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Life Settlement legislation backfires in some states
Life settlement legislation is first and foremost supposed to protect seniors and those selling their policies. States establish life settlement legislation that does this through licensing, disclosure mandates and transparency requirements. In general the primary goal of most new state legislation is to ensure that seniors have all of the necessary facts to make the wisest financial decisions. In addition, new life settlement legislation prohibits fraud, STOLI's and other unsavory elements of the life settlement landscape. Some states have gone as far as to say how life settlement brokers are compensated. Meaning life settlement brokers must be paid as a percentage of the settlement amount rather than the policy face amount of death benefit. The thought is that this will be provide a life settlement broker with more incentive t negotiate a higher settlement on behalf of their clients. All in all, most new state legislation makes sense and is well received by consumers and the life settlement industry alike.
However, Vermont recently passed new legislation that aimed to protect consumers but ended up taking away choice and options. Vermont's new law limits a life settlement broker's commission to 2% of the negotiated settlement amount. Unfortunately, this has crippled the life settlement industry in that state. As a result, Vermont seniors don't have access to a much needed financial option that they previously did. The arbitrary limit on commissions makes the economics unfeasible to act as a life settlement broker.
Let's look at the math behind a hypothetical transaction. I am using round numbers for the settlement amount, but it will illustrate the point nonetheless. For example, let's say a senior has a $100,000 life insurance policy that they agree to sell for $50,000 to a life settlement provider. That means the life settlement broker would be entitled to a $1,000 commission. Most people would hear that figure and think $1,000 sounds like a lot money that should make anyone happy right? Not exactly as good as it sounds when you examine the economics. The insured must have medical records as part of the process. Most often, the life settlement broker requests that information and pays the expense. This can range anywhere from $40 to $250, depending upon to the medical facility or copy service supplying the records. Lets say $150 to be fair. If the policy is being shopped to a wide variety of providers, which it should be to ensure the highest settlement possible, the insured will require 2 life expectancy certificates. Each life expectancy certificate is approximately $300. The subtotal is now up to $750. So the net commission or gross profit in this example is down to $250. I will grant most people that $250 is better than nothing, but the expenses above are far from complete.
First, the costs above are assumed by a life settlement broker whether or not the policy is sold. So a life settlement broker must put out the $750 each time. Sometimes the policy will sell and they will collect a commission, while other times the broker will expend time, money and effort and get nothing. So the $250 gross profit I mentioned above must also cover the expenses for every case they work on that doesn't result in a sale or commission. That $250 is starting to look bad now.
Then you have overhead. This is a little skewed since we are talking about Vermont, but most life settlement brokers are licensed in many states. Thus, they have licensing expenses in those states. In Texas, it is $750 just to register your out of state corporation to do business there. Then several hundred of dollars more for the life settlement broker's license. Plus, life settlement brokers have to pay for all of the other normal business expenses, telephone, fax, insurance, rent, salaries, etc.. Now that $250 is looking downright scary.
The average life insurance policy size in the USA is aprox. $370,000. So lets use that amount and assume a $100,000 settlement. In that case, the life settlement broker would receive a $2,000 commission. The broker still has all of the expenses as before, but there is still a risk that after several weeks or even months of working on a case, they will receive no commission at all. Most businesses might decide that the reward of operating in that type of environment is not worth the risk. In fact, that is what has happened in Vermont. Some reports say at least 1/2 of the brokers have stopped doing business in Vermont. If you do the math, the larger policies may still be economically viable, but there again you have the risk of expending money with no return. If life settlement brokers are forced to cherry pick the high dollar policies, what is that saying? High dollar policies are owned by high net worth people or businesses. Since life insurers are diligent about only insuring someone for an amount that is in line with an insurable interest. Makes sense right? So what then happens to the average senior that doesn't have a high dollar policy. Maybe they have a $100,000 to $1,000,000 policy. One where the broker is scared the reward isn't worth the risk? Unfortunately, economics of the Vermont law set up a de facto divide in accessibility and options to the average senior. The law takes away a choice or financial planning strategy from the senior with an average size policy. While at the same time, ensuring the rich or high net worth people have options that everyone else doesn't. I am not blaming high net worth individuals. I am saying that everyone should have the same access to the financial strategies they employ and the state shouldn't arbitrarily try limit the free market. Every time the government tries to manage the economics of an industry, someone usually gets the short end of the stick. In this case, it is those that least deserve it, the seniors.