Grim Reaping: The Business of Life Settlement

Investors love a sure thing, and in this life, it doesn't get more certain than death. So it's no surprise that in recent years the market for investing in life settlements—buying a stake in someone else's insurance and collecting the reward when they die—has grown tenfold to nearly $20 billion. Life settlements can offer legitimate value to investors and policyholders, but the industry remains largely unregulated. And just like the overcooked mortgage securities market, they've launched a flood of fraudulent policies—this time on people's lives.

A life settlement occurs when someone decides to sell his life insurance policy; perhaps he can no longer afford the premiums or the beneficiary has passed away. Through a broker, he sells the policy for a percentage of the death benefit. The policy is then passed on to investors who pay the premiums until the policy matures and collect the death benefit as a return on their investment. A life settlement typically pays more to the policyholder than surrendering the insurance back to the company that issued it.

More than a dozen multimillion-dollar life-settlement scams have come under investigation in states across the country since the start of 2008. "Life settlements serve a useful purpose by enhancing the value and liquidity of life insurance policies," said Fred Joseph, president of the North American Securities Administrators Association. "But they also pose significant risks. Thousands of investors, many of them senior citizens, have been victimized through fraud and abuse in life settlements."

Like any investment, life settlements attract capital by promising high returns. But the business also creates a sense of empathy among many of the individual investors. Often the senior investors empathize with the policyholders. "My parents don't have a lot of faith in government, and they certainly don't trust Wall Street," says the son of life-settlement investor Albert Scartz. "But they are growing older. They're feeling their own mortality and, I think, in an odd way, that gave them confidence in this investment."

The industry for selling life insurance first sprang up during the AIDS epidemic of the late 1980s. "Companies loved AIDS because it was a predictable death sentence," says Gloria Wolk, a life-settlement expert who learned about the practice while volunteering at AIDS services clinics. The shorter and more certain the life expectancy, the higher the returns promised to investors and the greater the lump sum offered to patients. It was a grim mix of free-market capitalism and human mortality. "But I saw the industry make a huge difference in the lives of terminally ill patients and their families," says Wolk.

The turning point came in 1996, when new anti-viral drugs destroyed the market for AIDS policies. But by 1999, the industry had reformed, offering its services to seniors instead of the terminally ill. Since then, the sector has experienced rapid growth. In 2002, it was valued at $2 billion. Now that number is closer to $20 billion. "When you look at the age of the population in the United States and the amount of life insurance in force ($15 trillion), you realize that the life-settlement market, as it stands right now, is just the tip of the iceberg," says Zohar Elhanani, COO of Legacy Benefits.

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Just as the overheated market for securities backed by people's homes created a wave of subprime mortgages, the market on people's lives has created a boom in fraudulent insurance policies known as stranger-originated life insurance. STOLI is illegal. It begins with a life insurance agent, who, in many cases, is now also a life-settlement broker. The agent convinces seniors to take out large policies by offering meals, trips, and cash. The agent or life-settlement firm agrees to pay the premiums. Ownership is then quickly and quietly transferred, often to a trust, where it can be sold on the open market.

In the retirement communities of West Palm Beach, Fla., the practice of flipping life insurance for cash is common. "I think I first heard about it from friends on the golf course, maybe four or five years ago," says Wally, a retired doctor from New York. "A few years later a friend said her son was in the business and could be trusted." Wally passed that time as well, but he still gets offers. "Around here it's a very common thing, an easy way to make some money." Many seniors are unaware that participating in STOLI is illegal and may endanger their ability to collect on real insurance in the future.

CONTINUED : Is STOLI "basically non-existent?"

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