost of life insurance for everyone and they are entirely unregulated which makes this a breading ground for fraudulent and unscrupulous life settlement companies to prey on the hopes and fears of the elderly.
Consider this statement from a NYT article on the subject:
the industry has been plagued by fraud complaints. State insurance regulators, hamstrung by a patchwork of laws and regulations, have criticized life settlement brokers for coercing the ill and elderly to take out policies with the sole purpose of selling them back to the brokers, called “stranger-owned life insurance.”
Besides, it’s a relatively small portion of the population that can really benefit from this. After all, unless you have a large estate or a significantly younger spouse, it rarely makes sense to even carry a life insurance policy this late in life.
What others are saying