Life settlements in the news

So you've made it to retirement, you don't really need that $2 million insurance policy to protect your heirs anymore, but what can you do with it? Sell it to rich investors, such as Warren Buffett or a hedge fund, reports the New York Times.
The practice is known in some circles as "life settlements," and should not be confused with "viatical settlements" of life insurance. The latter involve terminably ill persons who wanted to cash out their life insurance to meet medical payments. One useful medical advance and suddenly the viatical settlement market has many disappointed investors, if it means that insureds move from "hopeless" status to "will remain alive indefinitely." With life settlements, the insureds must be healthy, putting the purchases of the insurance policies on a sounder actuarial footing.

For insureds, a life settlement means a more financially secure retirement. The investors take over premium payments, collect the proceeds eventually, and expect to have an above-market rate of return.

Sounds like a win-win, but then we get to the insurance companies. The dirty little secret of the insurance industry is that most life insurance policies never pay off, which is why the premiums can be so low. Policies that investors take on won't be lapsed, and that development has not been in the equation. Says the Times:

Life insurance companies, in particular, rely on policies lapsing before the policyholder dies. Last year, for instance, insurance companies reduced their financial exposure by $1.1 trillion when 19.8 million policyholders stopped paying premiums, according to the Insurance Information Institute. In comparison, the industry paid death benefits on only 2.2 million policies.

If those lapsed policies had been sold to investors rather than canceled, insurance companies could have eventually paid out as much as a trillion dollars, say analysts.

Well, it's hard to have a lot of sympathy for the insurance companies. But the Times also reports on speculator-initiated life insurance, or "spin-life" policies, in which investors lend money to the insured to buy policies, with an agreement to buy the policy back at a stated date in the future. That strategy would seem to me to be vulnerable to the insurable interest rule.