What are Life Settlements?

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A life settlement is where the owner of a life insurance policy sells it to a third party. In general, the owner will sell it for more than its cash value, which the owner can get from the insurance company, but less than its payout at death. It sounds a little creepy, to be buying life insurance policies, but it’s something that can make sense for both the buyer and the seller. In many cases, the seller may not want to continue the policy or may not be able to make the payments on those policies. They can get cash from the life insurance company or they can sell it to a third party, who would become the new owner and continue making payments on the policy. By making a life settlement with a third party, they can extract more of the value out of the life insurance policy after years of premiums.

As you’d expect, this business is loosely regulated and I only happened upon it because the SEC was considering classifying life settlements as securities, which would put them under more scrutiny. Right now there is little and inconsistent regulation of life settlements, which makes many people, both in and out of the life insurance business, uneasy.

So what’s bad about life settlements? Since there is little regulation, you’d expect abuse. As Frank Keating, CEO of the American Council of Life Insurers, said in this PBS piece: “This is a system that corrupts life insurance, wrecks the white-hat image and the reality of the industry and encourages people to buy a policy for short- term gain, but for long-term loss. You know, die as quickly as possible. You have a group of investors who can’t wait for you to die. I mean, what a ghoulish business.”

While I can understand that perspective, life insurance is a business. If a consumer can start a policy and make a smart business decision about it, I think you should let them. If they no longer want to pay the premiums, they can get more than the insurance company is offering through a life settlement. The abuse part comes in, and this is the common complaint about annuities, when life settlement companies take advantage of people with a less than fair payout, though that’s hard to quantify, or throw in hidden fees and charges. That’s why regulation of this industry is probably for the best.

{ 8 comments, please add your thoughts now! }

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8 Responses to “What are Life Settlements?”

  1. freeby50 says:

    “this is the common complaint about annuities,”

    I’m not sure what annuities have to do with life settlements. Unless you’re comparing the 2 as both being susceptible to unfavorable terms or high fees.

  2. billsnider says:

    I need a little help from a financial agent or insurance saleman to answer this.

    I always understand that in order to collect on an insurance policy, you have to have an insurable interest in the person. Strangers can’t collect.

    Is this not true?

    Bill snider

    • AMP says:

      To take out a policy on someone, ie. to be an owner of an insurance policy, you have to have an insurable interest in the person: they have to be a key man in your business, a spouse, a relative, etc.

      The owner can name whoever they want as a beneficiary.

  3. Ron says:

    I had never considered that the insurance company would pay the cash value of the policy if you no longer needed the policy. Is this in fact true?

    • AMP says:

      Only certain types of life insurance have cash value – generally whole life. Term does not. You’d get at least an annual statement with your cash value balance.

  4. Shirley says:

    While I understand the business/investment side of this, I still find it somewhat ‘creepy’. And if the insured is not a person close to the buyer, how does the buyer know when the insured dies?

  5. I don’t have any vested interest in life settlements, but find them interesting.

    One of the things that made them more popular was actually AIDS. You had people known to have a short life expectancy, often with no heirs. They’d get cash up front to enjoy what they had left of life (take a trip to Europe, etc). Hey, you can’t take it with you, right?

    As I understand it, you general invest in a bundle of policies (i.e. 1% of 100 policies as opposed to 100% of 1 policy). This diversifies the “risk” (of the person returning to normal health) and also removed the incentive to, uh, speed up the inevitable (with a bullet, for example).

    There are definitely some unsavory elements in the industry at the current time, though.

  6. I got an e-mail from someone in the industry about life settlements this week, but I don’t know enough about it to be comfortable. It would be great if there was a 3rd party regulatory that oversaw these policies to give them greater credibility with the public.

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