From my perspective, the owner of an insurance policy should be able to sell it to anyone at the highest price possible because it is his or her property. It seems that the life insurance companies and the insurance regulators have a different view.
On Sept. 12, the Financial Services Commission of Ontario issued a release titled Trafficking in Life Insurance warning policy owners and life insurance agents that selling or transferring life insurance policies "may not be legal in Ontario" depending on the circumstances.
People might relate the term trafficking to selling illicit drugs or property obtained by crime, but I suspect that very few outside the insurance industry would relate trafficking to the transfer or sale of insurance policies involving consenting adults.
The release says "Any person , other than an insurer or its duly authorized agent, who solicits or assists Ontario policyholders in the selling, trading, transferring, pledging or assignment of life insurance policies might be in violation of section 115 of the Insurance Act," which is titled "Trafficking in life insurance policies prohibited."
Most provinces and territories have similar provisions, but the real threats to agents are from insurance companies that will cancel their contracts with agents who get involved in this so-called trafficking. As one company puts it in its code of conduct, "Under no circumstances are you to engage in any activity, including trafficking or trading of life insurance policies, related in any way to viatical or life settlements."
Life settlements refer to the sale or transfer of a life insurance policy to a third party, generally an investor as opposed to someone like a spouse or child or parent or employer who would have an insurable interest in your life. Viatical settlements typically refer to transfers or sales when the life insured is terminally ill. Anyone in this latter situation should have his or her insurance agent contact the insurer. In many cases the insurance company will advance a substantial portion of the death benefit based on the specific circumstances.
As it stands the owner of a policy can surrender it to the insurance company for its cash surrender value or donate it to a charity and get a tax credit for the cash surrender value, a practice encouraged by insurers.
The seller of a policy is typically an individual who no longer needs the coverage or is no longer willing or able to pay the premiums. There are also individuals who have acquired policies on their lives from employers. For instance a corporation holding a policy on the life of its president won't need that policy if the president retires or leaves. Often it will transfer the policy to the insured as part of a termination or retirement package. The insured may want to sell it if he or she can get more than the amount available from surrendering the policy.
Some policies don't have cash surrender values. For instance Term-100 policies typically require monthly or annual premiums for life or until age 100. Someone who took out, say, a $1 million policy in the 1980s may not need the coverage anymore. He can continue paying the premiums to keep the policy in force, or he can transfer the policy to his children and let them pay the premiums and collect the benefits at his death. Alternatively he can sell it to a third party at some discount from the face value to reflect his age, the premiums required and the payout.
There are tax consequences if the transfer is to someone other than a child or spouse. The insurer that issued the policy can provide what your cost is for tax purposes, called the adjusted cost basis.
As the Ontario release indicates, there are third parties willing to buy policies for more than the cash surrender value but less than the net death benefit. It states "The third party, usually an investor, maintains the policy and changes the beneficiary designation. Upon the death of the insured, the third party receives the proceeds of the life insurance policy from the insurer."
So why would an insurance company object to the sale? The answer is it assumes that over time some policy owners will stop paying premiums, allowing the policies to lapse, which means the insurer won't have to pay a benefit or keep reserves for that policy.
But policies issued in the 1980s or early 1990s have premiums that reflect the double-digit interest rates at the time. When investors hold such policies they view them as analogous to a high-yield savings program with a quality institution. You pay the premium and sometime in the future, when the life insured dies, you get a huge payout. In the hands of investors these policies are unlikely to lapse.
My suggestion to the insurance companies is to run their own market in life settlements and buy policies individuals no longer need or want. If third parties see a profit in the practice, surely insurers' actuaries and investment analysts will see the same.
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