In this month's issue, I would like to address the topic of insurable interest in a life insurance policy. I find this topic comes up frequently when a life insurance policy is sold into the secondary market. The advisor representing the seller asks, "how can you sell this policy if the buyer has no insurable interest?"

All states require that the initial purchaser of a new life insurance policy, insuring the life of an individual, have an insurable interest in such individual's life at the time of original issuance of the policy. Whether an insurable interest exists in the context of the purchase of a life insurance policy is critical because, in the absence of a valid insurable interest, life insurance policies are unenforceable under state law. When a life insurance policy has been issued to a policy holder without an insurable interest in the life of the individual who is insured, the life insurance company is generally not required to pay the death benefit under the policy, but must return all premium payments, usually without interest. Any such determination could have a material adverse effect on the ability to collect the death benefits otherwise due.

Now, everyone is considered to have an insurable interest in their own lives, and it is assumed that the insured person would name as beneficiaries only those people who would have an interest in he or she living a long and healthy life. Business partners would also have insurable interest through a partnership (buy-sell agreement) or key-person in the company. Moreover, though state law requires that an insurable interest exist when applying for a life insurance policy, it no longer applies once the policy becomes effective with the life insurance carrier underwriting the policy. (Review the below article "100 Years of Life Settlements")

Aside from the fact that the beneficiary does not need to have an insurable interest in the insured, most insurance policies cannot be canceled by the insurance company after the policy has been in force for more than 2 years. These two aspects of life insurance are what allow for the existence of life settlements. And the truth is that life settlements can be beneficial to those who no longer want or need their policy and those looking for a good investment.

Anyone interested in selling their life insurance policy should consult with an attorney or financial advisor to ensure that the decision makes financial sense and that the terms and conditions are in their best interest.

100 Years of Life Settlements

California Broker Magazine, December 12, 2011

On December 4, 1911, the United States Supreme Court decided the case of Grigsby vs. Russell, which is considered to be the legal basis for the life settlement industry today. The decision, written by the legendary Justice Oliver Wendell Holmes, Jr., ruled that the sale of a life insurance policy, which was validly obtained by someone with insurable interest, could be legally sold to a third party without insurable interest. Read more...

GAO Study Finds that Life Settlements Deliver Almost 8 Times Surrender Value to Seniors

The U.S. Government Accountability Office recently issued a long anticipated report on the state of the emerging Life Settlement market. One of the key findings, based on analysis of over 1,000 life settlement transactions, was that seniors selling their policies in a life settlement transaction received almost 8 times as much money as they would have had they surrendered the policy to the insurance company. "This confirms what we have been saying all along, life settlements are good for consumers and result in maximizing policy value for seniors who no longer want or need their life insurance policy," said Brian Smith, President of the Life Settlement Institute. For example, proceeds of a life settlement may help a senior pay for long term care.

Using just the 1020 policies relied upon in the study means that life settlements delivered $232 million more value to seniors than they would have received from the issuing insurance company. The study shows that seniors would have received $37.4 million if they surrendered their policy but instead received over $269 million from the life settlement transactions.

The study also found that although the vast majority of states have adopted pervasive regulation of the life settlement market, some have yet to do so and differences among state laws can be significant. Smith added: "This finding also comes as no surprise to us. We have been working with state legislators and state insurance regulators to adopt consistent model legislation across the country and eliminate such discrepancies. Last year we helped get legislation enacted in several states including New York and California. However, there are 50 states and it takes time to get these initiatives passed. The National Conference of Insurance Legislators (NCOIL) Model Life Settlement Act is a very good bill and we will continue to support its adoption around the country.