Life insurance policies are expensive and many older adults decide they can either no longer afford the payments or no longer have a use for their policies once they retire. If you are an adult over the age of 65 and you have a policy with a death benefit of more than $250,000, you have likely been told that a good alternative to letting your policy lapse is to sell it on the secondary market. Insurance agents and life settlement brokers will tell you that, if you sell, you will receive a lump-sum cash payment worth substantially more than the cash surrender value of your policy. Before you agree to the sale, there are a few things you should know:
First, your “lump-sum cash payment” is not as good of a deal as it sounds. Life settlements brokers and insurance agents push these transactions because they get paid to do so. High commission fees, which can range from 10 to 30 percent, are often built into the gross sales price. Since the fees are built into the price, you won’t know that the sales agent or broker is making thousands of dollars off your policy, but he is. (“Think twice about ditching your life insurance,” Prism Money blog on Reuters.com, Feb. 11, 2011). You also may have to pay taxes on the money you receive from the sale. Additionally, the life settlements market is opaque, which makes it extremely difficult to find out how much your policy is actually worth. As such, it’s likely that whatever offer you receive will be less than fair.
Second, you have other options. If you want to sell or surrender your policy because you can on longer afford the premiums, you should make sure to carefully consider your other options first. According to the Prism Money post mentioned above, you may be able to borrow against your current policy or use the cash value that has built up from previous years to pay your premiums. Remember: No matter how much you are offered to sell your policy, the payment will be much less than the overall death benefit and may be less than the total amount you’ve paid into your policy over the years.
After selling your policy, insurance companies may attempt to sell you another, noticeably riskier product known as a variable universal life policy.
The practice of selling life insurance settlements on the secondary market has generated a significant amount of regulator concern over the past two years. In 2010, the Ohio Department of Insurance issued a consumer alert that warned consumers of the potential risks involved in STOLI (Stranger-Originated Life Insurance) investments.
The thin line between life settlement transactions and the much more controversial STOLI investments coupled with the heated debate over investor protections led the SEC to issue a report last summer in which the Commission asked Congress to officially categorize life settlements as securities. The official categorization would allow federal securities law to govern the transactions. It would also mean that the life insurance settlements market would to be regulated more closely and in the same manner as other securities.