Sell your life to a stranger

By Kiplinger's Personal Finance Magazine

Kenneth Sahs, 71, faced a once-in-a-lifetime decision last year. His $500,000 convertible term life insurance policy would soon expire. Sahs could drop it and get nothing or convert it to universal life, a form of cash-value insurance, and take on $12,000 a year in premiums.

Then Sahs and his wife, Marie, learned that they had a third choice: to sell the policy to an investor. To their delight, the Sahses got a quick $125,000. No more eventual death benefits, but no premiums either.

"Insurance companies don't tell you there are opportunities like that," Marie Sahs says. "It's like a treasure chest you don't know to look for."

The couple called an independent insurance consultant, who solicited offers from a life-settlement broker and relayed the terms to the Sahses. Much of the payout will be taxed at the low capital-gains rate, a further benefit.

Many seniors are now selling their life insurance policies to raise cash. In 2006 alone, policies worth $6.1 billion in death benefits changed hands. This trade wouldn't be possible, however, except for one controversial aspect: The party on the other end profits from your death -- and the sooner, the better.

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When you (or a family member who may actually own the policy on your life) sell the insurance, the buyer becomes the owner and beneficiary. Upon your death, this stranger stops paying premiums and collects the death benefit.

These transactions used to be called viatical settlements. They were especially ghoulish because early investors were generally small companies that offered big discounts from the death benefit to buy policies from AIDS patients, who weren't expected to last long and desperately needed cash for medical bills. (Some investors lost a lot of money when new drug combinations greatly prolonged the lives of AIDS patients.)

• Calculator: What is your life expectancy?

Now these deals are called life settlements and are moving to the financial mainstream. Institutions such as Goldman Sachs, JPMorgan Chase and Credit Suisse, as well as hedge funds and German pension funds, are investing in packages of life settlements because the rate of return is not correlated to the stock market, making life settlements a portfolio diversifier. Even some life insurance companies, such as Phoenix, are becoming investors.

How the process works

If a settlement is a great deal for Goldman Sachs, can it be fair to Kenneth and Marie Sahs -- or to you and your family? The answer is partly a matter of perception: Does $125,000 seem like a small fortune to you? Or is the reduced amount a sacrifice?

As the life-settlement business grows, it's getting cleaner, and pricing is becoming more consistent. Investors usually prefer people over 65 who are insured for $500,000 or more. If you have a cash-value policy, they'll generally offer far more than you would get by surrendering it to the insurance company -- often two and a half times that amount, says insurance adviser Norman Hood of Rushville, Ill. Investors will also buy term policies, which have no cash value, if the policy is convertible to a cash-value policy and the premiums make sense to the investor.

The size of a settlement varies with the insured person's age, health and life expectancy, but sellers generally get 20% to 30% of the death benefit. The Sahses got 25%, a little more than some other 71-year-olds would get, because Kenneth has a history of heart problems, shortening his life expectancy.

The hunt for this treasure starts with a life-settlement broker, which you can locate online or through a financial adviser. These middlemen gather your health and financial data and solicit settlement offers from investors. One transaction feeds a bunch of mouths, so brokers expect competing offers to vary, sometimes drastically.

Insist that the broker get five or six offers and show you all of them, as some states require. Be suspicious if anyone tries to steer you toward one offer, because it may be the deal with the highest commission. You've kissed away a fortune if you discover that the broker took a cut of 30% of the death benefit when 10% of the settlement amount is fair.

Continued: Easier assessments

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