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Life Insurance–the new “bubble”?

So you’re a 73-year old man in need of a little (or a lot of) cash. You get a brilliant idea to buy life insurance valued at $10 million and sell it to someone who will pay the premiums and get the payoff. Then you do it again with a $5 mil policy (which surprisingly nets you more money).

But now you’ve got a problem. You’ve got so much life insurance on you that nobody wants to insure you. Plus, there’s some legal sketchiness about buying life insurance on an old person to profit from it when he dies (though I don’t think it’s illegal-correct me if I’m wrong).

Of course, if you’ve been reading the Washington Post today, you know who I’m talking about. Larry King. Whoops!

Mr. King isn’t very happy. Something about not getting enough money and not being eligible for more life insurance and whatnot. His age and health history may have something to do with it, IMHO, but I really don’t care too much about him. I’ve never even watched his show.

What’s worse, though not surprising, is that this is apparently a thriving market. According to the Post:

…industry analysts suggest that if the pace of life insurance policy re-sales over the past several years is any indication, the $30 billion that traded hands last year could easily grow to more than $150 billion over the next decade.

“The lure of easy money is seducing participants into the secondary market for life insurance and putting life insurers in compromising positions,” Fitch Ratings said in a special report in September. “The flow of capital to date and the potential for this market have created a gold rush atmosphere, increasing risks for all involved.”

Why would anyone feel safe doing this? It’s like making yourself the subject of a death bet. Wouldn’t someone have a big interest in killing you? The sooner Mr. King dies, the sooner they can stop making payments.

From the Post again:

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.

I suppose you could still sell your insurance in England, but at least no one can take it out behind your back like Walmart did.

Maybe this is finally a way of getting back at the insurance companies for profiting from our laziness and fear (though some insurance makes sense to me…just not many warrenties).

But……

Somebody’s got to ask the question-will there be a life insurance bubble? And perhaps a subprime life insurance crisis? People found “free” money in the internet, their houses, now it’s their lives…one can only wonder what’ll be next.

P.S. If nothing else, insurance companies may raise rates on us ordinary folk to handle the payouts…


{ 1 trackback }

Mrs. Micah: Finance and Life / Mrs. Micah at Get Rich Slowly
November 28, 2007 at 8:31 am

{ 9 comments… read them below or add one }

Money Blue Book November 28, 2007 at 2:05 am

I had no idea he was that old..wow. I can only hope to be so coherent when I’m at that age. I do wonder how he relates to the younglings he interviews sometimes.

Money Blue Book November 28, 2007 at 2:06 am

Ah I see you are getting infected by these annoying trackback spammers too…I’m always like…hooray a comment…but then I see the originating site 🙁

mrsmicah November 28, 2007 at 6:56 am

They get really excited by the word “insurance” 😛

Andrew Stevens November 28, 2007 at 1:23 pm

The Wal-Mart policies (and others like them) are gravely misunderstood. Most COLI (corporate-owned life insurance) policies are not bought for insurance reasons; they’re bought for tax reasons, usually as a form of deferred compensation for executives and other highly compensated employees (who have limited tax-free or tax-deferred options for retirement due to income limits on such vehicles). (Please note well: life insurance policies are terrible investment vehicles compared to 401(k)s, Roth and traditional IRAs, etc., but should probably be looked into if you wish to save more money for retirement and are legally capped on all such plans.)

When saving and investing for such deferred compensation, corporations have a choice between normal fully taxable investments and life insurance where the proceeds are tax-free (within certain prescribed limits), but they have to pay COI (cost of insurance) charges. As long as the COI charges are smaller than the taxes, that’s what they’ll buy.

It should be pointed out that the company doesn’t even particularly care about getting paid on these policies when the person they’re insuring dies (though it’s certainly quite a windfall if it happens). It’s really being used as a Variable Universal Life policy, i.e. for the investments, not for the payoff at the end. Wealthy individuals, even single ones, often have life insurance policies for themselves for the same reason, to provide retirement income, not for the death benefit. Ideally, the company wants the COI charges to be as low as possible. The lowest COI charges go to the youngest people, as you would expect. This is why Walmart was insuring young employees. They kept tabs on the employees (even after they quit) for bookkeeping, so they knew when to submit a claim (these are whole life policies and you’re guaranteed to eventually cash in), but it’s simply not true, as some people allege, that they were breathlessly waiting for these people to die. The face amount of the policy is always very much a secondary consideration.

The law on these policies has been changed in most states so the companies must insure one of the executives who is actually participating in the deferred compensation plan, rather than just any employee.

As for the Larry King thing, I wouldn’t worry about life insurance companies. The secondary market will only have a very tiny effect on premiums. It may (or may not) lower lapse rates which could cause premiums to rise slightly, but I don’t see very much increase in risk from these types of transactions, unless it actually tempts people to start committing murders. I don’t regard this as very likely.

Andy November 28, 2007 at 1:43 pm

A giant company like Walmart may not care about collecting the death benefit on an employee but smaller companies sure do, it pays for the cost of insurance (COI) to keep the program going, which is designed to benefit those who can afford to defer more than the 401(k) limit.

Andrew Stevens November 28, 2007 at 1:50 pm

In such contracts, the face amount is kept as low as possible for it to still legally qualify as life insurance (rather than a MEC, a modified endowment contract). Certainly, recovering the face amount matters, but they’re guaranteed to recover it eventually. It is true that they probably do better the earlier they recover it (i.e. the earlier the insured dies), but this is not terribly important. The products are only bought if they’re a smart investment deal even if the insured lives to be 130. A small company which needs the insured to die early in order to protect their investment has made a serious error in judgment.

By the way, I read Fitch Ratings warnings (mentioned in the Post article) about the risks to life insurance caused by the secondary market. Their analysis was that the primary risk is that such settlements could cause the government to withdraw the tax advantages of life insurance. I hadn’t thought of that, and I do concur with their judgment.

fathersez November 29, 2007 at 11:16 pm

Wow, I did not realize this was big business.

I’ll have a very poor opinion of an employer who would even think of collecting the insurance proceeds for itself. The proceeds should be given to the family of the deceased.

The concept of people selling their policies, and having their “investors” running around hoping that the insured will “die”, this just boggles the mind.

Just like farmers fertilising their farms to make their plants better, and companies spending money on advertising their products, the above” investors would be thinking hard of how to speed up the process of collecting on the proceeds.

Doesn’t it look very much like the lucrative hard drugs industry?

Andrew Stevens November 30, 2007 at 2:55 am

The life settlement secondary market serves a purpose. Let us imagine that you’re an old man with a universal life insurance policy which you no longer need. Your beneficiaries may have predeceased you, for example, you may need cash because of failing health, or you just can’t afford the premiums anymore. Without a secondary market, you would have to accept the cash surrender value of the policy from the life insurance company itself. A lot of times this is probably fine, but if, for example, you are very sick, the cash surrender value is not going to be worth as much as the policy is actually worth. With a secondary market, you can get much closer to its fair market value.

Many life settlement firms (though not all) withhold personal information when selling the policies, so the investors don’t actually know whose policy they have bought, precisely to avoid the sorts of situations you’re talking about. As long as you’re dealing with one of these reputable firms (Larry King wasn’t, apparently), you probably don’t have much to fear on that score.

As for COLI, the company is paying all the premiums on the life insurance; it’s not clear to me what’s wrong with collecting the benefits. Nothing prevents the employee from having his own insurance (and many employees have employer-provided life insurance; I do for one) and it has no effect on his own insurability. In most of these cases, the insurance isn’t bought for insurance purposes anyway. However, many companies do buy life insurance on their key employees to protect themselves against losses if he suddenly dies. (There’s a good chance Microsoft has a policy on Bill Gates, for example.) I don’t see why it’s unethical for them to do this.

However, I can certainly see the argument against allowing a company to insure an employee (with themselves as beneficiary) without his knowledge or consent. And most states have changed the laws to require this. I am reasonably sure that there has never once been even a suspicion of any foul play in these sorts of policies. Murdering your own employees (or even ex-employees) is rarely a sound business practice.

David June 20, 2008 at 1:50 pm

Andrew may not know about it, but two brothers made over $1.6 million killing their “employees”. Although this article doesn’t mention it, they were convicted.
I think employee life insurance is abused when a company insures low-level employees or holds onto policies after the employee leaves. It’s gambling, not insurance.
The reselling of life insurance policies on the elderly is an open invitation to fraud. It subverts the intent of insurance, which is the policy owner should suffer a loss when the insured dies. In the industry, it’s called an “insurable interest”. This isn’t the case with strangers.

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