Maryland Bar Bulletin
Publications : Bar Bulletin : April 2007

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Life Insurance, Insurable Interest and Secondary Markets

~Options for the Insured and the Beneficiary~

“Tony, we’ve hit on a great new scam,” says Phil. “A guy has some life insurance, we buy the policy from him, name ourselves – whadayacallit? – the beneficiary, then the guy has an ‘accident’. We get the money.”

Soprano looks at Phil and says: “Forgetaboutit! They’d never let us buy some other guy’s policy.” “Naw, Tony, they do! Some guys even take out new life insurance on themselves just to sell it to guys like us. Well, usually to hedge funds – some people think they’re guys like us.”
A script idea for the Sopranos? Maybe. Based on fact? Yes.

Should Tony Soprano – or any other ‘investor’ – profit from a person’s death?

The public policy issues inherent in this question have led over the years to a body of law codifying protections known generically as “insurable interest.” The concept is that the beneficiary would suffer a loss at the death of the insured which is no greater than the benefit of the insurance proceeds and thus would have an interest in keeping the insured alive rather than have him or her dead. This removes wagering on one’s death from the mix, and that is good for civilized communities and nations – as well as the individuals who are insured and the insurance companies who are pricing products expecting not to have to deal with accelerated death payments for an overly enthusiastic beneficiary.

However, a marketplace for secondary life insurance sales has developed in recent years. Terminology varies. It can be referred to as Investor Owned Life Insurance (IOLI); Viaticals; Life Settlements: and other similar nomenclature. Those handling the transactions are acting on behalf of investors who would benefit from the early death of an insured upon whose life the investors own the rights to the life insurance proceeds. The insured’s benefit in this is the receipt of a purchase price greater than the inherent cash values of the policy contract.

Much of the current activity in this market started with AIDS patients seeking to accelerate values in life insurance policies to raise money for their treatment. Since their disease was often considered terminal in the early years of AIDS development, it seemed to be a ‘good buy’ for someone to take over the premium and pay out a portion of the death benefit early to the insured while he/she was still alive, and a ‘good sale’ for the insured since they’d receive money for treatment or personal use prior to death. The concept began to expand to people who might see no current use for their existing policies. Unfortunately, the evolution of the sales process has been such that disclosure of all risks has been uneven. Insurance companies have addressed terminal patient issues with contract revisions such as Accelerated Death Benefit clauses.

Due to the need for society in general, insured individuals, insurance companies, and bona fide beneficiaries to have protections against wagering on one’s life, these insurability statutes need to be closely reviewed with the secondary market in life insurance in mind, by anyone considering selling their policy. A very thorough summary of these risks – all in addition to the big risk of the impatient investor beneficiary – is given in the July 2006 issue of Estate Planning. A few keys words of caution from its authors:

  • If insurable interest statutes are violated, could the policy be void from the beginning?
  • What are the unknown tax consequences of such a sale, or at death?
  • What is the potential for litigation and its inherent cost if such a sale is challenged?
  • Is the insured aware and comfortable with his/her medical history being passed out among those involved in the transaction?

FranklinMorris has decided not participate in sales of new policies involved under the genre of Investor Owned Life Insurance. These are policies created simply to be available for later sale to a third party. Anyone considering existing policies for re-sale should have them closely reviewed prior to pursuing such a sale. Usually, older policies that may be attractive for sale to an investor group are attractive for the current owner to retain themselves.

FranklinMorris will keep its mission of providing insurance to clients who need it, manage money for clients who seek advice, assist in benefits design and administration, and help plan for individual and business clients’ financial security – not for their demise at a profit.

From David M. Morris, JD, CLU, President of FranklinMorris, Coordinating Broker for the Bar Associations Insurance Agency, Inc. For more information on the insurance benefits available to MSBA members, visit our website at: www.msba.org/departments/membership/baia/franklinmorris.pdf.

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Publications : Bar Bulletin: April 2007