Investors Find Morbid Niche In Surrendered Life Insurance
Wednesday, April 29, 2009
While companies across the financial services industry were taking a beating last year, a firm in Waco, Tex., with a less than cheery way of making money was boosting its profit by 46 percent.
Its niche: helping investors place bets on when people will die.
The firm, Life Partners Holdings, helps investors buy life insurance policies from people who no longer want or can no longer afford the coverage. The investors pay the remaining premiums and collect the eventual death benefit -- the sooner the better from their standpoint. In a recent regulatory filing, Life Partners predicted even greater interest this year.
"People who typically would invest in the stock market and in bonds are now investing in life settlements," said Andrea Atwell, who handles shareholder relations for Life Partners.
The recession has focused new attention on the life settlements business as policyholders -- including some victims of Bernard L. Madoff's scam -- seek to raise cash by liquidating policies.
Concerned that the burgeoning trade poses risks to consumers and investors, the Senate Special Committee on Aging is holding a hearing today to examine the largely unregulated industry.
Life settlement companies offer policyholders more money than they ordinarily could get by surrendering policies to their insurers. In the case of term policies that have no cash surrender value, the deals enable policyholders to recoup some of the money they invested in premiums.
For sellers, the risks include potentially unforeseen tax liabilities and murkiness as to what the tax code actually requires. For investors, a key pitfall is predicting when the insured will die, which can make the difference between profit and losses.
In a variation on the theme, promoters enlist the elderly and infirm to take out new policies for the purpose of sharing them with investors.
The life insurance industry has a lot at stake. Many consumers let their policies lapse before they die, enabling insurers to collect years of premiums without having to pay benefits. When investors get involved, they reduce the lapse rates, forcing insurers to make more payouts. The growth of life settlements could cause insurers to raise prices, industry officials say.
Then there's what one Senate staffer called "the creepiness factor." The transactions give investors a rooting interest in the insured's death. To monitor that interest, some companies involved in the administration of life settlements check in by phone periodically to see if the insured is still there.
David S. Lenaburg, chief executive of Rockville-based Banner Life Insurance, gave voice to the ultimate fear. Citing court records of a 2006 money-laundering case, Lenaburg wrote to a regulator that the seller of one policy "apparently ended up with a drug cartel owning a vested interest in his early demise."
"Nothing good can come of this, and the potential for tragedy is shocking," Lenaburg wrote.
In an interview, Lenaburg said he knew of no case in which an investor was alleged to have hastened a payout, and he agreed that traditional beneficiaries have similar incentives. "We've paid off claims where a husband killed his wife over the insurance proceeds," Lenaburg said.
The argument that life settlements could lead to homicide is mitigated by the fact that investors may not know the identity of the insured, and they may hold stakes in batches of policies rather than individual contracts.
Regulators have accused members of the industry of engaging in a variety of harmful practices, such as scheming to depress the prices paid to policyholders and charging exorbitant commissions. A Colorado regulator accused Life Partners of selling unregistered securities and misrepresenting the risks; without admitting or denying the allegations, the company settled the suit in December, agreeing to buy back interests from investors.
R. Scott Peden, general counsel of Life Partners Holdings, said most of his firm's insurance investors have received annualized returns of 10 percent or more.
"Speculators have realized that there's great money to be made in buying these life insurance contracts," said Scott L. Berlin, a senior vice president at insurer New York Life. "What's happening is that seniors are getting talked out of their insurance."
Major investors in regular life settlements include AIG, the big insurance company that was bailed out by the government. In an annual report for last year, AIG said it valued its life settlements at $2.6 billion. To help shareholders assess those investments, it classified them by how much longer the insured are expected to live -- "0-1 year," "1-2 years," and so on.
Wall Street has also created derivatives pegged to life insurance, including "synthetic life insurance contracts" that don't involve the purchase of anyone's policy but pay off when the real people on whom they are based die, according to the Insurance Studies Institute.
One trade-off for people who sell policies is that, having parted with the coverage, they may not be able to replace it. In addition, the amount policyholders get for selling the policy may turn out to be less than the present value of the death benefit.
Forrest L. Schwalm, a 73-year-old minister in Dayton, Ohio, said he was glad to collect $4,000 in March when he sold a term policy with a death benefit of $250,000 to a firm called Coventry First, one of the larger players in the industry. If he had kept the policy, he said, when the 10-year term expired in less than two years, the monthly premium of $111.56 "would literally go through the sky." Schwalm, an avid runner, said he was looking for creative ways to save money after his investments lost about a fifth of their value.
Eddie Nelson Powell I, a 60-year-old doctor in rural Roseboro, N.C., said he sold two policies for about $150,000 to help meet mortgage and car payments after both of his legs were amputated. "If someone wants to profit off of my life, so be it," Powell said. "They're taking a chance, too -- I may live for another 40 years."