Life
Insurance For Sale in a Secondary Market
© The Wall Street Journal
Don’t
be surprised if an insurance agent calls you with a new sales pitch:
Sell your life-insurance policy to someone else.
The idea, which
is gaining in popularity among older policyholders, is to raise
cash from a policy now, rather than wait until death.
The tactic mirrors
a controversial practice from the 1990s in which terminally ill
patients, particularly those with AIDS, sold their policies for
cash to cover medical cost. Those investments, known as viaticals,
burned many investors when new AIDS drugs that substantially prolonged
the lives of patients became widespread.
A decision over
the summer by the National Association of Insurance Commissioners
could further boost these transactions, which are called life settlements.
The group decided that insurance agents don’t need separate
licenses to broker the sale of a policy. A number of states had
required a separate license. “That will hugely broaden this
market,” says Doug Head, executive director of the Orlando,
FL.-based Viatical and Life Settlement Association of America.
In a life-settlement
transaction, a policyholder sells an existing policy to an investor,
who then is named the beneficiary. The investor pays the premium
and collects the payout when the seller dies. The vast majority
of investors are institutions, but some individuals and investment
clubs dabble in them, too.
Already, the
face value of policies sold in life-settlement transactions amounts
to more that $2 billion, according to Conning Research and Consulting,
a financial-services firm in Hartford, Conn. The life-settlement
industry is growing at an annual rate of just under 20%, Conning
estimates.
For many policyholders,
the idea of selling an insurance policy to a strange is an unusual
one. People generally assume that life-insurance policies –
particularly term policies, which provide coverage foe a set number
of years and then go away – have no value to anyone but the
insured and the beneficiary. Indeed, owners let nearly 90% of all
term policies lapse, so the insurance company never has to pay a
claim. What policyholders sometimes don’t realize is that
a policy is an asset that has a market value.
Life settlements
can make sense for sellers who no longer need coverage and no longer
want to pay premiums. Selling an unwanted policy increasingly is
becoming a financial-management tool for older people who face a
cash crunch, who don’t want to rely on their children for
financial support or who are trying to find money for costly long-term-care
insurance. Some holders of term polices sell them instead of letting
them lapse because they’ve found equal or better insurance
coverage at a lower rate.
Buyers are investors
chasing profits. Life settlements can generate annualized returns
of between 5% and 14%, according to professionals who either buy
the policies or who help insured people sell.
Insurance companies
typically dislike such sales. After all, insurers have priced life-insurance
policies with the idea that most will lapse and insurers won’t
have to pay any benefits. With more policyholders selling to investors,
insurers now face the increased likelihood that the contracts will
remain in force and require payoffs someday.
Agents and brokers,
however, are able to generate commissions from the sale of a policy,
and sometimes yet another commission if the can persuade a seller
to invest the proceeds in a long-term-care contract or an annuity.
For people with
universal-life coverage, which combines a death benefit with a savings
component, the value of a policy in a life-settlement transaction
is generally at least three times the underlying cash value of the
policy, says Mr. Head, of the Viatical and life Settlement Association.
Even term policies, which have no underlying cash value and typically
disappear at the end of a set amount of time, are worth something
-- often between 10% and 30% of the policy’s face amount.
That can be
a significant amount of money. Maple Life Financial, a Bethesda,
Md., buyer of policies, recently paid $248,947 for $1 million term
policy held by a 66-year-old. The firm also paid a couple n their
80s more than $232,000 for a $2 million universal-life policy that
had a cash value of $54,300.
Unlike with
viaticals, terminal illness isn’t a necessity of life settlements,
though sellers generally must be at least 65 years old and own a
policy that will pay at least $200,000. Mark Feinstein, managing
partner at Aaronson, Rappaport, Feinstein & Deutsch, a New York
law firm, says the firm and a partner in his 60s had three $1 million
term policies in force on the partner’s life. In replacing
those policies a few years ago with ones that charged cheaper premiums,
the firm realized the old policies had value to investors. Instead
of letting the contracts lapse, “we sold them for [a combined]
$160,000,” says Mr. Feinstein. “I thought they had no
value. I would have just turned the policies in for nothing.”
Investing in
life settlement can be risky. Investors will fare poorly in the
insured lives longer than expected. Moreover, miss a premium payment
and the insurance company can terminate the policy, meaning investors
lose their entire investment. If you’re not careful, you could
buy a term policy that expires before the seller does. For that
reason, most pros buy only term policies or can be renewed. The
premiums, though, often jump after renewal. Also, beware of policies
less than two years old. Most policies have a clause that allows
an insurer to nullify the contract if a pre-existing condition results
in death within two years of the insured’s taking out a policy.
Sellers run
risks, too. If you know you need life insurance, don’t sell.
You could find that at an advanced age replacing your insurance
is impossible or prohibitively expensive. Also, heirs or a widowed
spouse get nothing when you die, possible creating hardship or ill-will
within the family. For that reason, life-settlement companies generally
make a beneficiary endorse the sale. And while an insurance payout
is tax-free, the proceeds on the sale of an insurance policy aren’t,
so you’ll owe taxes on the money received in a life settlement.
By Jeff D. Opdyke
