BENEFITS OF A SECONDARY MARKET FOR LIFE INSURANCE POLICIES, THE

Real Property, Probate and Trust Journal, Fall 2003 by Doherty, Neil A, Singer, Hal J

More than twenty percent of policyholders over the age of sixty-five are estimated to hold policies the economic values of which exceed their cash surrender values.12 Conning Corporation, an insurance industry researcher, concluded that the total value of life insurance policies held by senior citizens is $492 billion, which means that the potential market for life settlements is close to $100 billion.13

The secondary market for life insurance policies allows policyholders who have experienced a negative shift in life expectancy to obtain the fair market value for their life insurance assets. Although it does not make sense for most policyholders to surrender their policies at the market value,14 the flexibility offered by the secondary market for life insurance policies gives a policyholder the ability to respond to changes in his life situation.

There are a variety of situations in which the secondary market sale of a policy by an eligible individual is welfare improving:

* The premiums on the policy are no longer affordable.

* The beneficiary for whom the policy was originally purchased is now deceased or no longer has a need for the policy.

* A key-man policy, designed to protect a company from the financial loss of a key executive, is no longer necessary, either because the business has folded or the individual is no longer integral to the business's success.

* The policyholder owns multiple life insurance policies and wishes to eliminate one.

* The policyholder wishes to replace an individual policy with a survivorship policy, a long-term care insurance policy, or funds for long-term care.

* The policyholder requires funds to pay for medical expenses or for new and experimental treatments for himself or someone close to him.

* The sale of the policy would allow the policyholder to maintain a desired standard of living and live out his final years with dignity.

* The policyholder wishes to remove the policy from a trust or estate.

* A reduction in the value of the policyholder's estate reduces the tax liability for which the life insurance policy was designed to provide.

* An increase in the liquidity of the policyholder's estate eliminates the need for the policy.

* The policyholder wishes to donate highly appreciated assets to charity, but would be faced with liquidity constraints resulting from such a donation.15

The many examples listed above detail situations in which a policyholder might wish to sell his life insurance policy. Although it has always been possible for a policyholder to sell his policy to the incumbent life insurance company, in cases where the policyholder experienced a decline in health, the underpayment by the insurance company restricted the policyholder's ability to meet the above goals. The secondary market for life insurance policies gives the policyholder the economic freedom to choose between a number of buyers and, in so doing, to receive the fair market price of the policy.16

Life settlements are one of several life insurance innovations through which companies that develop innovative actuarial analyses have been able to glean profits through their superior ability to assess mortality and other risks. In this sense, life settlements essentially are similar to innovations introduced in prior generations, such as the differentiation between smokers and nonsmokers that began in the 1980s. However, unlike most prior innovations in the insurance industry, which sought to "skim" the healthiest-the least risky-patients from the pool, life settlements actually benefit those who have become greater-than-average risks.17 Moreover, because the existence of a secondary market for life insurance has improved the liquidity of all life insurance policies that potentially qualify for settlement, the secondary market makes policies in the primary market more valuable for all consumers, regardless of their current state of health.