Life settlement - A necessary evil?

In spite of the not-too-pleasant perception about insurance in general and life insurance in particular in our part of the world, I can say with some level of certainty that in Ghana, three out of five formal sector working persons have at least one life insurance policy!

I am of the view that the level of awareness and education created by various stakeholders and the growing need for financial inclusion in our personal financial plans have markedly contributed to this positive trend!

That notwithstanding, we should also realise that as public awareness increases leading to growth, the number of those who may want their policies cancelled or surrendered for various reasons also increases.

A strong, growing life insurance industry remains one of the key avenues for domestic financing for local infrastructure and economic development across the globe.

Both life and general insurance penetration rates in Ghana are still under two per cent, creating a significant opportunity for future growth and drawing interest from global life insurance insurers seeking to tap into the industry’s unexploited opportunities.

It is, however, sad to say that in the past few years, some life insurers have had to grapple with the challenge of policy surrenders and cancellations from some policyholders.

I believe that if the subject for today’s write-up is taken a closer look at by local insurers, some policyholders would have the option of using LIFE SETTLEMENTS to deal with their personal circumstances.

What is ‘Life Settlement’?

Just like any other product, life insurance policies could also be sold out to third parties when the current owner is confronted with economic challenges or simply cannot continue paying premiums.

I was approached by a gentleman who wanted to sell out his six-year term policy after paying premiums continuously for nearly three and half years on the policy.

The gentleman would not take it kindly with me when I explained to him I could not help with such an arrangement as selling out policies to third parties may be new to our market.

He claimed he did a similar thing in Europe some years back when he was returning to Ghana after years of sojourn there.

Indeed, it is a truism that in the western world, life insurance policies could be sold out to third parties akin to selling shares on the stock market. This process is what is called LIFE SETTLEMENT.

How is it done?
Typically, life insurance policies are considered assets, hence the owners of such assets can cash on them if they are financially handicapped.

All they need to do is to find a buyer to sell the policy (GRIGSBY v. RUSSELL in a 1911 US Supreme Court ruling).

There are certainly some drawbacks to using life insurance to meet immediate cash needs, especially if one is compromising his or her long-term goals or family's financial future.

Nevertheless, if other options are not available to enable one to raise funds, life insurance, especially cash-value life insurance policies, can be a source of needed income.

How it works

As mentioned earlier in certain jurisdictions, one can easily convert his or her life insurance policy into cash be it a funeral insurance or an investment policy.

However, let me be quick to add that sometimes the process may not be as smooth.

First, one needs to have the policy appraised to determine the selling value.

Then there will be the need to scavenge for a buyer.

Once a buyer is found, he or she will receive a cash settlement on the policy and he or she will continue to pay premiums and collect the benefit when the policy matures or when he or she passes on.

But locating a good buyer on one’s own can be complicated, which is why many people sell their policies to a settlement company or to a third party through a life settlement broker.

If one sells to a settlement company, he or she will receive a percentage of his or her policy’s value in cash.

If he or she uses a broker, he or she may also pay a commission to the broker. However, a broker may be able to find a better deal than the individual would on his or her own.

The challenges

The following are some of the consequences of selling out one’s life insurance policy:

•    Compromising on one’s long-term financial needs;

•    Inability to meet one’s insurance needs in the future; leading to an unhappy and tortuous ending;

•    Beneficiaries would be deprived of their future benefits; and

•    One’s records and confidential information might be in the public domain.

What one needs to know

There are a few things one should consider before selling his or her policy. For example:

•    One’s life insurance policy may not have much value on the market. Some life settlement brokers have the conviction that only about 25 per cent of the policies they see are worth so much.

•    One won’t get the full face value - Most sellers receive just about 13 to 21 per cent of the value of their policy.

•    Brokers charge high commission - The 2009 commissions’ rate for brokers in Europe, for example, was about nine per cent.

•    Buyers are selective - Buyers are always looking for people over the age of 65 with chronic or terminal illnesses and ‘preparing to go’.

If one is young and healthy, his or her policy won’t be as attractive to a buyer.

•    One may have tax complications – One’s settlement could be subject to income tax.

•    One’s eligibility may change.

Life settlement could change one’s eligibility for government assistance programmes (i.e. in some jurisdictions).

•    It isn’t the only option.

If one is selling a policy because he or she needs cash, he or she may have other options such as taking a policy loan on his or her life insurance policy (i.e. if one exists on the policy), accelerating one’s payout date or selling the policy to a family member.

However, it is important to keep in mind that these options also have pitfalls and should be discussed with insurance or personal financial advisors.