Life settlements – buying rights to senior citizens’ life insurance policies – is a risky gamble that should be avoided by most investors, according to Leslie Scism and Larry Light in their Feb. 6 Wall Street Journal article, “Grim Risks of Reaping Death’s Rewards.”
These arrangements allow senior citizens to sell their policies at a discount to face value. The buyer receives the death benefit when the seller dies. In the meantime, the buyer pays the policy premiums.
The appeal to investors is the possibility of a good return and that betting on mortality is apparently not correlated to stocks, bonds or anything else.
The risks include the fact that insureds may live longer than expected, resulting in the investors making more premium payments and waiting longer for the death benefits. The risks also include the possibility of purchasing rights in a fraudulent policy.
When and if the policies do pay off, there is a substantial tax hit. Last May, the Internal Revenue Service ruled that death benefits received by investors will no longer be taxed at lower capital gains tax rates, but must be taxed at higher ordinary income tax rates.
“This is not a place for amateurs,” says Doug Head, executive director of the Orlando, Fla.-based Life Insurance Settlement Association. “It’s a high-risk investment that requires considerable sophistication.”
Between January 2004 and July 2009, the Securities and Exchange Commission took legal action against 27 U.S. life-settlement funds and advisers, according to the article. Life settlements are on the North American Securities Administrators Association’s top-10 list of “investor traps.” Shady operators and ponzi schemes have surfaced in some life settlement deals.
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