By Jane Bryant Quinn
Sunday, June 22, 2008

Need money? Got a cash-value life insurance policy? Not feeling too well these days? You may be approached to sell your policy to an investor for cash up front. Maybe that's a good idea, but maybe not. You might part with a valuable policy unnecessarily and incur taxes you didn't expect.

I'm talking about the life-settlement industry, which appeals to older people seeking cash.

If you have a policy you don't need anymore, you have two ways to monetize it: Surrender it to the life insurance company for its cash value, or do a life settlement. (There will soon be an interesting third way, for people who want to keep their policies. More on that below.)

With a life settlement, you're selling your policy to an outside investor who will pay the premiums while you live and collect the proceeds when you die. Investors offer you more -- usually, substantially more -- than the policy's surrender value. You generally qualify if you're 65 or 70 and up and have some sort of health problem. A little bit of doddering helps.

A life settlement makes sense if you truly have no need for any more insurance -- no beneficiary who could use the money, no charity you want to give the policy to, no business purpose, no estate taxes to fund.

It's also useful if you have a policy that's poorly priced -- say, an older universal life policy with large surrender charges. Sometimes you can sell it for enough to buy a new and better policy for the same face amount, said fee-only life insurance adviser Peter Katt of Mattawan, Mich.

That is, as long as you don't care that a stranger is going to profit from your death. Your policy could wind up in Tony Soprano's Individual Retirement Account. Settlement brokers promise not to reveal your name and address to the investor, but it sometimes happens anyway, Katt says.

Policy sales are taxable, but there has been no clear ruling from the Internal Revenue Service. You owe ordinary income tax on the amount by which the policy's cash value exceeds the premiums you paid. Any settlement money you receive in excess of the cash value may or may not be a capital gain. Your accountant decides.

The Life Insurance Settlement Association puts the size of the settlement market at $12 billion to $15 billion a year. That's a rich source of commissions for middlemen. They can receive as much as 35 percent of the policy's purchase price or perhaps 5 percent of the policy's face amount. That's why they're so eager to solicit you.

Most investors want cash whole-life and universal-life policies with face amounts of at least $250,000. A few accept amounts as small as $50,000. You can sell a term policy if it's guaranteed renewable or can be converted into universal life. Brokers earn less from variable-life policies and don't like to work with them.

The amount you're offered will depend on your life expectancy as well as such things as the premium amount and how old the policy is. Investors like policies bought some time ago, when you were in better health.

Alas, because of the rich commissions, agents are persuading some people to sell when they shouldn't. As an example, take an older person who knows his or her heirs still need insurance coverage but can't afford to pay the premiums anymore. Selling sounds like the best option.

It's not, Katt says. Instead, start paying the premiums from your cash values. If you die, your beneficiaries will get the net policy proceeds. If you live, you can sell the policy a few years later when the cash values have run down. In the future, you will have a shorter life expectancy -- meaning that you will be able to sell at a higher price than you'd get today (grim arithmetic, but that's how it works).

Starting in July, you will have an alternative to life settlements. A new company, Legacy Funding Group in Malvern, Penn., will lend you money against your policy. In most cases, you will be offered at least as much as you would get by selling it and possibly more, said Larry Fondren, founder and president.

These so-called legacy loans will be funded by lenders and investors who will pay all the premiums. You owe no tax. At your death, a portion of the policy proceeds are used to repay the loan plus 9 percent interest. Your heirs get anything that's left, with a minimum guarantee of 10 percent of the money. That's clearly a better deal than a life settlement. Legacy also structures deals with potentially rising death benefits.

New York Life Insurance offers a similar loan arrangement called Access Plus to its own policyholders in 22 states and the District. In general, it's for people whose life expectancy is between one and 10 years, spokesman William Werfelman said.

Who is investing in life settlement policies? Mostly institutions, said David Kleinhandler, a New York insurance agent who specializes in this business. They buy pools of policies that he expects to yield an average of 11 or 12 percent, pretax.

He advises against this game for individuals. If the insured person lives longer than expected -- maybe because he or she is healthier than was advertised or new medications are developed -- your gains on that policy might shrink to zero. You might even have to put up more money to pay the premiums. And there's usually no way out. That's a risk the little guy shouldn't take.

Jane Bryant Quinn, author of "Smart and Simple Financial Strategies for Busy People," is a Bloomberg News columnist. Alexis Leondis in New York contributed to this column.