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Win-Win situation? Who's the big loser? (Part 4 of 11)
Friday November 23, 2007 12:00AM | Click here to visit original article.
From the old codger's viewpoint, it is a great deal for him too. Since he couldn't afford to make current payments to keep the policy up anyway, in his mind the value of the policy was a precisely calculated "$0". And here you come along and give him $500,000 hard cash for it. Sucker! Wait, you say, how can this "win win" situation be? Not everybody can be a winner in a transaction, right? Absolutely right. In this situation there is a loser, and a big loser too. It is the old codger's kids. Had the old codger kept the policy alive, his kids would have been big winners at his death - just like the investors will be, and even more so since unlike the investors the kids will not have to pay income taxes when the policy pays off (although the old codger's estate may have to pay federal estate taxes, depending on what happens with estate tax repeal). In other words, if this transaction makes so much sense for the investors, it makes even more sense for the old codger's kids. Basically, the old codger is giving up a very valuable future asset for basically pennies now - it is simply not a good trade. However, few of the life insurance salesmen tell their clients to engage in life settlements really work to advise their clients that it is a bad trade to settle their life insurance policy instead of keeping it alive. To an extent, the insurance company is also a loser. The reason has to do with what is called a policy "lapse", meaning that the insurance company receives premiums but does not have to pay out on the policy. Anytime a policyholder doesn't keep a policy up, there is a lapse. Suppose the old codger did not sell his policy to the investor, but simply let it lapse. In that case, the insurance company would have collected premiums from the old codger for years, but in the end never paid out any death benefits to the old codger's estate. Policy lapses are sweet money for life insurance companies, and do impact their profitability. A life insurance company can make a bunch of bad underwriting bets but still be profitable if lapse rates are high enough. Indeed, there are some industry analysts who suggest that some life insurance companies are only profitable because of their lapse rates. Life settlements can theoretically work to reduce lapse rates, because the investors who buy the policy will always contribute just enough money to keep it paid up until it pays off. If enough people hear about life settlements and sell their policies before they lapse, the lapse rates would go to zero and the life insurance companies would be forced to raise rates. This would make life insurance less competitive against other investments, and probably lead to lower sales. But if you think that any of this causes the life insurance companies to worry, you're wrong. Life insurance companies know that any loss of sales due to higher premium rates will probably be more than offset by the greater sales due to people who start buying life insurance policies as investments with the thought of later selling the policies to fund retirements. Life insurance companies had always been somewhat embarrassed by lapse rates anyway, since they tended to indicate that policies had been improperly sold in the first place. Also, life insurance actuaries already assume that a certain number of policyholder's will have health declines, and thus will hold their policies until their death. From an actuary's standpoint, the concept of life settlements in causing losses to the insurance companies isn't nearly as onerous as the insurance agents try to paint it out to be when making a sale. Finally, the life settlements markets are limited to a relatively small part of the market since they are only for people over 65 and who have had a dramatic health change. This group probably represents less than 0.5% of all life insurance policies, so life settlements probably are not going to impact life insurance profitability that much. It is, however, an argument that life insurance agents falsely use to try to portray the insurance companies as the big losers, and not the kids of those who are selling their policies. ---Source: http://www.quatloos.com/life_settlement-life_settlements.htm |
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