Apr 28, 2008

Who Knew? Stranger-Owned Life Insurance Scams

estpl042908.JPGIf you, or anyone you know, has been approached by someone offering to buy them a life insurance policy and promising a risk-free way to earn some serious cash, be cautious. From the same folks who brought you risky mortgages that you couldn't afford and packaged them as 'no-risk' securities on Wall Street now comes stranger-owned life insurance: a way for third party investors to package life insurance policies into securities, promising a high yield with 'no risks'. Yeah, right. Here's how it works: A promoter will offer an elderly, wealthy person a fairly surprising deal: The older person agrees to purchase a $10 million life insurance policy, and the promoter lends them the money to pay the premiums for two years. They'll even throw in cash up front for the hassle of applying and going through a medical exam. The insured pays nothing during that time, not even interest. If they die during that time, their family gets the death benefit, minus the cost of the loan. If they don't die at the end of two years, they can keep the policy and pay back the loan plus interest. Or, they can sell the policy and use the money to pay back the loan, or transfer it to the lender and pay nothing. What's wrong with this picture? Lots. As the Music Man said, "We've got trouble, right here in River City." Grandpa's not breaking the law by agreeing to do this, but the promoters are aggressively pushing the boundaries of acceptable insurance practice and policy. They're betting that Grandpa won't agree to continue that policy after two years but will instead allow them to become the owners of the policy on his life. That's a pretty good bet, since Grandpa wasn't even thinking of buying that policy until the promoter came to town! If they pay Grandpa $500,000 up front for the hassle of going through the application process and taking that medical exam, and he doesn't choose to own it after two years, they know that when he dies, they'll collect the $10 million -- which is a great return on investment, even after the up front cash payment and the tax they'll owe on the payout. But, let's face it, life insurance isn't supposed to be packaged into investments and sold to strangers. It gets special tax treatment (it builds up value tax free and payouts are not taxed as income or capital gains) because it's supposed to protect families after a death. It's supposed to be about widows and orphans, not hedge funds and investments pools. You aren't allowed to buy life insurance on people you don't know or have no economic interest in insuring. But, here's the really clever/evil part of this scam: after a policy's been owned for two years, the insurance company can't do anything about a stranger owning the policy. That's why the promoters are willing to pay Grandpa up front to buy a policy he doesn't even want! It might not even work out so well for Grandpa: Buying the policy and selling it after two years could mean that he can't buy insurance coverage in the future. He might take a tax hit on the accrued interest he didn't pay for the two years; he might be taxed on the cash advance up front. The life insurance industry doesn't like this scheme either. They're worried that if Congress realizes that life insurance policies are really just investments, Congress will start taxing them that way, and they'll lose their special tax-favored status. If that happens, life insurance will probably become more expensive, and we'll all lose one of the all-time best estate planning tools for protecting our families at a reasonable cost. If scams like this transform the insurance industry in the same way that the mortgage industry was transformed, the whole industry could implode faster than a Las Vegas neighborhood emptied by foreclosures.

To learn more about common types of fraud committed again elders, see Long-Term Care, by Joseph Matthews (Nolo).