Life Settlements: Too Good To Be True?
By: Jay Gaudreau | Posted: 05th December 2006
LIFE SETTLEMENTS: TOO GOOD TO BE TRUE?
A relatively new segment of the life insurance industry has emerged which is creating quite a stir. I am referring to the rapidly growing life settlement industry. Essentially, a life settlement is the sale of ownership rights to an existing life insurance policy from the insured to a third party for more than the surrender value but less than the death benefit. Advocates of the industry say that it’s a win-win situation for everyone involved. The seller gets immediate funds, and the buyer can receive greater sums upon the death of the insured. Sounds great, doesn’t it? Like most things, in order to understand it we must first look at its history.
The life settlement industry is a spin-off of the viatical settlement industry. Viatical settlements came about in the late 1980’s during the outbreak of the AIDS epidemic. AIDS patients had exhausted their funds in order to pay for medical treatment. One of the few things of value that many of these patients had left was their life insurance policy. At this time, a group of investors decided that it made sense to purchase these policies. If someone had a $1,000,000 policy that they were willing to sell for say $500,000 and their life expectancy was one year, anyone could see that this was an exceptional investment. The investors would see a pre-tax profit of $500,000 minus any premiums they had to pay to keep the policy up. I can’t think of anyone that would turn down a 100% yearly return on their investment. This practice grew into a billion dollar industry overnight. Thankfully, medical advancements began to lengthen the life expectancies of AIDS patients and instead of having one year to live, patients were living for 10 or 20 years after their diagnosis. As a result, instead of seeing a 100% return on their investment, investors were seeing a 5% or 10% return. Suddenly, betting on death wasn’t such a sound investment and the viatical settlement industry vanished as rapidly as it had arrived.
Life Insurance has always been a very profitable business. There are numerous reasons to purchase life insurance: tax-free savings, financial security for dependents, I could go on all day. The only problem with life insurance is that you have to actually die in order to reap the benefit of it. Well, not anymore. The same investors that made billions of dollars through the viatical settlement industry came up with a plan so that people can profit from their death – before they die. A life settlement allows the insured to receive a substantial lump sum – usually in the hundreds of thousands of dollars, while they are still alive. So the insured gets a big cash payout to enjoy while they are still alive and the investors get a big cash payout when the insured dies. It looks like everyone is a winner here, doesn’t it? Unfortunately, in order for there to be a winner there must also be a loser.
So who loses in this deal? Insurance companies. Insurance companies love it when a policy lapses. A lapse is when the insured stops paying their premiums and as a result, the insurance company never has to pay a death benefit. So if someone faithfully pays their premiums for years and years and then suddenly stops, the insurance company gets to keep all of that money and never has to pay out a dime. Unfortunately for the insurance companies, policy owners who would have allowed their policies to lapse in the past are now selling their policies. Upon the sale of the policy, the buyer is obligated to pay the future premiums until the insured dies. Of course the buyer won’t allow the policy to lapse because the whole reason that they purchased the policy was to realize the death benefit. As a result, many insurance companies are forbidding their agents to advise their clients to pursue a life settlement.
Life settlements can be extremely beneficial for some people. For example, if there are immediate financial needs, a life settlement is an excellent means to provide income. There is essentially no risk and there are no out of pocket expenses. On the other hand, life settlements don’t make much sense for some people. If an insured doesn’t mind paying the expensive premiums to keep the policy up, they should obviously keep the policy in order for their beneficiaries to realize the full death benefit. As with any investment opportunity, a life settlement should be carefully considered with one’s advisors.
Jay Gaudreau
www.waginsurance.com
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Tags: advocates, outbreak, life insurance policy, life settlements, life insurance industry, life expectancies, surrender value, sound investment, dollar industry, medical treatment, premiums, life expectancy, medical advancements, death benefit, aids patients