Personal Finance

Are Life Settlements a Good Idea?

| by Ed Hinerman

If someone offered you money for your term life insurance policy, which we all know has no value unless you're dead, would you take it? If you were sick and had been racking up medical bills and someone offered you enough money to pay those bills, let's say $100,000, in exchange for ownership of your $500,000 life insurance policy, would you do it?

Life settlements really came on the scene in unison the with AIDS crisis. With AIDS victims taking expensive experimental drugs to try to beat the disease, a new market was born under the guise of helping them out, but with the intent of making a quick buck. Often an AIDS patient would be offered as much as half of the death benefit of their policy in trade for the ownership rights of the policy. The patient got money now to pay for treatment and when the treatment didn't work, the new owner got the death benefit. Back then people with AIDS usually didn't last more than a few years and the dirtball, I mean new owner, of the policy could often double their money in very short order.

As a practical matter viatical sales to AIDS patients fell victim to better and better drugs that extended their lives well beyond any models used by those selling the contracts. That left the new policy owners holding the policies far longer than anticipated which effectively lowered and often negated any profits.

History lesson over. Fast forward to the 21st century. One thing about dirt balls is that if you don't do something to get rid of them, they'll just keep on coming back. Viatical sales were repackaged and given a softer and gentler name, life settlements, and a new way of target marketing was formulated. Rather than AIDS paitents, the new audience for this pitch was the older, sicker person with a measureably short mortality expectation. It was the same song and dance, just with new dancers. Depending on the actual life expectancy, a cash offer would be made to purchase the ownership of the policy.

The cash offer is computed by determining life expectancy, and these companies believe they can do that very accurately. Then the annual cost of premiums on a converted policy are determined and the formula is something like years left to live times the annual premium plus a substantial profit subtracted from the death benefit. So, that might look like 4.5 years left to live times the converted annual premium of $32,000 equals $144,000. A little slop in case the person lives too long plus a healthy profit, say another $200,000. If the policy had a $450,000 death benefit, the insured person would receive the leftovers of $106,000.

A real downside to this is that very often this is kind of done behind closed doors and the counsel of family members may never be heard. Many beneficiaries of life insurance policies never find out the policies were sold and they are no longer beneficiaries until after the death occurs and they are cleaning up estate matters. That's when they find out that because of a slick sales job, the family missed the opportunity to convert that policy themselves and net $300,000+ after premium payments.

Another target for life settlement agents are older people with "excess insurability". That would be someone who, based on income or net worth, could carry say $5,000,000 worth of life insurance, but because they've never felt they needed that much they only carry $1,000,000. The have $4,000,000 of excess insurability. An agent talks them into applying for and purchasing the additional amount, even though they don't need it, holding it for 2 years to get beyond the incontestability period, and then selling it at a profit over the premiums they've paid.

These types of practices have our governing bodies seriously reconsidering the golden egg in life insurance, the fact that the death benefit is not taxable as income. So, while all the schemes and scams are going on, the goose that layed that golden egg is in real danger.

Bottom line. There are some well oiled life settlement agents out there. They know how to make you want it and how to make it easy. If anyone approaches you about selling your life insurance policy, consult with your state insurance commission on where to get the other side of the story.

Just an aside. There is huge money to be made by agents who handle these transactions.

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