Pros and Cons of Life Settlements

Posted in Life Insurance

September 2nd, 2010

Life settlements have grown in popularity in recent years. This practice of purchasing life insurance policies from senior citizen policyholders who are in need of money has resulted in a cash crop for investors. However, some critics argue that because the practice is virtually unregulated and some conflicts of interest are also at play, it could become problematic for the policyholders.

With the life insurance industry already under scrutiny, it’s possible more issues with life settlements will be brought to light. As they stand now, both policyholders and investors still argue in favor of their benefits, so let’s take a closer look at the pros and cons of life settlements.

Why Investors and Policyholders Love Life Settlements

There are a number of reasons why investors and policyholders love life settlements. Here are a couple of pros for the investors:

• Guaranteed return: One major benefit of purchasing a life settlement from a policyholder is the guaranteed return. There’s no doubt that at some point, the policyholder will die. Since the investor has purchased the life insurance policy, when the holder dies, the investor will redeem the cash.
• Double the profit: The nature of a life settlement allows the investor to purchase a $1 million policy for $500,000, for instance. This means, when the policyholder dies, the investor cashes in on double the return.

One major benefit for the policyholder is the money. For a person in need of some quick cash, a life settlement could be a quick option that could help pay down bills and take care of other immediate needs.

Problems Associated with Life Settlements

With definite benefits for each party, it may be difficult to understand why there could be any problems with life settlements. However, several have been named:

• Conflict of interest: One major issue that many critics have with life settlements is the conflict of interest. One person is looking for money while the other is looking for a person to die. With that said, the investor could undergo shady tactics to convince the policyholder to sell–or even go as far as make sure the policyholder dies in a specific time frame.
• High fees: According to the Government Accountability Office, another issue with life settlements is the possibility of excessive fees charged to the policyholder. Since there are differing fees to consider based a policyholder’s state of residence and other factors, they could be charged more than they originally anticipated.
• Unregulated: To date, 12 states and the District of Columbia are lacking insurance laws specifically geared toward regulating life settlements. As for the other 38 states, regulation varies, similar to auto insurance policies. The authority to examine brokers who negotiate settlements is often not followed through on and many policyholders could go unprotected in their transactions.
• Wall Street has caught on: Another issue with life settlements is that Wall Street caught on in recent months and has looked to profit as well. Due to the major Wall Street crash just two years ago, no one is eager to see it dive into any more risky investments.

The good news is that many federal agencies have decided to take a closer look at life settlements to make sure that no one is mistreated during the process.

Life Settlements Task Force Created

One major adjustment made in the world of life settlements is that the Securities and Exchange Commission (SEC) has created a Life Settlements Task Force. The task force is responsible for analyzing the life settlement market and regulating any gaps that could expose investors or policyholders to risks.

A big risk that the task force is aiming to regulate is the stranger-originated life insurance (STOLI) transaction where a stranger approaches a senior citizen and encourages them to purchase a policy only to have them transfer it later. This action would violate state laws and is being closely monitored.

What If I Want to Sell?

If you have decided that you would like to sell your life insurance policy, there are a number of existing companies ready to help you get started. However, before you do, make sure you learn all you can about how you can benefit from life settlements, as well as how they could hurt you.

The more you learn about this risky transaction, the better your chances will be of making the right decision for you and your family.