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September 7th, 2009 at 7:57 pm
Ghoulish indeed!
The life settlement market is driven by life insurance agents. The commissions are huge, and hidden from life insurance sellers and their advisors.
First some economic basics:
Life insurance companies have sold policies and until recently, been the only widespread buyers of life policies. Life insurers are near monopsonies, in that they are the only buyers of life insurance policies. Sales of life insurance policies by owners include:
Surrender of policy for cash value, the most common sale
Sale of policy to another related buyer, generally for business purpose, such as a stock purchase agreement, or as part of an employee’s compensation
Sale to investors in a so-called life settlement transaction
The owner of a life insurance policy can always sell the policy back to the insurer by surrendering it. From the insurer’s standpoint, they are indifferent about paying the policyowner the cash surrender value or waiting until death to pay the death benefit. Based on the insurer’s pricing assumptions the present values are equal.
Until three decades ago, all life insurance policies were term insurance or whole life.
The advent of universal life allowed policyowners to pay an indeterminate premium.
So long as the insurance charges and operating expenses are met each month, the policy remains in force. If the cash value hits zero, the policy lapses.
By now you have figured out that this is a natural arbitrage situation. A life insurance company will pay only the cash surrender value of a policy whereas other buyers might offer substantially more. How much more depends on the buyer’s assumptions about the present value of remaining payments before they collect the death benefit.
Initially all life settlement transactions were over-the counter deals. Remember that prior to the opening of the CBOE in 1973, all options transactions were over-the-counter and today a large number of option and derivative transactions are over-the-counter.
Personally, while I wouldn’t want an investor having an interest in my early death owning a life insurance policy on my life, I am indifferent about the expansion of this business. Individuals looking to sell their life insurance policies should hire a fiduciary consultant for a fee. Such consultant will insist in full disclosure of all fees and commissions paid to agents and brokers involved in the transactions. The consultant should also be able to advise the seller on the likely next step, a pitch by the agent for a new life insurance policy to replace the one just sold.