"Win-Win" Way to Sell Your Life?

Following is another article on a topic relevant to this Blog, written by a law student in the Elder Law class (Fall, 2007) at Widener University School of Law (Harrisburg Campus), as edited & revised by me.

The topic: Expansion of the "viatical settlement" market for life insurance into "life settlements".

Selling your life

By David Liebhaber
(edited & revised for online posting by Neil Hendershot)

It is reported that well-financed companies, such as Credit Suisse First Boston and Deutsche Bank, and wealthy investors, like Warren E. Buffett, are spending billions to buy life insurance policies that insure the lives of elderly policyholders.

Why would sophisticated companies and individuals make such an investment?

The 2000 United States Census had reported that an annual premium cost for $6 million of life insurance coverage for a person 80 years of age is approximately $400,000. But if an 80-year old's personal circumstances have changed to exert increased financial pressures, can that level of premium payment be sustained?

Some companies and investors are able and willing to meet such obligations -- as an investment with an uncertain term. Some savvy business investors have calculated the risks and concluded the outlay in premiums would be worth the potential payoff when the insured dies.

How does it work?

Let us take a hypothetical elderly gentleman, Mr. Smith. He is an 82-year-old man in good heath (for his age). He is retired and now receives annual income of $40,000 from social security and his pension plan. But Mr. Smith previously had acquired life insurance to benefit his heirs big time -- in the range of $6 million.

The insurance company now is charging that hefty annual premium. On his retirement income, he can't afford it, right? Or could he?

Selling existing life insurance policies is not new. In some situations, it serves social purposes and also meets the parties' personal needs. See: "Selling Your Life Insurance", Fact Sheet 208, posted by AIDS InfoNet.

The concept is known as a "viatical settlement" on a existing life insurance. The principles are explained in an online article entitled "Selling Your Life Insurance Policy --Understanding Viatical Settlements", posted by the National Association of Insurance Commissioners.

A viatical settlement is the sale of a life insurance policy to a third party. The owner (viator) of the life insurance policy sells the policy for an immediate cash benefit. * * *

There is an established market for "viatical settlements". See, for example, the website "Sell Your Life Insurance Policy", posted by one, among many, of the commercial entities involved in this market.

Financial and investment advisors also participate in the process. See: "When Your Life Insurance Is A Pot Of Gold", by Jeffrey D. Voudrie, CFP, dated Nov. 15, 2005, posted on the website of the Senior Journal:

Don’t cancel your life insurance policy without reading this first! Depending on your situation, you may be losing tens of thousands of dollars if you do. If you have a life insurance policy that you no longer can afford or need, consider selling the policy. Read on to find out how. * * *

But this niche, secondary market has outgrown its original intended purpose, according to one commentator/blogger, Richard Reich, who wrote about it on his LifeInsure blog on November 16, 2006:

This business [involving viatical settlements] has now grown beyond the original small market to an ongoing large market described by the Chicago Tribune as the $13 billion secondary life insurance market and one promoted by insurance agents.

Recently some abuses have been investigated by the “ever diligent” Elliot Spitzer for the potential abuses by a company in this business called Coventry First, LLC a large buyer of life insurance policies.

As the Chicago Tribune quoted Coventry: ” Coventry issued a strong denial, arguing that its existence has helped break insurance companies’ hold on policy owners.”

Here’s some advice I agree with and again quoted from the article: "Policy owners need to determine if a life settlement is in their best interest in the first place.” * * *

A variation on the "viatical settlement" was the subject of an article published by Business Week on October 31, 2005, entitled "Wanted: Your Life Insurance", with the byline Investors are keen to offer "life settlements" -- Seller beware.

Remember the hard sell you got when you bought that insurance policy 20 years ago?

Well, times have changed. It's quite possible the agent who sold you that policy now represents investors who want to buy it.

They'll pay you a lot more than you could get from surrendering it to the insurance company, though the sum will be much less than the death benefit. * * *

What if, as a "life settlement", an investor would agree to pay Mr. Smith’s yearly $400,000 annual premium in conjunction with a further contract. This would be the deal: If Mr. Smith should die during that first year, the insurance company would pay Mr. Smith's designated beneficiaries the $6 million, subject to repayment by the beneficiaries of the premium advanced by the investor, plus 17% interest, for a total of $468,000. Thus, the beneficiaries would net $5,532,000.

But, if Mr. Smith would survive that first year of the arrangement, then the deal would give Mr. Smith an option: either sell the $6 million policy to the investor for $2 million then, or continue with the annual premium payments under the same arrangement, always subject to that, or an adjusted, interest rate. The option chosen would then apply throughout the rest of Mr. Smith’s life, until the policy would "mature" and its benefits would be claimed, subject to the investor's recovery provisions.

If Mr. Smith needs or wants the money quickly, he could “cash out” his policy and get the $2 million from the investor. But, if he does not need the money immediately, he could allow the investor to continue paying his premiums for the rest of his life. His designated beneficiaries will receive a diminishing amount from the $6 million payout at Mr. Smith’s death.

A nascent, but growing, and largely unregulated market has developed around investors who are hoping to make money from a large generation of Americans who are reaching retirement age.

Insurance executives point out that this market may cripple their industry and make life insurance for the elderly nearly extinct. They argue that insurance companies will no longer be able to afford to insure the elderly due to an increase in the number of policy holders and an increase in payoffs.

Insurers are worried because they count on many customers to cancel their life insurance policies before they die. This may occur because dependent children grow up, because pensions supplant wages, or because the policy premiums become too expensive. If far more policies are maintained and ultimately result in payouts, the insurance business becomes much less profitable.

Insurance executives say that this emerging market could be ruinous to the industry as a whole. Indeed, industry analysts say they expect the cost of life insurance to rise as companies prepare to pay out more claims. Over the next decade, the insurance industry could be forced to pay out unexpectedly more than $100 billion in death benefits as spin-life policies come to maturity, investors estimate.

Just as with "reverse mortgages" using one's home as an asset to lien, many people have come to rely on selling their policies to provide urgently needed money for medical care and living expenses when their income declined or their savings disappeared.

In such an unorthodox matching of contrary interests based upon a highly-complex life insurance arrangement, there is room for shoddy agents, unscrupulous marketers, and outright swindlers to work much harm.

Specifically, this speculation or “spin-life” market could be dangerous to the elderly. The deals are so lucrative to the investors and their agents, it is reported that older people are being wooed aggressively to participate.

Fox example, in Florida, investors sponsored free cruises for seniors willing to undergo physical exams and apply for life insurance while onboard. Spammed messages and blanket mailings containing solicitations for such arrangements are received by millions of the elderly. An elder individual who is not careful may agree to such a plan without an understanding of the details of how it works. And once the commitment is made, it is difficult to undo.

Elderly individuals could even be victimized by their own named beneficiary. Let us assume that Mr. Smith's son convinced him to maintain or take out such a life insurance policy, based on the son's promise to pay the policy premiums in exchange his nomination as the policy's beneficiary. Later, the son might assign his rights to one of these investment firms in the second year, leaving Mr. Smith with nothing.

And consider the larger question of social policy: Does such an arrangement exploit the elderly, where the interests of the investor clearly favor Mr. Smith's early demise?

In other words, is there really any "win-win" way to sell your life?

For a detailed examination of such insurance buyout arrangements and their effects -- for the individual, for the industry, and for society -- read the excellent article "Late in Life, Finding a Bonanza in Life Insurance", by Charles Duhigg, published on December 17, 2006, in The New York Times, which was a primary source for the article above.

Update: 12/27/07:

In late November, 2007, The San Francisco Weekly published an extensive article reviewing such insurance arrangements on the elderly. The author labeled the arrangement -- as to one investigated company --an "Elder Insurance Scam". See: "Roll of the Die - Human Life Speculators Bet on Elder Deaths" (11/28/07), by Matt Smith.

The article quotes an offer made to elderly folks:

"We pay your monthly premium and will be the beneficiaries of your policy," the ads declared. "IN RETURN, YOU RECEIVE A LUMPSOME [sic] OF $120,000 to $150,000 within 60 days! All you need to do is pass the physical examination (again, FREE of charge), and you're set."

But beware, warns the article. There is far more to this arrangement than that simple offer.

The practice of reselling life insurance policies to strangers began with the onset of the AIDS epidemic in San Francisco, when relatively young sufferers condemned to death by the disease sold life insurance policies to investors to obtain money during their final years. The practice has evolved into an industry called "viatical settlements," in which people with terminal illnesses sell their life insurance benefits to brokers.

Entrepreneurs have expanded this business to include policyholders who haven't been diagnosed with terminal illnesses, calling this line of investments "life settlements."

Lately, the business has expanded further still to include people who don't yet have life insurance policies, but are encouraged to take out new, very large ones specifically for the purpose of reselling them. * * *

Entrepreneurs in this line of business say it has the humanitarian effect of providing money to seniors during what may be a time of great need.

Detractors, however, call stranger-originated life insurance a macabre business in which investors, brokers, and speculators sit around hoping people they've bet on will die. Industry experts I've spoken with said they haven't heard of any murders associated with this business practice. But many find it disturbing just the same. * * *

Update: 02/26/08:

This posting was cited by Donald E. Kelley in his review of software that calculates the values in life settlements. See: "Life Settlement NumberCruncher -- Software designed to help you decide whether to keep or settle life insurance policies", posted on February 14, 2008, by Trusts & Estates as a "Technology Review":

As wealthier clients age, there may come a time when they need to decide whether to continue paying premiums on a life insurance policy or dispose of the policy through a life settlement.

These days, even Wikipedia is claiming that: "A growing number of experts now believe that informing clients about offering life settlements should fall under the fiduciary duty of a financial advisor." During the estate-planning process, this concern extends to other advisors, such as attorneys and accountants.

The new Life Settlement NumberCruncher program by Steve Leimberg and Mike Weinberg is an excellent tool that helps you evaluate whether to keep or settle a policy.

The secondary life insurance market has exploded in recent years. It typically involves the insured/policy owner, the insurance agent or broker, the life settlement provider (who assembles and prices the deals) and the funder (such as a hedge fund.)

For a quick description and analysis of the secondary life insurance market, see Jay Vadiveloo (Deloitte Consulting), "The Life Settlements Market, an Actuarial Perspective on Consumer Economic Value," ACORD LOMA Life Insurance Forum (May 23, 2006).

The market for life settlements targets situations in which there are large policies and elderly insureds with impaired mortality. Life Settlement NumberCruncher will help you address the numerical component of the decision to retain or sell the policy. This program also should help you fulfill your professional (and perhaps even fiduciary) responsibilities to give well-reasoned responses if a client consults you regarding an offer to purchase such a policy or asks later why you didn't recommend a life settlement -- or if, after the client's death, the policy beneficiaries question why you recommended a life settlement.

The New York State Insurance Department -- "Life Settlements -- Top Ten Questions" and "Life Settlements -- Life Insurance Rescue" from the Quatloos website help explain the life settlement process. For a description of the life settlement process and a discussion of the pros and cons of life settlements, also see the PA Elder, Estate and Fiduciary Law Blog (Sept. 21, 2007). And see J. Alan Jensen's and Stephan R. Leimberg's, "Stranger-Owned Life Insurance," ACTEC Journal, Fall 2007, at p. 110, and James C. Magner & Stephan R. Leimberg's, "Life Settlement Transactions: Important Tax and Legal Issues to Consider," Estate Planning (April 2007). * * *