The Trade-offs of Selling Your Life Insurance

For some retirees, life settlements can sound pretty tempting. After all, these increasingly popular transactions let you exchange your life insurance policy for a nice chunk of cold, hard cash. Typically, a broker will offer you an up-front payment worth a certain fraction of your policy’s face value, then sell your insurance to a buyer who will pay the premiums on the policy. If you’re a 75-year-old man with $1 million in life insurance, you might get $250,000 now from a life settlement, and the investors who buy your policy would get $1 million when you die.

The whole concept of letting strangers own insurance on your life may strike you as ghoulish or even dangerous, but if you’re struggling to pay premiums, your spouse or other beneficiary has died—or you just need money—it can be a useful item to liquidate. Face-value transactions in the life settlement industry are growing rapidly, rising from $2 billion in 2002 to an estimated $12 billion in 2007, according to Conning Research & Consulting.

Life settlement deals seem so potentially lucrative that a business of what’s known as stranger-originated life insurance has sprung up, where seniors, often lured by brokers, take out new policies for the express purpose of selling their insurance to investors. Of life settlements reached in 2008, fully half involved policies that were less than four years old, according to research by Life Policy Dynamics, a life settlement consulting firm.

But I don’t think life settlements belong in your retirement planning—not yet, anyway. The Securities and Exchange Commission doesn’t require settlement providers or brokers to register as securities dealers, and state regulation is haphazard. So life settlement companies don’t typically disclose what policies they have on their books, how they value them, or the fees they charge investors and policyholders. Result: enormous, often unreported commissions, which all too often lead brokers to lure seniors into selling insurance they still need or, worse, into misrepresenting their health or financial status to acquire new insurance to sell. More than 100 civil cases involving life settlements are under litigation, up from virtually none in 2005, according to a recent report by the U.S. Senate Special Committee on Aging.

Life settlements carry other risks for consumers. After a life settlement, you may owe capital gains taxes you hadn’t expected, and you might not be able to get more life insurance if you need it. Although many seniors might not realize it, experts say there’s a limited amount of life insurance an individual can qualify for. “Insurance sold to someone else does not free up their capacity for additional insurance coverage,” Scott Berlin, senior vice president at New York Life, testified at a Florida state hearing on life settlements.

As the secondary market for life insurance keeps growing, competition is sure to heat up, forcing regulators to get their acts together, transparency to spread and fees to fall. But we’re not there yet.