June 18, 2011 by wcobserver
“Take out a life insurance policy, and you’re just gambling with the Insurance Company,” goes a cynical line of reasoning. “The company is just collecting your premium and gambling you’ll live a long time; and you, on the other hand, are betting you won’t … Who wants to bet like that?”
For most of my professional life, I’ve disputed this line of reasoning by saying “no, in fact buying life insurance takes the gamble out of life. Neither you nor the Insurance Company knows how long you will live, but they know how long the average person will live. They help you pool your risk of dying too soon.”
Early laws governing life insurance were designed to prevent wagering. It was decided at an early point in history that using life insurance to speculate was against social policy. Early in my own career, I came face to face with the principle of insurable interest. Broadly stated, that means I cannot take out a policy on your life unless I have a financial interest, meaning that I would suffer a loss at your untimely death. Otherwise, it would just be speculation. Moreover, the insurance company usually limits the amount to about 10 times your annual income.
Obviously, a wife and mother has a vital interest in the continued life (and paycheck) of her husband. To a lesser extent, parents have a need and right to get coverage on dependent children. If you’re an engineer who happens to be my business partner, I stand to suffer a big loss if I’m left without your services because you died unexpectedly. Therefore, partners are able to purchase business life insurance on each other.
However, in the absence of a blood or business relationship, I may have had a hard time proving to the insurance company that I should buy and own a policy on your life. But after the policy is in force, you may be able to transfer your ownership right and premium paying obligations to me. As a rule of thumb, the principle of insurable interest only had to be proven at time of policy issue.
Sorry to say, this time-honored safeguard has been turned on its head recently. As we speak, there is a big market in what’s called “life settlements.” Let’s call it a used policy store. It started out this way; a businessman had bought a $1,000,000 term policy to cover his debt. Otherwise, the bank would have taken a dim view of loaning him the money. It’s now 10 years later, and he no longer needs this policy. So he’s approached with this proposition, “since you no longer need that policy, why not sell it for cash to the used policy store? They plan to pay the premium until you die, and collect the insurance then.”
You might like that deal, but I wouldn’t! Why, you ask? Because, it violates the principle of insurable interest. I don’t know about you, but I wouldn’t sleep very well knowing someone was holding a $1 million policy on my life, and hoping I didn’t live very long. They might want to fix the brakes on my car!
It gets worse! In recent years a new twist on this story has developed. Unscrupulous operators sometime approach your healthy 70-year-old mother to take out a new policy and immediately transfer it. These are called “wet ink” transactions. Reputable companies have set up safeguards against this unsavory practice. Some operators are now being sued. It seems some investors are losing out because insured people are living too long.
For my part, I decided a long time back that I wouldn’t touch so-called life settlements with the proverbial 10-foot pole! Life insurance should not be for speculation!