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.