Vol 6 No 7		November 2004

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Marketing Death-Futures Life Insurance

Soliciting well off elderly persons in order to convince them to buy large life insurance policies they don't need or want and then to relinquish the policies to the parties that sold them in the first place is an ethical abomination.

Three times during a single week in October I was contacted about proposals to buy life insurance using a third party lender for premium payments, usually for two years, with the intention of selling the policy on the secondary market two years later. None of those solicited had any objective need for additional life insurance or any subjective desire for it except it was presented as a great deal. Although the proposals were not identical, they had many similarities.

• Minimum issue age of 60, with probable average issue age over 70 and the insured having some health problems.
  
  
• Minimum annual premiums of $100,000. For example, a $5,000,000 policy for standard 72 year old male has annual premiums of approximately $225,000.
  
  
• An intermediary firm puts the potential insured and lender together, recruits the insurance agents, and negotiates with life settlement firms after two years.
  
  
• Insured receives a two year non-recourse premium loan (typically 12% interest) from a third party lender. After two years either the insured repays the loan and keeps the policy or, in satisfaction of the debt, transfers ownership to the intermediary who attempts to sell the policy in the secondary life settlement market.

This death-futures lottery purports to provide profits for the insured, lender, intermediary and life settlement firm. This can only happen if life insurance policies are not being priced correctly or the insured's health deteriorates more than just the passage of two years. I have noticed several life insurance companies being so intent on selling life insurance policies they use very liberal underwriting criteria and issue policies as standard risks where other companies view the insureds as sub-standard risks. This aggressive underwriting can instantly create a mis-priced life insurance policy.

Potential problems with this arrangement include: consumer lending and premium financing issues; insurable interest and settlement law issues; tax and privacy issues; and well, murder, since avarice persons now have an interest in the insured's life span. I don't know anyone that can authoritatively offer an opinion on the potential for statutory problems at this point because I don't think any challenges have arisen. If these proposed transactions occur infrequently they may not reach the radar screens of those responsible for regulating such activities. As for possible mayhem I don't know if insureds are at more risk driving their cars, but I'm not sure I would be completely comfortable knowing I have invited others into having an adverse interest in my longevity.

What kind of profit might an insured receive from this scheme? Let's consider Bob, a 72 year old male with moderate heart disease. Bob's true underwriting status is sub-standard Table 4, but he can obtain a Standard rating from companies more interested in writing a policy then prudently assessing and pricing risks. Bob acquires a $5,000,000 policy with an annual target premium of $225,000. A Standard insurance risk has a life expectancy of 17 years, whereas a true Table 4 risk has a life expectancy of 13 years. Bob's true life expectancy is 13 years, but presumably the issuing company has priced the policy with a life expectancy four years longer. The mortality-arbitrage in this case is based on this four year gap. Two years of financed premiums at 12% interest creates a debt of $534,240 that Bob has to cover to retain the policy. Unless Bob, with moderate heart disease, has a significant cardiac event that would shorten his life expectancy even more there is practically no chance Bob can repay his loan and make any money selling his own policy. After several trial calculations I am unable to understand how the other parties to this transaction (agent, intermediary, lender and life settlement firm) can each profit if they are acting independently. An overall profitable scenario can be constructed if the parties are all essentially sharing in the profits. I can only assume that if this scheme is profitable for all parties it will continue being marketed and if it isn't, marketing will cease.

My two concerns are how does this scheme affect Bob, and is it a good thing for the life insurance business? Bob is inconvenienced having to go through all of this by having to figure out if he should do it, going through the underwriting, managing the paperwork and then having to figure out what to do after two years. If he lives two years and is in the same health I doubt he will gain anything. But, if he dies in the first two years his family will receive death benefits less the repayment of the premium payment debt, and if he has a significant deterioration in health his family could receive a substantial profit by Bob retaining his interest in the policy by paying off the debt. He then can either retain the policy until his passing or sell it himself to a life settlement firm. I will continue to evaluate and advise clients that have been solicited to be insureds in this scheme and let them make their own choice.

However, my view of how this affects the life insurance business is not so neutral. Soliciting well off elderly persons in order to convince them to buy large life insurance policies they don't need or want, and then to relinquish the policies to the parties that sold them in the first place, is an ethical abomination. Life insurance enjoys important tax benefits because it protects families, businesses and estate assets upon the demise of insureds. It is also appropriate to combine protection and living benefits of life insurance that are derived from its favorable tax status. But using life insurance for the sole purpose of providing profits to those who have devised, marketed and sold these death-futures policies is shameful and so contrary to the public good that it could risk continued favorable tax treatment of life insurance.