2/18/2011 11:21 AM ET|
Sell your life to a stranger?
You may be able to get cash by selling your life insurance policy to an investor. Here's how to find out whether it's a smart move.
If you've heard anything about the life settlement industry, it's probably because of deals that went wrong.
Life settlement is the practice of selling your life insurance policy for cash to investors who continue paying your premiums and who collect the death benefit when you die.
The practice has been around for a few decades, but it gained notoriety starting in the mid-2000s after hedge funds became big investors, wealthy people began buying policies specifically to flip them and many individual investors got burned by people who hung around much longer than their life expectancies suggested.
Here are just some of the cases that made headlines:
- Talk-show host Larry King sued an insurance brokerage in 2007, saying he was paid too little for the $15 million in policies he sold and wasn't told how tough it would be to get affordable replacements.
- The widow of a wealthy Manhattan lawyer sued after learning her late husband bought $56 million in life insurance coverage and quickly sold it to investors. She argued the death benefits should have come to her.
- An 81-year-old man in Los Angeles sued his agent, an insurance company and a bank after he said he was persuaded to pay $690,000 in premiums for a $6 million policy, only to find out there were no investors who wanted to buy it.
The idea of giving strangers a financial interest in your death may strike you as kind of creepy. But life settlement is a legitimate option for older people who have policies they no longer need, said Darwin Bayston, the executive director of the Life Insurance Settlement Association, an industry trade group.
What's your policy worth?
"So much of our senior population is just not prepared for retirement," Bayston said, noting that selling unneeded life insurance policies could be an alternative to selling a family home or using a reverse mortgage to tap the home's equity for cash. "Maybe their policies have value. . . . They can take a look at it and see what it might be worth."
The answer could be: not much. The recent boom in life settlements ended with the 2008 financial crash, which wiped out most of the market for what Bayston calls "manufactured STOLI," or stranger-originated life insurance, that was taken out by rich, healthy people to sell for a quick profit. Changes in life-expectancy tables -- actuaries figured out we were living longer -- dealt the industry another blow.
Today, most of the business involves policies owned by seniors in poor health, and "it's a buyer's market," said Glenn Daily, a fee-only insurance consultant who evaluates policies for investors and sellers.
The institutional investors that buy most policies -- big banks, pension funds, hedge funds, even life insurance companies -- are looking for a sizable expected return, typically in the range of 15% to 20%, after accounting for the policyholder's life expectancy and the cost of future premiums. Broker commissions and other costs further reduce the potential payout to sellers.
Often, Daily said, "people are disappointed."
"They think there's this pot of gold they can take advantage of," said Daily, who evaluates individual polices for a $1,895 fee. "They find out their policy is worth 10 cents on the dollar, or you go through the work (of trying to evaluate its worth) and it's worth nothing."
When is a life insurance policy most likely to have value in this market? Here are some guidelines, according to Daily:
- It's a cash-value policy, particularly a universal life policy. Cash-value policies, also known as "permanent" insurance, combine a death benefit with an investment component that builds up value over time. Term insurance, which is pure insurance with no investment component, typically has no value unless the owner's death is imminent. (See which is right for you with our quiz.)
- The policy has a face value of $250,000 or more, although some investors specialize in big portfolios of smaller-value policies.
- The owner has a life expectancy of 15 years or less. As you might expect, the shorter the life expectancy, the more the policy may be worth.
The policy also typically needs to be at least two years old and cover only one person. So-called second-to-die policies that cover couples are usually valuable only if one of those covered is already dead.
How to sell
To sell a policy, you'll need to work with an insurance agent or broker who specializes in this market, but you also should have an independent adviser -- such as an attorney, CPA or financial planner -- who isn't earning commissions from the sale.
Here's what to do:
- Make sure you no longer need the policy. The factors that are most likely to make your policy valuable -- you're over 65 and in poor health -- mean you're unlikely to qualify for new insurance. So review why you bought the policy in the first place, and make sure the need you were trying to cover is no longer there. If you still have people financially dependent on you, for example, you may still need insurance. You can take our quiz to estimate your needs.
- Consider your alternatives. If you need money, you typically can borrow against your policy's cash value and still keep your coverage in place. You also may surrender your policy to the insurance company for cash, although your payout could be less than you'd get from a sale. If you're considering selling your policy because you can no longer afford the premiums, talk to your insurer about your options. You may be able to lower or skip premiums if you have a lot of cash value in the policy. Another option: Ask your kids or other beneficiaries to take over the premium payments. This is often the best option if your life expectancy is very short, since selling the policy would net you only a fraction of what the policy will shortly be worth.
- Get several offers, if you can. This market is neither efficient nor robust, and some policies will generate little interest. But push your broker or agent to bring you more than one or two offers, since otherwise you may be presented with only the offers with high commissions attached.
- Negotiate commissions based on the purchase price. Some brokers try to claim a commission based on the policy's face value, regardless of the amount they eventually get for you. Daily says that's wrong, and that you should base the commission you pay on the purchase price. "You shouldn't have to pay more than 10% if you're a responsible seller who appreciates the business reality of the broker," Daily said. "If the broker can make a good case for charging more, then I'd be willing to listen. But this market has a history of taking advantage of policyholders, so you're justified in being skeptical."
Liz Weston is the Web's most-read personal-finance writer. She is the author of several books, most recently "The 10 Commandments of Money: Survive and Thrive in the New Economy" (find it on Bing). Weston's award-winning columns appear every Monday and Thursday, exclusively on MSN Money. Join the conversation and send in your financial questions on Liz Weston's Facebook fan page.
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Sometimes it's a matter of no longer needing the policy but sometimes the owner simply can no longer afford the cost. The article mentions borrowing against the policy but I have encountered people who have borrowed the maximum amounts and cannot pay the combination of the premiums and the accrued costs of interest. Generally, the loan will be paid off at death but if the loan amounts plus interest exceed the cash value, the policy will lapse leaving the policyholder and their beneficiaries with no insurance.
I have only been involved with one settlement case and in that case the owner needed to come up with both his premium and a loan payment. He could barely afford the premium. His $250,000 policy was going to lapse. Through a life settlement, I was able to negotiate an $83,000 settlement for him. I was paid 5% of the settlement amount. Did his investors enjoy a windfall-YES. Would the insurance company have enjoyed the benefit of his premium without having to pay a death benefit if his policy had lapsed-ABSOLUTELY. Would his family have been harmed if his policy had lapsed-WITHOUT A DOUBT.
Lastly, when I met this gentleman it was because he wanted to buy a policy to replace the policy that was going to lapse. Based on the premium he could afford I would have made approximately $5000 the first year and $450 per year for each the new policy stayed in force. That premium at his age would have bought about $25,000 worth of coverage. He got $83,000 with no further outlay.
It's easy to say what you wouldn't do but reality can change those beliefs. In this case, the only loser was the family to the extent that they lost 2/3 of the death benefit. Without the settlement, they would have lost 100%.
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