Playing Investment Games With Life and Death

Even in the best of times, some investors are always looking for that golden, seemingly risk-free investment that will net them fabulous returns.

But the farther afield they look, the more likely they are to be taken advantage of. In hard times, the chances of getting taken multiply a hundredfold.

The latest exotic investment option is what are called "life settlements," "senior settlements" or "viatical settlements." They're ghoulish products by any name. In a life settlement, a life insurance policyholder sells the policy to a third party for less than its full face value.

Although they can be marketed and sold legally, the products are so complex and opaque that they are prone to fraud, including Ponzi schemes, phony life-expectancy evaluations, inadequate premium reserves that increase investor costs and false promises of large profits with minimal risk, according to the North American Securities Administrators Association, which represents state securities regulators.

Life settlements, which have seen significant growth, made it to the association's most recent list of the top 10 investor traps.

These products started to get public attention when the terminally ill, most notably AIDS patients, started to sell their life insurance policies to raise cash for medical and living expenses. Now, policy sellers are mostly the elderly, typically 65 to 85, with a life expectancy of 144 months or less, said Stephan R. Leimberg, the creator and editor of "Tools and Techniques of Life Settlement Planning."

"Life settlements are a typical win-win scenario," said Andreas Hauss, founder of the International Society of Life Settlement Professionals. "Both the senior seller as well as the investor can take advantage of this opportunity." From the investor side, you make money by collecting on the policy's death benefit. How much is earned depends on the life expectancy of the insured. The sooner the seller dies, the more money the investment makes.

The life settlement industry was estimated at $5.5 billion in 2005. In 2008, it had grown to $11.8 billion, according to the Financial Industry Regulatory Authority, or FINRA, which regulates securities firms.

FINRA recently issued another alert to firms selling these investment products and to people selling their policies.

"We just want to make sure people are not pressured into a quick decision," said John Gannon, FINRA's senior vice president for investor education.

In a typical transaction, a broker, who takes a substantial sales commission, is supposed to help the insured get the highest possible amount for his or her policy. The insured gets a percentage of the death benefit while still living.

"I don't think this is any more ghoulish than anything else in the life insurance business," said Doug Head, executive director of the Life Insurance Settlement Association. "If the person most affected is willing to undertake any risk, the rest of us have no place in meddling with that decision." Yet Gannon said that regulators are concerned that policyholders may not fully appreciate the risks of life settlements.