Wealthy Engage in Controversial Re-selling of Life Insurance Policies

"If somebody owns several million dollars of insurance on my life who I don't know . . . it would make me a little nervous to know someone had an interest in having me dead quick," said Joseph M. Belth, editor of the Insurance Forum, an independent industry publication. "Because not only do they not want to have to wait for their money, but they don't want to pay for the premiums for long."

Insurance policies initiated at the suggestion of an investor or third party can be problematic because they violate the industry's principle of "insured interest." Prohibitions against stranger-initiated life insurance date back to 16th-century England, when people would bet on whether ships and seamen would return to port. To remove overt financial incentives for a third party to take out a policy on a person and then see him dead, English courts mandated that individuals have a personal or economic interest in a person to buy insurance on him.

But the sale of insurance policies to third parties came into favor in the 1980s as a way for AIDS patients to get cash from their life insurance policies before they died. Those transactions were legal because the policies were not bought with the intent of flipping them. In recent years, however, with the number of wealthy baby boomers increasing, the opportunities for brokers to make commissions on policies for them has grown.

Over the past year, at least half a dozen states have warned consumers about predatory insurance brokers who offer to sell individuals expensive policies with the intent of turning around and selling them to third-party investors who will pay the premiums in exchange for becoming the policies' beneficiaries.

"It is not illegal for somebody to approach Larry King and say there's great value in a life insurance policy and I'll loan you the money to pay for it," said Doug Head, executive director of the Life Insurance Settlement Association. "But if there is a prearranged agreement to sell . . . or kickbacks to the policy owner to incentivize them to get into the deal, they're all illegal right now, in our view."

There is also a corporate version of stranger-owned life insurance policies that some in the industry would like to address. Last year, Wal-Mart ran into trouble for taking out life insurance policies on employees. The company reasoned that it had an economic interest in the employees' well-being, making the policies valid. But opponents argued that employers should not collect death benefits from workers without their knowledge. Wal-Mart paid $5.1 million -- the amount it collected after employees died -- to settle a class-action suit brought by the workers' estates and families.

Insurance companies generally support efforts to regulate the growing secondary market for life insurance because the high rate of payouts to investor-policyholders has the potential to cause havoc on the economics of the industry. At least 85 percent of life insurance policies lapse or are dropped by policyholders without companies ever having made any payout, according to Head and other industry officials. Prices for policies are set with that in mind.

If more and more policies wind up in the hands of investors seeking returns, insurance companies say they may have to raise rates.

State insurance commissioners and legislators responsible for insurance statutes recently have been working to present model legislation that states could adopt to address stranger-owned life insurance abuses and conflicts of interests by brokers.

Under a measure drafted by the National Association of Insurance Commissioners, life insurance policies could not be re-sold within five years of their origination. Currently, some states impose a two-year period, though some industry analysts suggest that neither waiting period would stop abuses.

Another model presented last weekend at the National Conference of Insurance Legislators' annual meeting in Las Vegas requires brokers to disclose to policyholders that any change in ownership could affect their future insurability.

The District does not regulate life settlements and stranger-initiated life insurance policies, but its commissioner is proposing a bill that would regulate how policies may be sold on the secondary market and provide consumer protection provisions for stranger-originated life insurance policies. Maryland law does not specifically regulate the re-sale of policies. Virginia in recent years amended its statutes to say that policyholders no longer have to be on their deathbeds, as AIDS patients did a generation ago, to sell them.