BusinessWeek hit the newsstands last July 30 with a cover image of the Grim Reaper behind the headline: “Death Bonds: Inside Wall Street’s most macabre investment scheme yet.” In the opening paragraph of the article, author Matthew Goldstein gibes about the gathering of financial bigwigs in New York to talk about life settlements: “With all the happy banter, you wouldn’t have known that they were there to learn about new and imaginative ways to profit from people dying.”
The mainstream media has frequently portrayed the life settlements industry as intimidating, both in terms of its explosive growth and apparent morbidity.
The media hype can make it difficult for a consumer to separate the fluff from the facts; NuWire set out to investigate the perceptions that surround the industry and discover the reasons why consumers should agree or not agree to a life settlement.
Life settlements: past, present and future
The concept behind a life settlement is simple: a life insurance policyholder sells his or her policy, usually through a broker, for a lump sum of money that is usually three to four times the amount they would obtain by simply surrendering their policy to the life insurance company. The buyer, usually an institutional investor, takes over payment of the premiums and collects the death benefit once the insured person passes away.
The life settlements industry originally sprung from a weakened viatical settlements industry in the late 1990s and early 2000s. Before that, viatical settlements had become a way for patients afflicted with AIDS to obtain money from their insurance policies, which they critically needed. However, viatical settlements became less profitable with the development of medical advances that effectively treated and extended the life expectancy of AIDS patients. The industry was further troubled with allegations of fraudulent dealings.
Although the viatical settlements industry has all but disappeared, the life settlements industry is here to stay. Life settlements involve the same basic premise of buying policies for an amount based on the insured’s actuarial life expectancy, but have been expanded beyond the terminally ill to an elderly, wealthy population.
“The real change between life settlements and viatical settlements is that life settlements are done by people that do not need the insurance anymore, rather than people that need the money,” Zohar Elhanani, chief operating officer at Legacy Benefits, LLC, said. “The average policy that we currently purchase is around $2 million dollars [in] death benefit…so these are wealthy individuals who have reached [an] average age…around 80, and they simply don’t need the insurance.”
The life settlements industry has been gaining momentum and credibility as it attracts capital from large institutional investors such as Goldman Sachs, Morgan Stanley and Credit Suisse.
“The industry is evolving rapidly,” Elhanani said. “[According to] the Conning research report that came out at the end of the year…about 9 to 12 billion dollars of life settlements [were] concluded in 2007…and they project 90 to 140 billion on average in the next decade or so.”
Life settlement risks: the true and the false
The most well-known myth surrounding life settlements is that persons who sell their life insurance policy put their lives at risk should they live past their actuarial life expectancy. Although it is true that the continued payment of premiums will eat away at a buyer’s potential profits, the fear that such a situation might motivate the buyer to kill the insured is largely an irrational assumption. Policies are almost always purchased by institutional investors, not individuals.
“If I was protected for eight years [under life insurance], and…by selling my policy to an investor this investment [should] realize a 12 percent [annual] rate of return, [but I live for] ten years…why aren’t they going to send somebody to my house to exterminate me so they can get their money back?” David Kane, president of the benefits division at York International, said. “That was a very legitimate concern…in the early days when it was more private-type of money, but now most of the money is coming in through…large institutions…[and] people are generally not afraid that someone’s going to come ‘get them’ anymore because of [that] fact.”
Furthermore, such concerns have been largely based on speculation; there has not been any proof of murders motivated by life settlements, Doug Head, executive director for the Life Insurance Settlement Association, said. “There’s just no evidence that any of that has occurred,” Head said.
A more realistic risk for life settlements involves the downside for beneficiaries who would otherwise receive the death benefit sold to an institutional buyer. For example, the family of a person who agrees to a life settlement should be aware they won’t be able to realize the value of the policy when that person dies because someone else has been deemed the beneficiary, Eugenia Vecchio, an estate planning attorney in New York, said.
There is also the risk that sellers could become unknowing victims of fraud. Former New York Attorney General Eliot Spitzer filed a lawsuit against Coventry First, a financial services company considered to be one of the pioneers in the life settlements industry, in October 2006, alleging the company bribed life settlement brokers into suppressing competitive bids from other settlement companies. More than 90 percent of that suit has been thrown out by the court on a motion to dismiss, according to a Newswire release last November by Forbes. The Florida Office of Insurance Regulations investigated the same allegations and reached a settlement with Coventry Oct. 1, 2007.
While state regulations to compel greater transparency in life settlement transactions are pending, large broker-dealers and agents have been putting their own compliance measures in place to make sure every bid submitted is recorded and offered to the seller, Elhanani said.
“The main issue…is really the fiduciary duty of the agent and that’s heard more and more since the whole Eliot Spitzer allegation,” Elhanani said. “The fiduciary duty of the agent…[is] to get the best possible offer and to present that offer, not to keep it hidden in any way…and the stronger the definition of that fiduciary duty becomes, the better off the consumer [will be].”
A broker’s commission fees as well as the tax that would be deducted from the life settlement value are an additional matter of concern among policy owners who consider life settlements. Thus, experts advise sellers work with a representative they trust. An experienced and trustworthy estate planning attorney is a good source for understanding factors such as market trends and changing tax laws in developing a complete integrated estate plan, Vecchio said.
“[A life settlement] is not an appropriate methodology for every client to employ,” Vecchio said. “It’s only under specific and tailored circumstances that it is appropriate.”
Life settlements have also raised concerns over privacy issues on behalf of insurance policyholders. In order for a life settlement transaction to take place, the identity and some personal information about the insured will have to be disclosed to the buyer and downstream investors, and “that’s just the reality of the way it works,” Head said.
“If you sell a house, frequently you have to fill out a disclosure form and tell the buyer what you know is wrong with the house,” Head said. “Is that an invasion of privacy or is that just a bare market consideration?”
Conversely, a seller who wants to obtain identifying information about potential buyer and downstream owners is usually able to obtain that information. “We feel that it brings a lot more credibility to the transaction…[and] it’s a legitimate requirement,” Elhanani said.
Some states even require that this information is provided.
“A lot of states require that when there’s a new owner of the policy, that the name and the identity of the new owner be disclosed to the original seller of the policy that flows through the process and I think that’s a good idea,” Head said.
The consumer’s advantage
The risks associated with selling a life insurance policy on the secondary market are manageable for many consumers. “This is a fantastic marketplace for an individual who wants to sell their policy,” Kane said.
Before the market existed, the only value a consumer could realize in giving up their life insurance policy was its stated cash value, or the amount of reserves in the contract based on the total principal and interest in the account, Kane said.
More specifically, the surrender value is typically about 5 percent of the face value of a universal life policy, Head said. Life settlements, on the other hand, provide a much higher payout.
“It has generally been seen…[that the] settlement value of the policy is about 20 percent of face, so essentially [the seller would get] three to four times the surrender value being paid for settlement,” Head said. “That’s certainly a benefit to a consumer who is looking or is planning to surrender or lapse a policy.”
From the standpoint of an estate planning attorney, having the option to conduct a life settlement is an advantage in serving the interest of the client.
“I think that if a client has a contract that he or she willingly purchased, and there is an opportunity for that client to translate that into a lifetime benefit and they are represented by competent council in entering into the transaction, then certainly [a life settlement] should be one of the choices,” Vecchio said.
This is the first of a two-part article series that examines the controversies surrounding the life settlements industry. This article addresses the issues from the standpoint of the general consumer, whereas the second article Life Settlements: What Investors Should Know addresses more specific issues that affect the investor.