Selling a life insurance policy to generate income has historically been a controversial practice. Investors who buy the policies don’t make money until the selling policyholder passes away. Even though the vast majority of modern day life settlement cases result in extremely positive outcomes for consumers, this still creates a death-watch dynamic that is understandably morally repugnant to critics.
The industry accurately notes that such insurance settlements have long been an acceptable estate planning tool. Now, with a rising number of aging seniors, companies and brokers involved in life settlements are seeking acceptance as a mainstream retirement tool alongside annuities, long-term care, and other age-related financial products.
“A life settlement, in our view, is a legitimate transaction made in the financial interest of the policyholder.” says Michael McRaith, Commissioner of Insurance in Illinois and an active regulator in national life settlements issues.
“There can be valid estate considerations or a change in family circumstances that support the need to sell a life insurance policy,” he notes. “For example, parents who have had life insurance policies for decades that they may no longer need that policy and do not wish to leave death benefits to their grown children. So, it might be better for the parents to have access to a cash settlement for that policy. The most important concern for a consumer in any insurance transaction is that the consumer make an informed and educated decision. It should be in the best interests of their families and not necessarily in the best interest of the person [or firm] who is involved in the commercial aspect of a life insurance transaction.”
Life settlements emerged from obscurity in the wake of the AIDS epidemic. Known more commonly then as the viatical settlements business, it layered a money-making objective with a compassionate twist for terminally ill AIDS victims, who could receive income before they died by selling life insurance policies. The investors who became the new beneficiaries of those policies would continue making any premium payments and then collect on the policy when the patient died.
Questions arose about the propriety of convincing AIDS victims to buy life insurance, and there were creepy odds posted on the correlation between a patient’s blood cell counts and their expected time of death. Later, as improved drug therapies began commuting what had once been an AIDS death sentence, the viaticals business became less attractive to investors as life spans stretched from months into years, and then decades.
More recently, the image of life settlements was hurt by its association with what came to be called “stranger originated life insurance,” or STOLI for short. In STOLI transactions, brokers would often aggressively persuade older seniors into agreeing, for a fee, to have insurance on their lives purchased by third parties. Third parties would pay their premiums and collect the death benefits.
“These abusive STOLI practices essentially promote the wagering on human life, negating the good, social purpose upon which life insurance is based,” the American Council of Life Insurers said while explaining its opposition to such “manufactured transactions”.
In Illinois, McRaith recalled a full-page ad in The Chicago Tribune inviting people between the ages of 55 and 85 to meet a celebrity and learn about free insurance. Once in the meeting, they were encouraged to participate in a STOLI transaction.
“While the fee income was appealing to many seniors, there often were adverse financial consequences that were not disclosed, including income tax obligations and the loss of public benefits due to the extra income from their STOLI fees.” he said.
Life insurers also object to selling policies with a 100-percent certainty of having to pay death benefits. Traditionally, most life insurance policies are lapsed before the covered person dies and life insurance premiums reflect these lapse rates.
Many states have adopted new rules to sharply limit if not end STOLI, including imposing a multi-year holding period before life insurance death benefits can be assigned to a third party. Most states have some law that would prohibit stranger originated life insurance.
As the life settlements industry works to position itself as a mainstream option for seniors, The Wall Street Journal reported that Life Partners consistently understates the remaining life spans of the policyholders. This wouldn’t affect consumers unless it reduced investor interest in the future as it could reduce demand and with it the prices that consumers receive for selling their policies. The company reportedly confirmed that it is under investigation by the U.S. Securities and Exchange Commission, and the Journal reported that the investigation was linked to the issue of life expectancy calculations.
The larger issue for life settlements has been the economy. When the economic downturn happened many industries saw their lines of credit and investor capital cancelled.
So, instead of relying on credit or investor capital, new life settlement companies are using their own funds to purchase policies directly. The industry started showing signs of recovery in 2010 and the demographics seem to indicate growth ahead. Life settlements can soon become a more mainstream option for seniors considering how they are going to fund retirement and long term care.
Policyholders interested in selling a life insurance policy for a single cash payout are encouraged to begin their journey using a life settlement calculator for an immediate quote.
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