For years, a number of major life insurance companies and industry trade organizations have strongly opposed life settlements. The opposition has taken several forms:
- prohibiting producers from engaging in life settlement transactions for their clients,
- promoting and lobbying for legislation and regulation that would severely hamper or shut down the life settlement industry;
- opposing legislation that would require companies to disclose to senior consumers who are about to lapse or surrender a policy that other options, like a life settlement, exist; and
- creating administrative obstacles to the smooth completion of life settlement transactions.
Given the energy and expense that has been devoted to hindering the life settlement industry, one would think that life settlements are really bad for insurance companies. But is that true?
Before looking at the effect of life settlements on insurance companies, let’s consider how life settlements impact the two other main constituencies of the life insurance industry: consumers and producers.
Life settlements appear to be a clear win for consumers. A life settlement can add an unexpected and often badly needed salvage value to a policy that is about to be lapsed or surrendered.
Life settlements are also beneficial for producers. First, a life settlement can mean continuing renewal commissions on a policy that would otherwise be lapsed or surrendered. Second, the settlement itself can be the source of additional compensation. And finally, a life settlement can give a producer the opportunity to provide one more beneficial service for their clients.
Considering the positive effect that life settlements have on both consumers and producers, one would think that life settlements are really bad for the life insurance industry to justify such a strong anti-life settlement position. So, let’s consider the real or perceived impact on life insurers.
A life settlement can mean a policy, which would otherwise no longer be in force, will ultimately result in a death claim. Since insurance companies count on a certain level of lapses, this could adversely affect profits. But with an estimated $20 trillion of life insurance in force, and a current annual life settlement market of about $2 billion of face amount, the impact on profits is negligible at most. New life settlements annually make up only about .01% of the face amount in force.
Insurance companies also fear that life settlements would draw attention to the tax treatment of life insurance. Somehow, they argue, life settlements could be viewed as a tax dodge. Yet, the opposite is true.
Policy owners are taxed on the gain at the time they sell the policy and investors are, ultimately, taxed on the death proceeds under the transfer for value rule. Life settlements, therefore, create tax revenue.
Another factor for insurance companies is headline risk. The idea that investors could profit on the death of an unrelated third party can be uncomfortable. Perhaps they don’t want life annuity purchasers to realize that, similarly, the sooner they die, the more profitable it is for the insurer that issued the annuity.
Overlooked is the real headline risk that insurers would once again be considered anti-consumer by depriving seniors of the life settlement option. The industry surely does not need yet another black-eye like the failure to use the Social Security Death Master File to find deceased insureds or the controversy regarding retained asset accounts. Yet, the industry seems determined to shoot itself in the foot once again by failing to recognize the more substantial risk.
The added possibility of a life settlement, when a policy is no longer wanted, needed or affordable, makes life insurance a bit more attractive. What other industry would oppose something that actually makes their product more valuable?
Instead, insurers should embrace life settlements by endorsing the education and training of their producers about life settlements — and by promoting an orderly life settlement marketplace rather than being a disruptive force.
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