More people are selling their life-insurance policies for much-needed cash while they're still alive. But are life settlements a bad deal? At a time when retirement nest eggs have shrunk, home equity has disappeared and bank loans are hard to get, more and more people are selling their life insurance policies to get cash.

"People may chose to sell their life insurance if they no longer want or need the coverage, or if they are struggling to afford the premiums," explains John Yaker, president of Quantum Life Settlements.

In these transactions, called life settlements, a third party buys the policies, taking over the premiums and then collecting the money when the insured person dies.

Controversy Abounds

But while the lump-sum payment these life settlements offer might appear to be a godsend for a cash-strapped senior citizen, critics say life settlements are unethical or immoral -- and some say they could even provide an incentive for murder.

"It's the wild, wild West, generally an unregulated marketplace," says Byron Udell, founder of AccuQuote, a provider of term-life-insurance quotes.
That lack of regulation and oversight, in a market that has grown quickly in the last decade, has raised concerns from the Securities and Exchange Commission. One study estimated that existing policies with a collective face value of $11.8 billion were sold by policyholders to investors in 2008.

In a report in July, an SEC task force described the inconsistent regulation of participants in the market, including those who arrange for the buying and selling of policies and those who provide estimates of an insured person's life expectancy. In addition, the report noted that life-settlement investors would benefit from a set of standards.

The task force recommended that life settlements be clearly defined as securities so that investors in these transactions are protected under the federal securities laws. In 2009, the Financial Industry Regulatory Authority issued an alert warning seniors about life settlements.

The Attraction

To understand why there's so much fuss about these deals, it helps to understand their history. Before life settlements, if you owned a life insurance policy that you no longer wanted or needed, you had two choices: surrender the policy for its cash value or allow it to lapse. Then a third option developed: Sell your policy -- or the right to receive the death benefit -- to someone other than the insurance company that issued the policy, a transaction known as a life settlement.

The purchasers of life settlements, sometimes called life-settlement companies or life-settlement providers, pay off the policy holder in a lump sum and then typically either hold the policies to maturity -- i.e. to the death -- and collect the benefits themselves, or sell interests in a pool of policies to hedge funds or other investors.

The amount of the settlement varies depending on factors such as the insured person's age and health, as well as the terms and conditions of the policy. But typically, the seller will get more than the policy's cash-surrender value and less than the net death benefit. "Policy owners can net up to eight times more in a life settlement than if they surrendered their policy back to the insurance company," Yaker says.

But when you sell your life insurance policy, whoever buys it acquires a financial interest in your death. In addition to paying
you a lump sum for your policy, the buyer pays any additional premiums as long as you live.

Last Stop

That's one reason many financial experts say a life settlement should be the last stop -- and not the first -- during a desperate hunt for cash. "In a financial transaction where one person (the buyer) has a financial incentive for another (the insured) to die, there are massive ethical implications, says Bruce Fenton, managing director of Atlantic Financial. "Additionally, the industry itself has been plagued with unethical behavior, fraud, low quality providers and other issues." He adds: "I would avoid them at almost all costs, as both a seller and an investor."

Investors shouldn't be speculating on other people's lives, argues AccuQuote's Udell. "When a stranger has a vested interest in your death, it can be an incentive for murder," he says. "I predict five years from now there'll be a 60 Minutes story about people who died that they trace back to life settlements. Many of these policies are for more than $1 million. People will die before they should so someone will get millions. You will have to look over your shoulder the rest of your life."

There are plenty of other downsides. For starters, selling your life insurance means you disinherit your beneficiaries. You also likely will have to pay taxes on the payment you receive. And if you change your mind, chaos ensues. "If you sell a policy thinking you do not need insurance and later you do, but your health has changed or premiums are cost prohibitive, insurance is not an option," explains Brian McDowell, chief investment officer for FBR Wealth Management Group.

You also end up paying very high -- and, some argue, unjustifiable -- fees. Let's say a person who owns a $1 million policy with $200,000 in cash-surrender value receives an offer of $300,000 from a life-settlement provider. Assuming 5% commission on the $1 million policy, the cost -- usually paid by the seller -- would come to $50,000. That takes 17% off the offer price, leaving the seller with only $250,000. "Some see this amount of fees as unacceptable no matter the situation; others feel the fees may be warranted on a situational basis," McDowell says.

Buyer Beware

Buyers also take a big risk: The insured person could easily live longer than expected. "There are much better investments for the average investor," says Amy Danise, senior managing editor at Insure.com. "Plenty of investors got burned and didn't get the returns they expected because the person lived longer than expected. Every time they pay premiums, it cuts into their profits."

Furthermore, in the case of term-life-insurance policies, if the insured person outlives the term of the policy, the investor may end up having to pay for a new policy, which would be more expensive because the insured person would be older than when the expired policy was issued, says Richard McGrath, president of McGrath Insurance, who refuses to sell life settlements because he considers them unethical.

No doubt, there are times when a life settlement makes sense. One 54-year-old man, who's terminally ill with bone-marrow cancer, says he sold his $400,000 policy for $200,000. He wanted money to pay down some of his debt and live a little more comfortably during his remaining time with his wife and grown children. The family took a long-hoped-for trip to San Francisco.

He kept a bigger life insurance policy. "I wouldn't have sold the smaller one if it was all that I had, because I wouldn't leave my wife in a lurch." For him, selling was a good thing. "They'll make money off me, but it's also been very helpful to us."

It might also make sense to sell a policy that isn't performing as expected, says Bryan Freeman, president of Habersham Funding. In some cases, a bankruptcy, the purchase or sale of a business or any change that removes the need for the policy could drive a sound sale, he adds.

Life-Settlement Tips

Despite all the warnings and the controversy, many more people will likely continue to sell and buy these settlements in the tough economic times. If you're planning to get involved on either side of one of these transactions, here are some tips that may help you avoid getting burned.

Deal only with a settlement entity licensed in your state. This provides safeguards for all involved and may even provide you with advantageous tax treatment, Freeman says.

Know the facts. A death benefit may be tax free, but a policy that's cashed out isn't. If you're selling your policy, make sure to include the taxes, as well as all other fees, in your calculations. The offer price will be well below the value of the policy. "When all is said and done, my experience is that the seller usually receives about 50 cents for each dollar of 'intrinsic' value in a sold policy," says Scott Witt, a fee-only life-insurance advisor.

Get multiple offers from reputable settlement companies. With so much money at stake, shopping around is as important as ever. Never agree to a settlement without a written offer from the buyer.

Take your time and seek professional help. Make sure to select a financial professional who has experience with life settlements and who can explain all the ramifications of the deal, advises Stan Lewandowski, a wealth preservation specialist with Sagemark Consulting. Know too that the sale of the policy is irrevocable and should not be taken lightly.

Consider all your options. If you are considering selling your life-insurance policy for cash, you may have other options. "There are other ways to get money out of your policy. What's the cash value, can you get a loan?" asks Danise. If you have a long-term, catastrophic or terminal illness, you may also be eligible for what's called "accelerated" death benefits, which allow an insured person to receive benefits in advance of his or her death. If you're considering a sale because you can't keep up your premiums, it may make sense to reduce the death benefit -- and thereby lower the premiums.

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37 Comments

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sjoyner32342

I found it funny that I stumbled across this article now as 2 months ago, we had never heard of A Life Settlement. My parents really needed some money for my mothers health issues and they didn't think they had any options but here they were spending $600 per month a life insurance policy for my mother! They wanted me to benefit from it, but that was the last thing that I wanted as I just wanted them to be comfortable. They found A Life Settlement and worked with some extremely professional (and American) people so I thought I would give them a shout out...

http://www.alifesettlement.com/

September 19 2013 at 3:33 PM Report abuse rate up rate down Reply
rcdruryacfa

As a contributor to this article, I would have hoped for a much more positive spin on this topic. While Sheryl certainly provides great information and reasonable balance, this article seems to evade the bottom line: When one either is in dire need of cash or no longer has a life insurance need, his only other alternatives are to cash the policy out or let it lapse. If the policy is term or a minimally funded UL, there is little or no cash value to retain. A life settlement supplies substantially more money during the insured's lifetime than any other option. If there are no heirs involved, or the need for funds will inevitably force the demise of a policy anyway, a life settlement is the only answer that makes sense.

Rob Drury
Executive Director,
Association of Christian Financial Advisors

December 28 2010 at 6:52 PM Report abuse +1 rate up rate down Reply
Sonny

Ditto on the tax ramifications............that may actually leave very little after the tax is paid. I have seen some instances of negative return after tax.

December 27 2010 at 12:28 PM Report abuse +1 rate up rate down Reply
1 reply to Sonny's comment
rcdruryacfa

Sorry; not possible. Only gains are taxed. How could that be greater than the receipts?

April 22 2011 at 12:07 AM Report abuse +1 rate up rate down Reply
plp232@mail.com

Wow. http://67.42.80.195

December 27 2010 at 2:02 AM Report abuse -1 rate up rate down Reply
moafus

Ms. Nash tries to deal with the topic as fairly as possible; albeit, clouded by the influence of those she interviewed on the subject.

The main example is the irresponsible statement of Byron Udell of AccuQuote that Life Settlements could be a motive for murder. Such an extreme. Life Insurance policies in general have been motives for murder. Certainly a Life Settlement could, as well. But at an extreme.

A search of the Internet for the London Times Articles and the A.M. Best articles on Life Settlements will return a balanced view of the industry. Since life insurance companies only ever payout on less that 20% of the policies they issue, it is betting in reverse on the life of the insured.

In 1911, the Supreme Court ruled in Grigsby v Russell that a life insurance policy is an asset owned by the insured or designated owner by the insured. The historic and shameful moral dilemna lies in the failure of the insurance companies to inform their insureds of all the facts about the policy OWNED by the insured.

A more balanced treatment of this topic should be forthcoming from this publication.
E. Leonard

December 26 2010 at 9:02 PM Report abuse +1 rate up rate down Reply
1 reply to moafus's comment
accuquotelife

Mr. Leonard, as you well know, at the time of the creation of a life insurance policy, there is a requirement that the owner have an insurable interest in the insured’s life. The reason for this law is that there is a presumptiontion that if you have interest in the insured’s continued LIFE, there will be less of a likelihood of murder. So then, why is my statement regarding life settlements being an incentive for murder so extreme?

If you think about all the murder that has happened since the beginning of the civilized world, much of it is over money. And it’s usually a lot less money than is at stake in these transactions. This is clearly the reason why the law requires that the owner (at least at the time of the creation of the policy) have a legitimate insurable interest in the insured’s life.

The Supreme Court ruling Mr. Leonard references is the basis upon which the life settlements industry now exists. Without it, it wouldn’t. But the decision in my view should be reversed. Whatever “property rights” one may have and would be giving up if this decision were reversed are far outweighed by the legitimate public policy concerns about strangers owning life insurance on strangers (yes, the murder incentive angle). I see no reason why insurable interest is important at the time of the creation of the contract, but (so the court said) not important at the time of a transfer of ownership. Seems to me that the same public policy issues are present in either case. It’s just not good public policy for strangers to be speculating on the lives of other strangers, especially and specifically when those strangers have a financial interest in the insured’s death.

There is nothing shameful in my view about life insurance companies believing that it’s not a good idea for strangers to take ownership of policies on the lives the insurance company is covering. This article responsibly covers an aspect of this industry that is not often addressed and most likely never mentioned to the thousands of unsuspecting consumers who are presented with the sales pitch to sell their policies to strangers. Do the materials and conversations about this topic generally inform the insureds who are thinking about selling their policy to strangers that, once their policy is sold, they’ll have to be looking over their shoulder for the rest of their lives?

It seems patently obvious that E. Leonard has a financial interest in the life settlements industry, which would make it difficult for him to be objective. I have no such financial interest.

If anything is irresponsible, it is the way that these transactions are marketed to policy owners by the life settlements industry. They are selling the concept of transferring ownership of your life insurance policy to a stranger, without informing the insured of ALL the risks including the risk that your policy could be re-sold again and again, that it could ultimately fall into the wrong hands, and that there will forever be someone out there, who you do not know, that has taken over the premium payment obligations and that will stand to gain a LOT of money if you die.

Byron Udell

December 28 2010 at 1:41 PM Report abuse -1 rate up rate down Reply
Wayne

we shuld try not to get in a better way,ask kids for help,they will get it
back in the long run.

December 25 2010 at 1:10 PM Report abuse rate up rate down Reply
1 reply to Wayne's comment
rcdruryacfa

Good point, Wayne, as long as that point applies to the given scenario. What if the insured no longer has any potential beneficiaries? What if everyone involved lacks either the interest in or ability to pay premiums? What if the cash is more urgently needed by the insured during his lifetime? Like any other financial planning topic, the appropriate action is based on the scenario and the financial objectives.

April 22 2011 at 12:41 AM Report abuse +1 rate up rate down Reply
Robert & Lisa

The rich keep getting richer and the middle class and the poor keep getting poorer. The last two years more so than ever. Still think Obama and the corrupt Demoncrat thugs are the answer? There is a reason the elite, rich man, George Soros and his corrupt, evil, rich cohorts are supporting the unions and the corrupt Demoncrat politicians. After being brainwashed by our Socialist Government Educational system, are you smart enough to understand why?

December 24 2010 at 3:43 PM Report abuse +1 rate up rate down Reply
Vince

There is so much I could say about this one-sided article but I will limit myself to two main points: First, every insurance company that sells immediate annuities or pension plans has the same vested interest in the insured's death as someone who buys a life sttlement. There are no ethical considerations in life settlements that don't exist for insurance companies selling annuities. Second, a life settlement transaction ALWAYS pays the insured more than the so-called cash value offered by the insurance company. Claiming that the insured does not always receive the economic value of the policy is ridiculous as the insurance company always offers less than asuccessful settlement transaction.

December 24 2010 at 2:45 PM Report abuse +1 rate up rate down Reply
1 reply to Vince's comment
evd10

"First, every insurance company that sells immediate annuities or pension plans has the same vested interest in the insured's death as someone who buys a life sttlement. There are no ethical considerations in life settlements that don't exist for insurance companies selling annuities."... Nice try, but your reasoning is faulty. While it is true that life insurers or pension plans have a vested interest in the insured, the annuitants or the pensioners they mitigate risks by spreading it over a large number of policy holders, annuitants and pensioners and by basing their rates, fees and payouts on actuarial data. Investors who buy life settlements, generally, do not have the same ability, nor protection.

December 24 2010 at 4:34 PM Report abuse rate up rate down Reply
Bob Simmons

Wow ~ a lot of miss information in that article. Viaticle Settlements or Life Settlements have been around a long time and state and federal regs have been published on what a "fair" price range is based on life expectancy. CNA one of the nations largest most reputable companies pioneered this process in a proffesional, ethiccal and comforting process. Brokers often play a valuble role in getting multiple buying companies to compete driving up the settlement amount to the seller, which is no different than the brokers that shop multiple insurers to sell you life insurance. NO one that does not want to sell thier policy has to - it is an option, that for many is a truly life changing benefit. If insurance companies were not so greedy they would offer this benefit themselves to policy holders in terms of years not months. The bottom line, if you want to sell, sell if you don't need to don't!

December 24 2010 at 12:39 PM Report abuse rate up rate down Reply
1 reply to Bob Simmons's comment
evd10

"If insurance companies were not so greedy they would offer this benefit themselves"...Life insurance companies have always been reluctant to allow people to own and be the beneficiary on the policies of someone who is not related or does not have some other eqiitable interest in the insured, because of the possibilty of mischef and the bad publicity that may result from that. See tontine.

December 24 2010 at 2:34 PM Report abuse +1 rate up rate down Reply
hlipkruted

A few tears ago, my four children agreed that they did not want to pay the premiums on a policy I had which was over 20 years old, had equity of over twenty thousand, and would pay out $100,000 upon my passing. I considered selling it but found I would not get much more than the return of premiums I ultimately received. Most important, I would not have the guilt that I was not fulfilling my end of the contract if I continued to live; creepy, having the inveshment ghouls staring over my shoulder. PhD

December 24 2010 at 11:27 AM Report abuse rate up rate down Reply
1 reply to hlipkruted's comment
evd10

"my four children agreed that they did not want to pay the premiums on a policy"...Depending on circumstances it may have been a good bet for them to make. "had equity of over twenty thousand"...And what would have happened to your so-called "equity" if you died while the policy was in force? Oh, the insurance company keeps that "equity".

December 24 2010 at 1:54 PM Report abuse rate up rate down Reply