FINRA is the the Financial Industry Regulatory Authority, which is a private corporation that acts as a self-regulatory organization. As part of its responsibility to help consumers avoid being taken advantage of, FINRA has listed a number of facts and warnings about investment vehicles known as “Life Settlements.” Much of this information was recently listed in an article in Kiplinger.com.
A “Life settlement”, (which is sometimes called a “senior settlement”) involves selling an existing life insurance policy to a 3rd party—(a person or an entity other than the company that issued the policy)—for more than the policy’s cash surrender value, but less than the net death benefit. In the past, if you owned a life insurance policy (that you no longer wanted or needed), you generally had two choices: surrender the policy for its cash value, or allow it to lapse. Life settlements present a third option: selling your policy (or the right to receive the death benefit) to an entity other than the insurance company that issued the policy. That transaction is known as a life settlement.
Here are some basic facts you need to know before getting involved with a Life Settlement.
- Life settlements can have high transaction costs and unintended consequences, & even if you decide a life settlement is generally right for you, it can be hard to tell whether you are getting a fair price.
- FINRA has even issued an alert to highlight the questions you should ask and the factors to consider before entering into a life settlement.
- The purchasers of life settlements, sometimes called life settlement companies or life settlement providers, generally are institutions that either hold the policies to maturity and collect the net death benefits or resell policies—or sell interests in multiple, bundled policies—to hedge funds or other investors. In exchange, you receive a lump sum payment. The amount you will receive in the secondary market depends on a range of factors, including your age, health and the terms and conditions of your policy.
- When you sell your life insurance policy, whoever buys it is acquiring a financial interest in your death.
- In addition to paying you a lump sum for your policy, the buyer agrees to pay any additional premiums that might be required to support the cost of the policy for as long as you live. In exchange, the buyer will receive the death benefit when you die.
Some of the “Advantages” of Life Settlements:
- It’s a better alternative to letting an expensive or unneeded policy lapse. (sometimes)
- Life settlements can help fund things like hospice care in an emergency situation.
Some of the “Disadvantages” of Life Settlements:
- Sellers generally receive a fraction of the face value
- People tend to overlook other safer alternatives when motivated by the lore of easy cash and gains by security personnel or firms.
- Regulated by the SEC (proven to be ineffective)
- There is a High risk of seniors being taken advantage of by unscrupulous sellers of Life Settlements
- The insured receives far less than the death benefit.
- Settlement providers are fee based
- Commissions and a lack of fiduciary responsibility are present
- Loss of tax advantages (Beneficiaries normally receive death benefits tax free.)
- Both the Insured and investor pay a tax on received portion of death benefit.
- Investor’s returns can easily be negatively affected by the insured person outliving life expectancy tables.
- Insurance companies are constantly looking for fraudulent policies started for the sole purpose of executing a life settlement. (Investors will pay seniors to open policies)\
- Creditors may claim benefits for those who owe substantial medical bills and have significant debt.
- Life Settlements eliminate money that would be left to heirs tax free
- The amount you receive above the premiums you’ve paid for insurance, is taxable as income.
- You may outlive any added cash
Factors to Consider When Deciding to Sell Your Life Insurance Policy
- Life settlements have proven profitable not only for institutional investors that purchase policies, but also for the providers and brokers who handle these transactions.
- Competition among life settlements providers has become increasingly intense.
- Due to the life settlement industry being relatively new and the chance for targeting seniors who may be in poor health, it can be prone to aggressive sales tactics and abuse. You should always proceed with caution
Here are some of the key factors you should consider: (According to FINRA- Financial Industry Regulatory Authority)
- Consider your ongoing Life Insurance Needs—If you are considering buying a new policy with the proceeds of the life settlement, you will need to determine whether you will be able to get a new policy with equivalent coverage—and at what cost.
- Your old policy will still be in force and may affect your ability to get additional coverage. Even if you can get a new policy, you may have to pay higher premiums because of your age or changes in your health status.
- Be aware that surrendering your life insurance policy for its cash value or pursuing a life settlement are not your only options—especially if you would ideally like to retain your coverage.
- Difficulty Determining Fair Prices—One of the hardest things to know when you are selling a life insurance policy is whether you are getting a fair price for your policy. The best way to make sure you are getting a fair price is to shop around.
- Consider the Impact on Your Finances—A cash payment from a life settlement can have unintended financial consequences, especially if your financial circumstances have changed from when you first bought the policy. For example, if you currently receive state or federal public assistance, such as Medicaid, a life settlement can negatively impact your ability to participate in that program.
- Consider the Impact on Your Survivors—Carefully think about your need for current income, versus the future financial needs of your survivors. Even if you have determined that they do not need the proceeds from your insurance policy now, ask whether there could be a chance that their situation could change.
If you decide to go forward with a life settlement, here are some questions you should be sure to ask:
- Is the life settlement broker or provider licensed in my state?– A growing number of states regulate life settlement companies and life settlement brokers to some degree, and may require that they be licensed. Be sure to ask your state insurance commissioner whether the life settlement company or broker you are dealing with is properly licensed—and whether either has a record of complaints.
- If you are working with a securities broker, FINRA’s BrokerCheck.com should be your first resource to learn about his or her professional background, registration/license status and disciplinary history.
- Ask what the life settlement company that is buying your policy will do with it. Will they hold it themselves? Sell it individually? Or package it with other policies and sell interests in the package to other investors?
- What information will I have to provide? To whom? For how long?
- How can I protect my privacy? Before accepting any offer from a life settlement company, you should carefully read the application, and make sure that the company has procedures in place to protect the confidentiality of your information.
- In many cases, state regulations govern the handling of confidential information. Contact your state insurance commissioner to find out what regulations apply.
- What’s the best price I can get for my policy?
- What are the transaction costs?
- Life settlements can have high transaction costs. The commissions paid by life settlement companies to life settlement brokers and other financial professionals involved in the transaction can be as high as 30%.
- If someone recommends a particular life settlement to you, find out what they are being paid, and by whom.
- What are the tax consequences?
- The lump sum payment you receive in exchange for your life insurance policy can be taxable, depending on your circumstances.
- What if I change my mind? Always remember that you do not have to accept an offer to purchase your life insurance policy, even if you shopped around for the best price. If you do accept an offer and later reconsider, be aware that some states have laws that allow you to change your mind within a certain amount of time.
- Is the life settlement in my interest or my investment professional’s? At least one marketing brochure targeted at investment professionals not only touts the potential commissions from life settlements, but also emphasizes that additional revenues can be generated from the seller’s purchase of other investment products using the proceeds from the life settlement. Citing industry statistics, the brochure notes that almost half of all life settlement transactions result in the purchase of new life insurance. In other words, your investment professional stands to make two commissions off of a life settlement transaction. And you may end up replacing a perfectly good policy with a costly new one.
- Am I being pressured to make a fast decision? If you feel that you are being subjected to high-pressure sales tactics, and other aggressive advertising, marketing and sales efforts, beware. A legitimate investment professional will provide clear answers to your questions and will give you the time you need to make an informed decision.
Life settlements may make sense for people who no longer need or want their insurance policies, and would otherwise surrender their policies or allow them to lapse. But even then, you should proceed with caution. Always consult with an expert. if you’d like to contact an educator at Crash Proof Retirement regarding Life Settlements or Crash-Proofing your retirement, click here.