By: Martha M. Hamilton | Source: AARP Bulletin Today | January 28, 2010

It’s not unusual to look around for unused items to sell when you’re trying to come up with extra money. For some folks, that item may be their life insurance.

Why would you want to sell your life insurance policy? Think about it: Things change over time. Maybe those children you were worried about protecting are all grown up now and making more money than you are. Maybe you once worried about protecting your husband from financial stress if you died before he did. But that was before the divorce proceedings got under way.

Or maybe you and your spouse are both in your 80s and would like to have some cash for another travel getaway. Or, less happily, your medical costs are eating you alive and you need extra money.

So you may turn to a “life settlement,” a financial product that allows investors to buy life insurance policies from people who, like me, have a little gray in their hair. Life settlements provide a new way to extract value from insurance policies that have lost their original value for the holder.

If you don’t need your policy

Before life settlements came on the market, if you had an insurance policy that was no longer useful, you could either turn it back to the company for a relatively small sum (the “surrender value”) or let it lapse by ceasing to pay premiums. Life settlements have presented a third option: Sell your policy to an investor who pays you a fraction of the death benefit, but more than the surrender value.

For instance, say you were a nonsmoking man who bought $100,000 worth of life insurance when you were 35. Twenty years later you might be able to turn it back to the company for about $33,000. But an investor might be willing to pay you more. The way it works is that the investor continues to pay premiums to the issuer, hoping the eventual costs will end up being far less than the death benefit.

The sooner you die, the better the buyer does. So, yes, it’s a little ghoulish.

When the economy went south starting in 2007, there was speculation that older investors might turn to life insurance policies as a source of cash because other investments had plummeted in value. For a while, it looked as if there would be a growing market for bonds backed by life settlements, as investment groups started bundling them the same way they had previously bundled subprime mortgages to sell to hedge funds and other investors.

Goldman Sachs even set up an index that tracked the life expectancy of a group of people 65 and older who had sold their life insurance policies to an investment pool, planning to sell derivatives based on the index to institutional investors as a hedge against investments in other life settlement pools. As a result of all the activity in this market for life settlements, last year Securities and Exchange Commissioner Mary L. Shapiro created a task force to keep an eye on what risks the new products might pose.

But in the end, the market failed to grow as expected. In December 2009 Goldman Sachs shut down its index.

Finding a deal in “death bonds”

According to a Thomson Reuters story about Goldman’s decision to retreat from life settlements, part of the reason the market failed to take off was that investors stepped back from products backed by bundles of mortgages, credit card debt or life insurance. In the case of life settlements, it may not have helped that the products were sometimes referred to as “death bonds.”

Not that the market for life settlements is dead. It just “hasn’t grown exponentially” as people once thought it would, says Paula Dubberly, an associate director of the SEC’s division of corporate finance and codirector of the task force. Even so, the task force will keep an eye on how life insurance policies are purchased, how they are packaged and sold, and what players are involved, says Dubberly.

Life settlements are similar to viatical settlements, which grew in popularity during the 1980s, when AIDS patients cashed in life insurance policies in exchange for badly needed cash. Unlike life settlements, viatical settlements require that the seller be terminally ill.

Robert Hunter, director of insurance with the Consumer Federation of America, says that as competition has increased in the life settlements market, you may have an easier time finding a decent deal, but “you have to be careful.” Sellers of policies, who probably don’t spend much time studying actuarial tables, may be hard-pressed to understand whether the price being offered is a fair one.

Deciding whether to sell your life insurance policy is a “unique transaction that a consumer needs to evaluate carefully,” says Connecticut Insurance Commissioner Thomas R. Sullivan. “One’s life circumstances need to be viewed in their totality when considering whether to sell.”

Ask a lot of questions

Sullivan says one basic fact a seller needs to know is how much you could get for a policy by turning it back to the insurance company. He says you should also ask, “Is the salesperson getting commissions? Is this broker licensed by the state? What are the tax implications? Will it impact my finances because I might no longer qualify for Medicaid assistance?”

Some other consumer tips:

• Shop around and get quotes from several companies.

• Find out whether you have the right to change your mind after you get the money, and if so, how much time you have.

• The buyer has the right to ask you about your health from time to time. Make sure you know how that information will be protected.

• Contact your state insurance department to verify that the broker is licensed in your state.

“It’s like a car or home or any other asset an individual owns,” says Sullivan. “The individual consumer should be able to exercise the right to maximize the value of the policy. If the policy is $1 million and the surrender value is $20,000 and someone is willing to pay you $100,000 for it instead, I have no problems with that transaction at all.”

There are good deals and bad deals out there, Sullivan says. So what should be your approach? “Like anything else,” he says, “it needs to be buyer-beware.”

Source: AARP http://bulletin.aarp.org/yourmoney/retirement/articles/your_financial_future_looking_at_life_settlements.3.html