A recent letter to Columnist Malcolm Berko of the Copley ...



A recent letter to Columnist Malcolm Berko of the Copley News Service, published on Feb. 24, 2007 stated,

"Dear Mr. Berko:

I'm 81 years old and in superb health. My son wants me to purchase an $8 million dollar life insurance policy, because he wants to sell the policy to investors so he, his family and I get the money to enjoy the good life. I've never heard of selling a policy, but he's an attorney and says people sell their life policies all the time. My wife died in 2002 and I live with my daughter, but it would be nice to have a lot of money and really live nicely.

My son lost a lot of money in the real estate business in Florida and he says that the proceeds from selling this life insurance policy would also help him get back on his feet and pay off some of the money he owes. He says that I don't have to pay any premiums (which are $367,000 a year), for the insurance policy because he knows someone who will make the annual payments.

My daughter thinks this is terrible and illegal and doesn't want me to do it and buy the policy. But my son would get $1.25 million and I would get $500,000, which I would give to my daughter. She told me to write you and ask if this is legal and honest".

This is a typical example of a rapidly spreading consumer issue Berko calls

 

"so profitable that groups of competing speculator/investors sponsor free cruises for aging seniors who will purchase (apply for) life insurance policies while cruising the beautiful bottle-green waters off the Bahamas and sipping champagne."

 

 

EXECUTIVE SUMMARY:

 

You may have been contacted by a client who has been approached about "Free" life insurance.  He or she may have been told about how profitable this transaction could be and might even have been offered a car or cash or some other incentive to apply for a significant amount of insurance on his/her life - and the lure of a significant post-purchase profit by then selling the policy to a life settlement company or other investors. 

 

But you need to remind your client of the old saw, "all that glitters..."

 

FACTS AND COMMENT:

 

Some of the problems associated with "free" (investor-initiated) life insurance include these:

 

•        If, in fact, a client has any significant "unused insurance capacity," he or she probably has a real need for insurance coverage. Selling it to investors might make it almost impossible for the client to  meet that need! Since there are overall limits on how much coverage will be issued on any life, once the policy on the client's life is sold, no matter how much the client's family or business needs the coverage, (the insurance company wouldn't initially issue the policy if it didn't think the insured's family or business didn't need it), the client will probably will not be able to obtain more.  (Agents/brokers and counsel who suggest or "green-light" the sale to the investors - even though they knew or should have known of the family or business need for coverage may have liability).[1]

 

•        Disgruntled heirs are likely to claim that, "If this was such a great deal for investors, why wouldn't it have been an even better family/business investment?"  Clients should consider that if there is a real and demonstrable need for insurance, it may be a wise decision to purchase and retain the coverage for the family/business rather than selling it to strangers.  (There is already a lawsuit by the disgruntled surviving family of an insured who sold a policy on his life to stranger-investors - just days before his death.[2])

 

•        Any incentive (car, cash, or other "gift") to encourage the purchase of the policy) will be currently taxable as ordinary income to the insured.   

 

•        It is likely that the "free" insurance is not tax free. The client may be subject to tax each year on the economic value of the coverage received. There are several theories upon which the IRS could base the tax and the reportable income may be considerable.

 

•        If the insured or other policy owner decides at the end of the two year "free coverage" period to turn over the policy to the lender and "walk away from the loan," it's almost certain the IRS will treat that discharge of indebtedness as ordinary income.  The debtor will incur taxable income to the extent that the lender's forgiveness exceeds the value of the policy given up.  Few policies will have any significant value after only two years so it is likely that the debtor will have to report a significant amount of taxable income but the transaction will have generated no cash to pay the tax.  

 

•        If the policy is sold to a settlement company, any gain will be all or mostly taxable at ordinary income rates.  And it's possible that almost the entire sales proceeds will be considered taxable!

 

•        The insured's family may never receive any insurance proceeds - even if his/her death occurs within the two year "free" insurance period during which he/she names the beneficiary. This is because, if the insurer discovers that investors initiated the transaction and everyone's intent from inception was for the insured or the insured's trust to sell the policy to them, the insurer may rescind the policy and declare it void ab initio.  At best, the client's family will be involved in expensive and aggravating litigation and are not likely to prevail. This is because investor initiated life insurance is, by definition, a purchase the investors can't legally make on their own. It is violative of insurable interest laws and the insured has become complicit in helping them do something the law prohibits investors from doing directly.  Every major insurer in the U.S. has stated publicly and categorically that it will not accept applications for IILI and have changed their questions to identify and screen out these types of situations.  So if the applicant states or implies that his/her/their intention in applying for the insurance is to protect family or business, but the insurer later proves (based on marketing materials and perhaps the sworn testimony the parties to the transaction) that the intent from inception was to resell the policy to investors at a profit, the insurer is likely to sue and rescind the policy. Insurers are now actively making vigorous pre-and post-issuance investigations where the policy is issued to those ages 70 to 90.

 

•        The insured's estate is potentially liable to investors for millions of dollars! The insured will be asked to sign many documents.  Those highly complex legal papers are designed to protect the investors' and lender's interests.  The insured may have inadvertently guaranteed the existence of insurable interest. If he/she dies after the investors have purchased the insurance on his/her/their  life(s) and the investors are barred for a reason covered in the signed documents from collecting the proceeds, those investors may sue the insured's estate for the insurance they expected to receive - but didn't.

 

•        In most cases, regardless of what the insured thinks he/she's been promised, the investors do not bind themselves to purchase the policy at the end of the two year "free" insurance coverage! (To do so would be a clear "smoking gun" that the insured never intended to keep the coverage and that the real applicant and intended purchaser-owner was the investors).  The brochure of one sponsor of this scheme cleverly phrases the "we don't have to buy back the policy we are initiating" this way:  "If the policy is ever brought to the secondary market, the policy-owner has no obligation or requirement to offer the policy for sale through any particular life settlement company."

 

•        Even if the investors do offer to purchase the policy, they may offer much less than the insured anticipated.  There are several reasons why that may occur. The obvious is that the less the investors pay for the policies, the greater the investors' return.  Another is that the sooner the insured dies, the more profit they make - but if the insured lives longer than anticipated, the investors may not make a profit and can even lose capital.  So if, upon examination of the insured's health at the end of two years, the investors find the insured's longevity - has for any reason increased, ownership of the policy on the insured's life is not as valuable to them as they may have thought two years previously - and their offer will not be nearly as high as the insured had hoped. The problem is that what they decide at that time to offer may (or may not) be sufficient for the insured or trust to pay off the huge debt (a bank has been lending hundreds of thousands of dollars to pay premiums for two years!) and if the policy is turned over to the lender in satisfaction of the debt, there may be a significant income tax because of the discharge of the indebtedness.

 

•        After the insured or the trust sells the policy to the investors (or let the bank takes it and sells it to investors), the insured is the only party to the transaction that hopes the insured lives a long time.  He or she will be told (and will want to believe) that the odds are small of some investor taking steps to profit by a premature death.  But no one can assure the client that it can't happen.  In fact, there are hundreds of litigated insurance cases where that has happened, i.e., where people have been killed for the insurance on their lives. Compounding this troublesome fact of life is that the investors who instigate and originally purchase the policy have the legal right (and often the intent) to sell the policy on the insured's life - immediately - to other investors. There's no legal limit to how many times the policy can be resold - or to whom. So the contract on the insured's life can end up in the hands of anyone (even just one investor) and he or she will neither know or have any control over who will be his/her beneficiary. As astounding as it sounds, there is very little preventing a crime cartel from owning a majority interest in a corporation that purchases these "mortality futures" contracts from a legitimate life settlement company (or from the first or second or third or fourth round buyer of a block of policies).[3]           

 

•        There are long-run policy concerns about this transaction.  If Congress views life insurance - not as a means to provide security - but as a security - it will tax it as such.  At a 40% bracket, a death benefit of $1,000,000 would result in a $400,000 tax!  The insurance purchasing public loses because it will net less from each dollar of life insurance purchased!  Likewise, if misleading statements or omissions on applications result in a mismatch of premium rates to an insurer's actual experience, and investors pervert what was intended to provide security into "a security", insurance companies will be forced to increase premium rates (or discontinue coverage) for older insureds and perhaps even others.  Combined with increased income taxes, the inevitable result will be that future life insurance buyers (including you and your clients) will have to pay more and net less!

 

•        During 2006, state Insurance Commissioners in New York, Utah, Louisiana, and North Dakota have taken strong stands and recently issued public bulletins against investor-initiated life insurance.  Both the National Association of Insurance Commissioners (NAIC) and the National Council of Insurance Legislators (NCOIL) have recently spoken out against violations of insurable interest laws in general and both groups have proposed action to eliminate investor-initiated life insurance. 

 

CONCLUSION:

 

• Investor-Initiated Life Insurance is ultimately a gravity-defying "too good to be true" "suspend your disbelief" scam that will result in (more) lawsuits, some against advisors who should have raised red flags but didn't and some against life settlement companies who insist they, and not the insured's own family, should benefit from the insurance proceeds.   

• As in a game of musical chairs, some insureds will be left with a bitter taste when, instead of making an incredible profit upon the sale of a policy purchased for no other reason than just that - to profit on its sale, the insurer rescinds the contract because of the applicant's material misrepresentation. Rather than the no-risk high return free lunch they hoped for, many insureds will end up with acid indigestion.

• Families of many insureds will be angry, hurt, and feel cheated that total strangers profited from the death of a beloved family member.  They may even direct that disappointment and anger on the deceased - particularly when the insured's death occurs shortly after it was assigned to the investors.

• Individual and institutional investors will find (as they have in the past) that the type of life settlement companies that promote "free" insurance are not among the most ethical - and may discover that the "sure thing" high return investment isn't!  

• Life settlement companies will find themselves saddled with more restrictive, burdensome, and costly rules and regulations. 

• The dignity and integrity of life insurance will be sullied.  The job of the true life insurance professional - the man or woman with the brains and guts to stay away and keep clients away from this mess - will have grown more difficult.

 

Who wins?  Only those involved in promoting this scam - folks who - in the long-run - will be long gone to their next get rich quick scheme when it finally is shut down. 

 

What's my advice to those who advise?

 

I suggest you say to your clients the same thing I'd say to my 86 year old mother if she were approached by someone wanting her to become involved with investor-initiated life insurance:

 

One word will do.  DON'T!

 

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!

 

Steve Leimberg

 

CITE AS:

 

Steve Leimberg's Estate Planning Newsletter # 1095 (March 6, 2007) at

 

Copyright 2007 Leimberg Information Services, Inc. (LISI).  Reproduction in Any Form or Forwarding to Any Person Prohibited - Without Express Permission.

 

 

CITES:

 

Leimberg, "Stranger-Owned Life Insurance (SOLI): Killing the Goose that Lays Golden Eggs", Estate Planning, January 2005, Vol. 32, No. 1, Pg. 43.  Leimberg, "Stranger-Owned Life Insurance (SOLI): Killing the Goose that Lays Golden Eggs", Tax Analysts/The Insurance Tax Review, Vol. 28, No. 5, May 2005. Jones, Leimberg, and Rybka, "'Free' Life Insurance: Risks and Costs of Non-Recourse Premium Financing, Estate Planning Journal, Vol. 33, No. 7, July 2006, Pg. 3. S. Leimberg, "Planners Must Be Aware of the Danger Signals of "Free" Insurance, Estate Planning, Feb. 2007, Vol. 34, No. 2. 

 

P.S.

 

Mr. Burko had a few choice words for the 81 year old that wrote for advice: 

Some of them were:

"Yes it's legal. So is selling body parts but it rubs me the wrong way, sort of like tweed underwear."

 (Actually, Mr. Burko, since 1881, when the Supreme Court in Warnock v. Davis decided the first case on investor-initiated life insurance, it has NOT been legal for investors with no insurable interest to purchase life insurance on your life!  And the collusion of the insured in the scheme today makes the contract and the action no more legal now than it was back then).

My daughter, who is also a lawyer (and among the few highly principled ones, too), refers to the wholesale sale of life insurance policies as a "contract to sell your soul to the devil." ...

The sooner you get measured for a coffin, the happier the investor will be.

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