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Death For Sale: "Life Settlements" Are the New Subprime Mortgages on Wall Street

by Genghis 9/6/2009 - 5:40 pm   |

A few years ago, I met a young millionaire who had made a fortune buying life insurance policies from the elderly and reselling them to investors. He would offer policy owners cash upfront, and when they died, the companies to which he had sold the policies would receive the benefits. Of course, he earned a percentage. It struck me as a clever but shady operation.

Today, the NYT reported that this practice of buying what are euphemistically called "life settlements" may be the next big thing on Wall Street. Experts predict that the market could reach $500 billion. "We're hoping to get a herd stampeding after the first offering," said one investment banker.

It's a morbid business. The trick to turning a profit in this game is to buy policies from people most likely to die soon. If the original policy owner hangs on for decades, the investor would have to make payments for years before receiving the benefits, and the deal could well turn out to be a loser.

That said, the opportunity to self off life insurance policies is not necessarily a bad thing for old folks. Suppose that you long ago took out a life insurance policy for your children or spouse but no longer have dependents who need the money. You might be tempted to simply cancel the policy in order avoid more payments, in which case you would receive nothing. By selling the policy, you might receive 40% of the total benefits to enjoy while you're still alive. Of course, there will be cases of people maliciously denying benefits to dependents, but they can do that anyway by simply canceling their policies.

The real victim will be the insurers. Their actuarial scientists had calculated that a certain percentage of policy holders would cancel their policies before death, and they priced their plans accordingly. When people sell their policies instead of canceling them, it cuts into the insurers' bottom lines. Of course, the life insurance industry being what it is, it's hard to feel much sympathy for the poor insurers, but there will likely be an impact on consumers as insurers raise premiums to compensate. Thus, policy holders will have more choices, but they will pay for it.

The second concern is that unscrupulous brokers will take advantage of confused consumers. The NYT reports that state insurance regulators "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.'" So not only do people have to deal with slimy life insurance brokers when they're young and healthy; now they may have to deal with slimy life settlement brokers when they're old and infirm (and probably more confused). We'll get it coming and going, as it were.

The third concern is another Wall Street bubble. If investors believe that life settlements offer easy money, they may bid up the price to a level that no longer reflects the real value of the policies. And if medical advances extend average human lifespan, many investors could end up holding worthless assets. We've seen how that goes.

So let's hope that someone in the Obama administration is following the trend and ready to regulate. At least, there are probably some agitated insurance lobbyists already pounding on the White House door. In the meantime, if you have a life insurance policy, you'd be well advised to lock in your premium.

In regards to the article that appeared in this past weekend’s NY Times I felt it necessary to weigh-in on the issue.

 

First of all converting what would be an income tax free event, that being, a death benefit paid out to the initially designated beneficiary, such as a spouse or children, to an investor which would be taxable based on Rev Ruling 2009-14 would seem to me to be a thing the current administration would gladly support.

 

Second, policy holders are not being talked out of existing life insurance policies, they are attempting to receive an economic benefit greater than that being afforded to them by the life insurance company that issued the policy. They are going to surrender or let lapse a policy they no longer want or need.

 

Third, life settlements are for insureds that are NOT terminally ill but are over the age of 65.

 

This industry is regulated in many states to extent unseen or unheard of for any transaction involving insurance.

 

When a person purchases a life insurance policy, properly referred to as an insurance contract, they acquire certain rights. One of those rights recognized by the U.S. Supreme Court in 1911 was the right of the policy owner to sell their rights in the contract to a third party. The people who benefit from a life settlement are the ones who own those rights, namely the policy owner. How they benefit is by being able to obtain the true value of the policy instead of merely receiving the cash surrender value upon surrender or nothing upon letting the policy lapse. If a person no longer wants or needs their life insurance then why should they be denied the opportunity to receive a value greater than the cash surrender value but less then the death benefit? Instead it is the life insurance company that reaps the total economic benefit from the surrender or lapse.

 

How can a free market exist if it is not permissible for a policy owner to seek out the advice and counsel, for example, of their CPA, Lawyer, Insurance Agent, Financial Advisor or Financial Planner to help them determine what a fair value is? Or for that matter being prohibited from exercising a contractual right? Along the same line of reasoning, are insured’s capable of estimating whether or not the initial purchase of their cash value policies was a fair deal and that they were not being cheated?

 

When being sold life insurance in the first place the insured is being served by an AGENT of the INSURER. The agent is not a fiduciary of the insured. In regulated states the life settlement broker, is a fiduciary to the insured and policy owner to act in their best interests and to follow their instructions.

 

The life insurance industry has been putting in force policies based on lapsed based pricing assumptions, meaning they have full knowledge and belief that the policies will in fact lapse in 5-7 years therefore they fully expect that no claims will be paid. So would you then say that the public is being cheated because they bought permanent insurance which is under-priced knowing full well that the public is not going to reap any true financial benefit upon lapse or surrender?

 

Life insurance premiums are potentially on the rise because of stiffer reserve requirements set by the states, not because of life settlement activity. Remember “the [life settlement] market is still minuscule”.

 

The public should be concerned that there is an industry that readily admits that they do not want to face contractual claims they put in force for fear they will not have enough funds to pay them. That is the risk they face being an insurer and mispricing their policies.

 

The policy owner, the consumer, is the one that benefits from a life settlement. Why should they have this right and economic opportunity denied them?

 

Finally, the investors are large financial institutions and are already regulated. Perhaps the regulations already on the books need to enforced or enforced better.

by Stuart (not verified) 9/9/2009 - 10:53 am

You sound like you have a horse in this race.

I'll grant you your point on Genghis' concern #1, i.e., that life settlements are entitling the user to get the full benefit of their contract and that insurers really shouldn't benefit from users not being smart about their policies (although perhaps I'm putting words in your mouth), and I'll even grant that you address Genghis' concern #3 with your statements about existing regulations needing to be enforced/enforced better.

However, I don't see any solid refutation of concern #2: that some life insurance settlement brokers are preying on the elderly. That is a big concern to me. (Don't get me wrong, I'm also concerned with bubble issues, but I agree that bubble issues are not isolated to just this issue, not that I think Genghis would disagree with that.)

by Nebton 9/9/2009 - 11:08 am (re: Stuart)

Nebton,

It is easier to be pessimistic about something so you can say “I told you so” if something is to go wrong… clearly no one is going to go back to your blog and say, “hey wait a minute Mr. Critic… you said all these bad things about the industry and you were DEAD wrong… what a ignoramus you are!” Nope, that will never happen… Grrrrr… keep playing it safe critics…

Simply put, there will always be cons and scandalous activity, popping up out of the woodwork, just like in any industry. However, over the past few years, the settlement industry has been working hard to regulate more and more states so consumers/clients/seniors are better protected from any corruption.  I say, give the industry a chance! 

Clearly, all you critics love playing the Devil’s advocate (we won’t hold it against you).  But why must you all constantly focus on the few rabid dogs in the dog community when dogs have incontestably proved to be man’s best friend?  The fact is, upon further regulation, the bad dogs will be put down and the good dogs will be there to make people’s lives better!

LIFE SETTLEMENTS AREN’T FOR EVERYONE! …but for those who DO have the need, they SERVE as a tremendously viable option.  LIFE SETTLEMENTS OFFER THE INSURED THE OPTION TO CHOOSE …whether they want to capitalize on the available exit strategy or not.  If let’s say their needs or interests have changed, life settlements could literally save the lives of the seniors who have the need…

 

Take this REAL LIFE SCENARIO from “Late in Life, Finding a Bonanza in Life Insurance By CHARLES DUHIGG- Published: December 17, 2006”… “If I hadn’t been able to sell this policy we would have lost our house, all of our savings, everything,” said Andrew Schneider of Kaysville, Utah. Seven years ago his wife, Karen, learned she had breast cancer. Her expenses exceeded the Schneiders’ medical insurance by half a million dollars. Mrs. Schneider sold her life insurance policy for about $250,000 and used the money to buy medicine and pay bills, he said. The investors who bought her policy received a $500,000 death benefit when she died last year. …“Selling that policy extended her life for years,” said Mr. Schneider. “If this market hadn’t existed, we would have become financially destitute.”

 
…so to all you critics out there, I applaud you for trying to be concerned individuals, looking to offer well thought-out and “insightful” opinions about the industry,  however, guiding the public with misguidance does nothing but harm them!  Please stop bad mouthing the industry and destroying life settlements for all those who may potentially have the need.  If you are so concerned about being the so-called “public’s hero” and fulfilling your fiduciary obligations to “the people”, try to be more fair to the industry.  By simply twisting those “negatives” around before fully understanding the industry, you are no better than those rapid dogs or life insurance settlement brokers who are quote-unquote “preying on the elderly”… all you critics with your haphazard views are doing nothing but instilling fear, creating problems and tarnishing this senior opportunity.

 

Best regards!

by A Concerned Senior/Upstanding Citizen (not verified) 9/9/2009 - 1:05 pm (re: Nebton)

I'm not sure why you think I'm being pessimistic or why I'm twisting anything (please be specific if you think otherwise). I recognize that there is value in these settlements. I don't see why that value overrides concerns that there is abuse in the system. Allowing any industry to self-regulate is putting the foxes in charge of the hen house. It's just a bad idea. Where abuses have been recognized, they must be addressed, and in this case that means regulation.

Do you think all regulation is bad? If not, what specifically do you find wrong with what I've said?

P.S. Identifying yourself as "upstanding" does give one pause. Honest people don't usually feel the need to declare themselves honest, at least not until their honesty has been called into question…

by Nebton 9/9/2009 - 1:14 pm (re: A Concerned Senior/Upstanding Citizen)

...Haha, there we go, twisting at its best.

Nebton, how about we focus on the main issues here and not the name of my posting ID. As a little P.S. to you, while I responded directly after your post, I did not intend to get your panties in a bunch... I was not directing my post directly at you, but more so to critics in general.

 

As for the concerns, of course people are going to have concerns, it's a relatively new industry and people question what they don't know. Bare in mind, people fear what is negatively publicized… whether the sources are reliable or not.  With this being said, many people frown upon life settlements because they do not fully understand that life settlements are not synonymous to viatical settlements.  Life settlements are not immoral, impractical nor unethical (when properly advised and guided by a professional in the industry).  ...and what about all the negativity the industry faced in its early years when people were buying other people’s insurance policies without having insurable interest of the insureds? …STOLI policies are illegal! These are some of the reasons which play a big role for why life settlements has such a bad reputation!  Bad eggs in a once unregulated industry + lots of press = bad reputation… it’s unfortunate. 

 

As for regulation, giving the industry total control to regulate would be horrible and I couldn't agree with you more with your foxes in charge of the hen house analogy. However, some regulation is definitely good and in this industry, completely necessary.

by A Concerned Senior/Upstanding Citizen (not verified) 9/9/2009 - 1:58 pm (re: Nebton)

...Haha, there we go, twisting at its best.

I asked for specifics about how I was twisting.

Nebton, how about we focus on the main issues here and not the name of my posting ID.

That's why my comment about your ID was in the postscript. (I.e., suggesting merely an afterthought.) It was not even remotely part of my focus, but was merely meant as a helpful piece of advice. Here I'm giving you a specific example of how you're twisting an argument. (I.e., by suggesting that the name of your posting ID was my focus in the previous comment.)

I did not intend to get your panties in a bunch..

Sexism doesn't help your case.

As for regulation, giving the industry total control to regulate would be horrible and I couldn't agree with you more with your foxes in charge of the hen house analogy. However, some regulation is definitely good and in this industry, completely necessary.

So then, where is there any disagreement? What issues are you wanting to focus on? What point am I missing?

by Nebton 9/9/2009 - 2:07 pm (re: A Concerned Senior/Upstanding Citizen)

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