What's a "life settlement"?

There's a very interesting and informative article in BusinessWeek about life insurance "life settlements", where investors are willing to buy your life insurance policy today, before you pass away, for an immediately cash payout. The insurance policy stays active, but the investors then get the payout when you do die.

Sounds like it might not be a bad deal, particularly if you don't have any heirs or life partner that you're leaving behind, but there are some nuances and issues with life settlements that you need to know about before you decide to say "yes" to these investors.

First off, though, a telling set of projected scenarios for "Bob", a 72 year old retiree with a life expectancy of eight years and a $1 million dollar universal life policy purchased twenty years earlier. Here's what Bob could do if he couldn't pay the insurance premium any more...

• Cash in the policy with the insurance company and collect $100,000
• Sell the policy to a life settlement firm for approximately $275,000
• Reduce the death benefit from $1 million to $375,000, which would allow him to keep the policy in force for up to 12 years without paying an additional premium.
• Stop paying premiums but don't reduce the death benefit of the policy. This would run the cash value down to almost zero in five years, but at that point, the life settlement would be worth <>$475,000 because his life expectancy is only two or three years.

It's a bit macabre, I admit, but if you're in this situation, there are clearly smarter ways to leverage an existing policy than just sell it to a bunch of investors who would be seeing a respectable $10 for every $1 they "invest" in buying the policy benefit, even if they have to wait five years or longer. Not a bad return on investment for them at all, but for you?

These life settlements are the next generation of viatical programs from the 1990s when investors purchased the life insurance policies of terminally ill patients (many with AIDS or HIV). The target market's not the same, though: life settlements are offered to people at least 65 years old with some health conditions and a life expectancy of 2-12 years max. Policies must also be worth at least $250,000.

If you are looking at life settlements, make sure you consider all the options and different alternatives before you cash out. Once you've made a move in this direction, it's impossible to change your mind, so make sure you've done your homework thoroughly.