'Buying' your father's life insurance policy

This post comes from Jim Wang at partner site Bargaineering.

A reader, John, e-mailed me a question about secondary sales of life insurance policies. He had learned that his father was going to cancel his term life insurance policy at the end of the month and he was considering "buying" it from his father by paying the premiums and collecting the death benefit.

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We didn't get into the specifics but he ran the numbers and believes there's a 5% annual return if his father dies within 28 years (by age 91). He wanted to know if I thought this was a good idea.

It's always tricky when it comes to family and money, and it's especially tricky if it involves death. All the problems I see with this plan have to do with relationships, and navigating those issues is going to prove more challenging than navigating the financial aspects of this idea.

The investment

A 5% annual return over the next 28 years is good compared with the alternatives available right now. You can't get a 28-year certificate of deposit, but the yield on a 30-year Treasury today is about 4.40%. A 5% annual return is a 13.6% increase over the safest of safe investments. It's less than what you'd get in the stock market but it's far safer.

I don't know how John calculated the 5% return. I don't know if he calculated it based on the premiums, whether he accounted for present value, or any of the other stuff that a true apples-to-apples comparison would consider. Ultimately, I believe the decision isn't about money and more about the "other stuff," so I think this comparison is good enough.

The last few years have seen a boom in secondary sales of life insurance policies, where investors buy life insurance policies from individuals who are looking to cash out today. If investors can buy life insurance -- that is to say, they are paying someone for the right to make their premium payments -- then certainly John should be able to generate a positive return if he can get a life insurance policy for "free."

The other stuff

In my brief e-mails with John, it's obvious he can separate the emotional from the financial. That may not be the case for his siblings. While he'll probably discuss it with them all, when it comes down to the actual financial transaction (when his father dies), things may not be so easily resolved.

Death is almost always a very emotional time, and things decided, and documented, when the sky is sunny may not be so easily remembered when the clouds roll in. (John is aware of this, saying, "Some potential issues that I foresee are disputes by my siblings at the time of payout and the claim that my mother would have on the benefit if she were still living at the time. Everyone seems onboard with the agreement today, although a couple decades may change their opinions.")

There's also the less significant issue of pitting your financial interests against your social interests. When an investor buys a policy, hopefully he isn't sitting around hoping that the policy's former owner dies. Even if he is, it doesn't matter. It's clear that John doesn't feel this way, but it could become an issue.

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Here's where you guys come in. John was curious whether you thought it was a good idea and whether it was worth causing potential drama among his siblings later on?

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