Whether to Settle: Are You Getting Good Advice?
Making
financial decisions can be complicated, and often
the financial services industry doesn’t make the process easier for
consumers. The
history of the financial services industry is marred with scams and
unscrupulous advisors looking for a quick buck.
There
are also some very well-meaning advisors and agents who are just
unaware of financial tools that could be very valuable to their clients. Even scrupulous and well-informed advisors
may struggle to give you advice in difficult situations. This article should help you to understand
some of the reasoning underlying an agent’s or advisor’s advice
regarding your
life insurance policy. It will help you to spot dangerous scams and
misguided
advice regarding life settlements, as well as situations in which a
settlement
is (or is not) appropriate.
STOLI:
A Dangerous Scam
Sadly, there will always be professionals (and those who masquerade as professionals) who concern themselves with their own interests instead of their clients’ interests. In the area of Medicare supplement policies, for example, there was a time when dishonest agents would sell multiple policies to the same person, even though the coverage overlapped. States were forced to prosecute scammers and enact strict regulations regarding those contracts to protect the public. In the life insurance industry, the big scam was unnecessary replacement insurance. Agents would convince unsuspecting consumers to replace a perfectly good policy with a new one so that the agent would earn a commission – even if the new insurance was more expensive or offered less protection. These days, strict regulations to protect consumers are in place with respect to any life insurance policy that is written to replace another.
In life settlements, the biggest threat facing the industry today is something called STOLI, which stands for stranger originated life insurance. STOLI occurs when a con artist tells a consumer to buy a life insurance policy for the express purpose of selling that policy through a life settlement later on. In other words, a scammer attempts to convince you to buy a life insurance policy as a short-term investment instead of as insurance. This purchase does not protect a beneficiary, rather it is for the ultimate benefit of a stranger. STOLI is both illegal and dangerous.
If you fall for a STOLI scheme, there is no guarantee that you will be able to sell the policy you purchase later. Providers (purchasers) simply might not make an offer, and so you would be stuck paying the premiums on a policy that you had no intention of keeping, or giving the policy back to the insurance company at a loss. The lesson to learn is that if you are going to buy insurance, make sure that it is for that purpose. A more blatant abuse of fiduciary responsibility is summed up nicely in a recent article explaining STOLI:
Investors lend money for or “finance” premiums for unsuspecting seniors who thus get “free” life insurance for the first two years (the contestable period). Sometimes seniors also retain a partial death benefit or split-dollar position. The financial investors keep the settlement proceeds, which far exceed their loaned premium, and the brokers keep the earned commissions. Note that this arrangement may leave gullible seniors with a tax liability for the “loans” or cancellation of indebtedness (which may not be characterized as true indebtedness) on the marketed policies.
(Journal of Accountancy, June, 2008).
Beware of the ignorant and the misguided
While STOLI should always be avoided, there are many situations in which consumers legitimately purchase a policy only to find that it no longer meets their needs later. Keep in mind that nearly 90% of all life insurance never pays a death benefit. There is a very good chance that you will pay premiums for quite some time without ever realizing a benefit. Fortunately, once you own a legitimately purchased life insurance policy, it is yours to do with as you wish. A life settlement can be a great tool when a policy no longer fits in your plans. It can relieve you from premium payments while allowing you to capture a large portion of your policy’s value in an immediate cash payment.
Unfortunately, a shocking number of financial professionals know nothing about life settlements. Even more disturbing is the fact that some agents are prohibited, under threat of termination, from mentioning life settlements to clients. The reason for this appears to be that insurance companies have priced into premiums the fact that they will usually not pay a death benefit on a policy (remember, 90% of the time they don’t). A life settlement guarantees that they will have to pay the death benefit, and thus disrupts their profit models. Because of this gag rule, many consumers never hear anything about life settlements and risk giving up valuable property for a fraction of its market value – or even nothing!
Other financial professionals, including some insurance agents, are aware of life settlements and are not prohibited from discussing them, but choose not to. They believe that life settlements are never in the client’s best interest. In our experience, this belief seems based more in self-interest than in logic. Being an aggressive life insurance salesman leads even well-intentioned agents to believe that everyone needs more insurance.
Getting rid of a policy just doesn’t make sense to these agents, even though they sometimes advise clients to exchange a policy for one of their own. Interestingly, these replacements are the very cases where a life settlement makes the most sense. If a policy is going to be cashed in or allowed to lapse, it only makes sense to get maximum value for that policy.
The Power of Life Settlements in a Policy Replacement
Let’s look at Randy’s case as an example of an appropriate life settlement. Randy is 65 and retired. All of his kids are grown and he receives Social Security, which provides him a steady benefit and will also benefit his wife after he dies. Randy has a universal life policy that he has been paying on for many years. Because of the sliding markets, the cash value in the policy has been decreasing, dropping to just $5,000. Soon, there will be no cash left in this $100,000 policy. Since he doesn’t have a great need for insurance, he calls his life insurance agent and asks if he can use the $5,000 of cash value to buy a “paid-up” whole life policy to cover future burial expenses.
Randy’s agent tells him that with the $5,000 he can get $15,000 worth of coverage (plenty for final expenses) with no further premium payments. This seems like exactly what Randy wants, but if Randy’s agent is smart, he will first get his policy valued for a life settlement. While a life settlement is not always an option, a typical life settlement generates (according to recent industry-wide figures) about four times the value of a policy’s cash surrender value. Assume, conservatively, that Randy’s agent can obtain $18,000 for Randy’s policy through a life settlement. Even after paying broker fees, Randy will have more than double his original $5,000, and he’ll be able to buy more than twice as much life insurance.
This is a great outcome for Randy, and it’s also a great outcome for his agent. In addition to helping his client, the agent will get twice the commission on the insurance sale because Randy was able to buy a larger policy. The agent may even get additional commission directly from the life settlement if he is licensed (or otherwise legally able) to act as a life settlement broker.
A life settlement isn’t always the answer
Life settlements are not always appropriate, however, even when they can temporarily solve financial problems. Let’s look at the case of Susan. Susan is a 76-year-old widow who has been taking care of her grandchild after her son died in a tragic car accident several years ago. Her granddaughter is only 5 years old, and depends on Susan for everything. Recent stock market declines have taken a toll on her retirement income and forced her to take a job at Wal-mart. She has a $250,000 policy and inquires about a life settlement. It turns out that she can get $35,000 for this policy. Susan is eager to sell, thinking that this money could be enough to help her get through the rough times until the market turns up.
This is a very difficult case, but it likely would be in her best interest to keep the life insurance in force. An unscrupulous life settlement broker might tell her to sell the policy (thinking about the big commission that he would earn), but this is a situation where insurance is appropriate. Without a life insurance policy, Susan’s granddaughter would have no financial resources at all if anything happened to Susan. Even if things did turn around in the future, Susan is likely uninsurable and would never be able to get a new policy. Selling Susan’s policy would leave her granddaughter unprotected for years to come. The decision is, of course, still Susan’s to make, and she deserves to have all the considerations brought to her attention. This is where it is so important to have good financial advisors.
As can be seen, a life settlement is not for everybody, but it can be a very useful tool and in some cases an undeniable asset. Every financial professional should know something about them, or at least somebody in the life settlement business to whom he or she can refer consumers who may need this information.
How can I get more information?
If you would like more information about life settlements, call Open Life Settlements at 866.877.4054. Whatever your questions or concerns, we’ll do our best to answer them.
