Collecting on Life Insurance early could lead to the next financial meltdown

It looks like one of the things that has always been seen as a “sure thing” could be coming back to bite investors. Life insurance companies have been offering policies to people for years and premiums often go up as the insured begins to age.

An investment scheme that has popped up in the last few years is when someone who is insured can no longer afford the premiums or is looking to “cash out” a life insurance policy that he or she has been paying on, someone will come along and buy it for a fraction of the payout and sell it off to investors who will pay the premiums until the original insured person dies.

There have been over a dozen life-settlement scams to come under investigation since 2008. Life settlements get capital by promising high returns. The business also gains the attention of other senior citizens who have empathy for the policy holders that have looked to cash out. And so, there have been a lot of companies ready to take advantage of those people.

Like when the market for securities became bloated and backed by homes created the subprime mortgage mess, the market for life settlements has created a surge in fake insurance policies called STOLI’s or stranger-originated life insurance. These STOLIs are illegal and begin with a life insurance agent who is also a life-settlement broker. The agent talks a senior citizen into taking out a big life insurance policy and wines and dines them. Then the agent agrees to pay the premiums and the ownership of the policy is transferred to investors.

Again, the problem with these STOLIs is that they are illegal and could endanger the policyholder from being able to collect any insurance in the future. Some scary statistics are that more than 50% of life settlements right now were on policies that were less than 4 years old. The reason for the increase and the large amount of settlements on policies that are less than 4 years old is the STOLIs. These policies equal out to huge losses for the insurance companies also and could potentially hurt the insurance companies to the point where they are unable to pay out real insurance claims.

It appears as though the government is taking note. Last month Senator Herb Kohl led up a special committee on the problems associated with life settlements. The committee meeting ended with the IRS and SEC being contacted to talk about gaps that are left in legislation in life settlement procedures. The SEC has agreed to look into the issues facing the industry. Due to this activity, it seems as though the market has cooled down a bit.