By Robert Powell, MarketWatch
BOSTON (MarketWatch) -- Life settlements are not wildly popular investments. But they are wild investments. And to that end, federal regulators and lawmakers are fast at work trying to tame these slippery products, which promise a much higher return over more traditional conservative offerings.
A life settlement is a transaction in which an individual with a life insurance policy sells that policy to another person, who then assumes responsibility for paying the premiums.
Last week, the Government Accountability Office (GAO) warned consumers about participating in life-settlement transactions "due to a lack of clear, consistent state oversight." The Securities and Exchange Commission recommended that life settlements be clearly defined as securities so that the investors in these transactions are protected under the federal securities laws. Read the SEC report at this website.
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In its report, the GAO noted that 12 states and the District of Columbia have no laws or regulations pertaining to life settlements.
Indeed, insurance policyholders can complete a life settlement without knowing how much they paid in fees or whether they received market value for their policy, because brokers are not required to disclose such information. Read the GAO report at this website.
The SEC -- as did the Financial Industry Regulatory Authority (FINRA) in 2009 -- came to a similar conclusion as the GAO. The SEC, for its part, said that investors in individual life settlement transactions, or pools of life settlements, would benefit from the application of baseline standards of conduct to market participants. Read FINRA's report on life settlements at this website.
"The (GAO) report shows that regulation desperately needs to catch up to this growing industry," Sen. Herb Kohl, D, Wis., Chairman of the Senate Special Committee on Aging, said in a release. "We need to improve oversight not only of individual transactions, but of the bundling and trading of life settlements." Read about Sen. Kohl's April 2009 hearing on life settlements at this website.
Life lessons
What impact do these regulatory rumblings have on those who are selling their policies and those investing in life settlements?
Typically, the seller no longer wants the policy or can no longer afford to pay the premiums. In exchange, the insured party typically receives a lump-sum payment that exceeds the policy's cash surrender value, but is less than the expected payout in the event of death.
The bet being made is this: The investor is hoping that the insured dies at or around -- or better yet, before -- -his or life expectancy. That's a money maker. But if the insured lives beyond life expectancy, the policy holder loses
The investor gets a return that in effect reflects the difference between the buyout price and the death benefit, taking into account the cash flow.
But in the absence of any rules and regulations, are these investments a good deal?
Stephan Leimberg, publisher of Leimberg Information Services, Inc. and editor of Tools and Techniques of Life Settlement Planning, says the major advantage of investing in life settlements is that it's an asset, the performance of which is not tied to the performance of a stock market.
Brian Casey, partner with Locke Lord Bissell & Liddell, added that there's a chance for low double-digit returns and that credit risk of the life insurance company is less than for many other types of creditors.
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