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Get a Life, Plus Cash, for Insurance Policy
By Jane Bryant Quinn
Commentary by Jane Bryant Quinn

June 18 (Bloomberg) -- Need money? Got a cash-value life insurance policy? Not feeling too well these days? You may be approached to sell your policy to an investor for cash up front. Maybe that's a good idea, but maybe not. You might part with a valuable policy unnecessarily and incur taxes you didn't expect.

I'm talking about the life-settlement industry, which appeals to older people seeking cash.

If you have a policy you don't need anymore, you have two ways of monetizing it: Surrender it to the life insurance company for its cash value or do a life settlement. (There will soon be an interesting third way, for people who want to keep their policies. More on that below.)

With a life settlement, you're selling your policy to an outside investor who will pay the premiums while you live and collect the proceeds when you die. Investors offer you more -- usually, substantially more -- than the policy's surrender value. You generally qualify if you're 65 or 70 and up and have some sort of health problem. A little bit of doddering helps.

A life settlement makes sense if you truly have no need for any more insurance -- no beneficiary who could use the money, no charity you want to give the policy to, no business purpose, no estate taxes to fund.

It's also useful if you have a policy that's poorly priced -- say, an older universal life policy with large surrender charges. Sometimes you can sell it for enough to buy a new and better policy for the same face amount, says fee-only life insurance adviser Peter Katt of Mattawan, Michigan.

Profit From Death
That is, as long as you don't care that a stranger is going to profit from your death. Your policy could wind up in Tony Soprano's Individual Retirement Account. Settlement brokers promise not to reveal your name and address to the investor but it sometimes happens anyway, Katt says.

Policy sales are taxable, but there has been no clear ruling from the Internal Revenue Service. You owe ordinary income tax on the amount by which the policy's cash value exceeds the premiums you paid. Any settlement money you receive in excess of the cash value may or may not be a capital gain. Your accountant decides.

The Life Insurance Settlement Association puts the size of the settlement market at $12 billion to $15 billion a year. That's a rich source of commissions for middlemen. They can receive as much as 35 percent of the policy's purchase price or perhaps 5 percent of the policy's face amount. That's why they're so eager to solicit you.

What Investors Want
Most investors want cash whole-life and universal-life policies with face amounts of at least $250,000 to $500,000. A few accept amounts as small as $50,000. You can sell a term policy if it's guaranteed renewable or can be converted into universal life. Brokers earn less from variable-life policies and don't like to work with them.

The amount you're offered will depend on your life expectancy as well as such things as the premium amount and how old the policy is. Investors like policies bought some time ago, when you were in better health.

Alas, because of the rich commissions, agents are persuading some people to sell when they shouldn't. As an example, take an older person who knows his or her heirs still need insurance coverage but can't afford to pay the premiums anymore. Selling sounds like the best option.

It's not, Katt says. Instead, start paying the premiums from your cash values. If you die, your beneficiaries will get the net policy proceeds. If you live, you can sell the policy a few years later when the cash values have run down. In the future, you will have a shorter life expectancy -- meaning that you will be able to sell at a higher price than you'd get today (grim arithmetic, but that's how it works).

New Alternative
Starting in July, you will have an alternative to life settlements. A new company, Legacy Funding Group in Malvern, Pennsylvania, will lend you money against your policy. In most cases, you will be offered at least as much as you would get by selling it and possibly more, says Larry Fondren, founder and president.

These so-called legacy loans will be funded by lenders and investors who will pay all the premiums. You owe no tax. At your death, a portion of the policy proceeds are used to repay the loan plus 9 percent interest. Your heirs get anything that's left, with a minimum guarantee of 10 percent of the money. That's clearly a better deal than a life settlement. Legacy also structures deals with potentially rising death benefits.

New York Life Insurance Co. offers a similar loan arrangement called Access Plus to its own policyholders in 22 states and the District of Columbia. In general, it's for people whose life expectancy is between one and 10 years, spokesman William Werfelman says.

Who is investing in life settlement policies? Mostly institutions, says David Kleinhandler, a New York insurance agent who specializes in this business. They buy pools of policies that he expects to yield an average of 11 or 12 percent, pretax.

He advises against this game for individuals. If the insured person lives longer than expected -- maybe because he or she is healthier than was advertised or new medications are developed -- your gains on that policy might shrink to zero. You might even have to put up more money to pay the premiums. And there's usually no way out. That's a risk the little guy shouldn't take.

(Jane Bryant Quinn, a leading personal finance writer and author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. She is a director of Bloomberg LP, parent of Bloomberg News. The opinions expressed are her own.)
-- With reporting by Alexis Leondis in New York. Editor: James Greiff, David Henry
To contact the writer of this column: Jane Bryant Quinn in New York at jbquinn@bloomberg.net


Covered for Life -- by a Stranger
By Kimberly Lankford
Kiplinger's Personal Finance
Sunday, June 22, 2008; F03

Many seniors sell their life-insurance policies to raise cash. When you (or a family member who may own the policy on your life) sell the insurance, the buyer becomes the owner and beneficiary. On your death, this stranger stops paying premiums and collects the death benefit.

Investors and middlemen make such big profits buying seniors' life-insurance policies that they are enticing people to take out unneeded insurance expressly for quick resale. But their greed may be catching up with them.

Stranger Owned Life Insurance (STOLI) resembles playing the lottery when you know the winning numbers in advance. A broker or investor persuades an affluent person in his or her 60s or 70s to apply for a large life-insurance policy with the agreement to sell it soon, usually within two years. The investor lends the money to pay the premiums. So anything you clear would seem to be free and out of nowhere.

STOLI got attention a few months ago after word spread that talk-show host Larry King <http://www.washingtonpost.com/ac2/related/topic/Larry+King?tid=informline>  had bought two policies totaling $15 million in death benefits and flipped them for $550,000 and $850,000. The investors clearly expect that King, who is 74 and has had serious heart problems, won't meet many more presidents before he dies. Yet King wasn't thrilled with his $1.4 million payoff; he sued for breach of fiduciary duty, claiming that he didn't realize the broker would get almost as much out of the transaction as he did, that he didn't know how the sale would be taxed, and that he didn't know creating and transferring the policies would make it difficult to buy additional life coverage (life insurers set limits based on income and assets).

But commissions aren't the only problem. Deals with strangers are just one more type of policy clamoring for investors, and they lower the amount people can get for legitimate life settlements. It's also against the point of insurance: to protect those who would suffer financially if you die. Several states are changing their laws to put an end to STOLI.

Insurance companies are trying to stem STOLI sales by asking applicants whether they plan to sell the policy. Saying no and then doing so is fraud and could invalidate the insurance. Some companies are refusing to sell large life policies to anyone over a certain age.