The used car lot of the life insurance business. The lot where the worse shape the trade is in, the higher the trade in value. The market I’m talking about is what I believe is going to end up being the life insurance industry’s biggest black eye and possibly worse, the life settlement business.

Wikipedia defines life settlement as “A life settlement is a financial transaction in which the owner of a life insurance policy sells an unneeded policy to a third party”. On the surface it kind of sounds like a win/win proposition. On the surface it sounds like it could be a good thing for the owner of the policy and their family. On the surface it sounds like something that shouldn’t be that big a deal and shouldn’t have a negative impact on life insurance as a whole.

There are plenty of reasons to run the other way from life settlements, but let me just throw out the idea that perhaps this (life settlements) is an industry that has a dark side to it and it could very well unbalance the rest of the life insurance products to the point where life insurance will lose its’ most valuable owner asset, the tax free status of the death benefit.

This tax free status is something that is federal law put in place because of the inherent good of making families financially whole again upon the death of a loved one. That’s the purpose the government saw when it bestowed tax freedom. Those loved ones have what is known as an insurable interest in the life of the insured. Insurable interest is defined as being in a position to suffer financially upon the death of the proposed insured.

Companies care about it. Insurable interest is exactly why you can’t take out a life insurance policy on someone with whom you have no relationship. Insurable interest ceases to exist when a life insurance policy is sold in a life settlement. The purpose of the insurance is no longer to make someone whole upon a loss, but rather to enrich someone with no other interest in the insured other than investment and profit.

The government taxes profit on investment and personally I believe that it will not be long before they will tax income from life settlements. In our country’s cash strapped condition it would not take a leap of logic to just make all life insurance proceeds taxable either as income or capital gains.

Wisconsin just passed a law that throws a kink in what I see as truly the dark side of the life settlement business, the purchasing of term policies for the express purpose of reselling them after 2 years when they have outlived the contestability period. This practice is made even more dubious when you throw in premium financing. Wisconsin has now said new policies can’t be sold for 5 years after they go into force. That will blow premium financing and the quick buck mentality of a 2 year turnaround on life settlements.

There was also apparently an attempted amendment to the bill that was championed by one of the largest life settlement companies, Coventry First (almost sounds religious doesn’t it?) that would have made it a law for insurance agents to tell their customers about life settlement as a financial tool.

Bottom line. Just what we all need. A law that mandates agents to tell their clients about a product that is not in their best interest. I truly hope state insurance commissions dismantle this industry before it messes up one of the true gems of financial planning in the US, the right to own life insurance with a tax free death benefit.