That may seem a setup for an episode of "Murder She Wrote." But life settlements do have legitimate purposes. Indeed, they can be a godsend for some people. Consider someone terminally ill whose life savings and health insurance won't cover medical and other expenses. Selling a life insurance policy could make up the shortfall.
Others may not be facing terminal illnesses. But they know that, based on their health, they probably have only a few years to live. They opt to sell their life insurance for a tidy sum and use the money to live it up in the years they have left.
Here's a simplistic example of how a life settlement works. Say you own a life insurance policy having a $500,000 death benefit. You sell the policy to an investor for $100,000. The buyer now owns the policy and takes over paying the premiums, and you pocket $100,000. When you die, the investor stops paying premiums and collects $500,000.
For the investor, that's a $400,000 profit after one year, minus whatever the investor had to pay in premiums to keep the policy in effect. With each passing year, as long as you're alive, the investor keeps paying premiums, which chips away at that $400,000 profit. If you live too long, there might be no profit left at all. You see why investors only want to buy policies from people who have just a few years to live.
In fact, life settlements trace their roots to the 1980s, when AIDS patients sold their life insurance policies to pay for medicines and care. Back then these arrangements were known as "viaticals," from the Latin word "viaticum," meaning "provisions for a journey." Viaticals lost their appeal to investors when new drugs began to extend AIDS patients' lives.
The market shifted to focus on elderly people with only a few years to live. Viaticals came to be more commonly known as "life settlements," although the old term persists as well.
Now back to our earlier example, which we warned you is simplistic. In the real world of life settlements, a policyholder doesn't sell a policy to one investor. Rather you'd sell it to a life settlement company that buys policies from many policyholders on behalf of many investors. That lessens the risks for investors. If a few policyholders in the pool live longer than expected, that will have only a slight impact on the rate of return the investors get.
The life settlement company will take over paying the premiums on your old policy. To sell your policy, you might deal directly with the life settlement company that offers to buy your policy. More likely, though, you'll work with a broker who solicits bids from several potential buyers for you. These various middlemen take a slice of the action in the form of commissions and fees.
If you have a life insurance policy you no longer need, you can stop paying the premiums and let the policy lapse. Or, if the policy has a surrender value, you can cash it in for a payment from the insurer. The life settlement industry maintains that life settlements give consumers another choice.
Typically, life settlements involve policies having a death benefit of at least $250,000. The surrender value is usually 3% to 5% of the policy's face value, according to a white paper "Cashing in on Unneeded Life Insurance Policies" by the Life Insurance Settlement Association (LISA). For a $1 million policy, that's $30,000 to $50,000. Selling the policy to a life settlement firm will bring three to four times that amount, LISA says.
The amount varies depending on age (usually 65-plus) and medical condition of the policyholder, type of policy, rating of the issuing insurance company, size of the premiums to keep the policy in effect, and so on.
But before you even think about a life settlement, be sure you no longer need your life insurance. "Consumers buy life insurance to provide a cash benefit to their beneficiaries upon their death," says Brenda Cude, professor of housing and consumer economics at the University of Georgia, Athens. "If you sell your policy, you no longer have life insurance, and your beneficiaries won't receive a benefit after your death. How will this decision affect your beneficiaries?"
What if you're seriously ill and badly need the life settlement to help pay your bills? "Examine all your options," Cude advises. "Does your policy have an accelerated death benefit option that you could use to get some cash now? Or could you take out a loan using your policy as collateral?"
You'd still own your policy, and your beneficiaries would receive whatever is left of your death benefit after you die. But if you sell your policy for a life settlement, your beneficiaries get nothing.
If you decide a life settlement is a sensible solution for you, shop carefully. Here are some pointers from Jim Poolman, North Dakota Insurance Commissioner and chair of the Life Insurance and Annuities Committee of the National Association of Insurance Commissioners (NAIC).
The NAIC addressed these consumer protection concerns when it amended its Viatical Settlements Model Regulation in December 2006. Each state insurance department then decides whether or not to adopt the model regulation.
In the recent amendments, the NAIC also cracked down on a newer and highly controversial insurance practice called stranger-originated life insurance, or STOLI. In a STOLI, investors solicit elderly people to purchase life insurance for the sole purpose of turning around to sell those policies as life settlements. The investors even lend money to an elderly consumer to buy the policy, and the borrower repays the loan out of the proceeds from selling the policy. The targets of STOLI purveyors are elderly people who have millions of dollars in net worth.
You may not be in that financial bracket, so no one may eye you as a STOLI prospect. Still, when buying a regular life settlement, you need to heed the cautions listed above. Information on the National Association of Securities Dealers' Web site can help too. And, sit down with your financial adviser to talk though all your options.
Home & Family FinanceŽ Resource Center
Copyright © 2008 - Credit Union National Association, Inc.