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Death play

What Is Death Play?

Death play, more commonly known as a life settlement, refers to the sale of an existing life insurance policy to a third party for a cash payment. This financial transaction falls under the broader category of personal finance and investment. In a life settlement, the policy owner receives a lump sum that is typically greater than the policy's cash surrender value but less than its full death benefit. The purchaser of the policy becomes its new owner and beneficiary, taking over the responsibility for all future premiums and ultimately receiving the death benefit when the insured individual passes away.

History and Origin

The concept of exchanging future life insurance benefits for immediate cash can be traced back to the viatical settlement market, which emerged in the 1980s as a way for terminally ill individuals to sell their life insurance policies to cover medical expenses. As the market evolved, a broader demographic of policyholders—including those who were not terminally ill but simply no longer needed or could afford their policies—began to seek similar arrangements. This led to the development of the life settlement market. The practice gained traction as an alternative to lapsing or surrendering a policy, offering policyholders a way to unlock liquidity from an otherwise illiquid asset.

Key Takeaways

  • A death play, or life settlement, involves selling a life insurance policy to a third party.
  • The seller receives a lump sum payment, typically more than the cash surrender value but less than the death benefit.
  • The buyer assumes future premium payments and receives the death benefit upon the insured's death.
  • Life settlements offer an alternative to surrendering or lapsing a policy.
  • Factors influencing the settlement amount include the insured's age, health, and policy terms.

Formula and Calculation

While there isn't a universally applied formula for "death play" or life settlement valuations, the core principle involves determining the present value of a future death benefit, taking into account the probability of the insured's survival and the cost of future premiums.

The generalized concept involves:

( \text{Settlement Value} = \text{Present Value of Death Benefit} - \text{Present Value of Future Premiums} )

Where:

  • Present Value of Death Benefit: Calculated by discounting the face value of the death benefit back to the present, using a discount rate that reflects the investor's required return and the insured's estimated life expectancy.
  • Present Value of Future Premiums: The sum of all estimated future premium payments, discounted back to the present. This requires actuarial projections of how long premiums will need to be paid.

Actuarial science plays a crucial role in assessing the life expectancy of the insured, which is a primary determinant of the policy's value in a life settlement. Actuaries use mortality tables, such as the data provided by the Social Security Administration, to estimate remaining life spans.,,,
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19#18#17 Interpreting the Death Play

Interpreting a death play, or life settlement, primarily involves assessing the financial viability and implications for both the seller and the buyer. For the seller, the key interpretation revolves around whether the cash payment received is a fair value for relinquishing the policy and its future death benefit, especially when compared to other options like surrendering the policy for its cash surrender value.

For the buyer, typically an institutional investor or fund, the interpretation centers on the potential return on investment. This requires a careful evaluation of the insured's life expectancy (the longer the insured lives, the more premiums the investor pays, reducing the return), the ongoing cost of premiums, and the face value of the death benefit. The goal for the buyer is to acquire policies where the ultimate death benefit significantly outweighs the purchase price plus cumulative premiums paid, aiming for a profitable outcome.

Hypothetical Example

Consider an individual, Sarah, aged 75, who holds a $500,000 whole life insurance policy. Her children are grown, and she no longer feels the need for the large death benefit, especially given the increasing annual premiums of $10,000. The policy has a cash surrender value of $80,000.

Sarah decides to explore a life settlement. A life settlement provider offers her $150,000 for the policy. This offer is significantly more than the cash surrender value, providing Sarah with immediate liquidity for unexpected expenses. The investor who purchases the policy will now be responsible for paying the $10,000 annual premiums. Upon Sarah's eventual passing, the investor will receive the $500,000 death benefit. The profitability for the investor hinges on Sarah's actual life expectancy; if she lives longer than anticipated, the additional premium payments will reduce the investor's net return.

Practical Applications

Death plays, or life settlements, have several practical applications in personal finance and investment strategies:

  • Estate Planning: For individuals with significant assets, life settlements can be a tool in estate planning. By selling a policy that is no longer needed, the policyholder can reduce their potential gross estate value, which might impact future estate tax obligations.,,,
    16*15 14 13 Liquidity for Seniors: Many seniors find themselves "house rich, cash poor" or burdened by high insurance premiums. A life settlement provides a cash infusion that can be used for living expenses, healthcare costs, or to pay down debt.,
  • 12 11 Portfolio Diversification: For investors, life settlements represent an alternative asset class that can contribute to portfolio diversification. The returns from these investments are primarily driven by mortality rates, which tend to be uncorrelated with traditional financial markets. Life settlement policies are typically traded on a secondary market.,
  • 10 9 Funding Long-Term Care: Proceeds from a life settlement can be directed into specialized accounts to fund long-term care needs, such as nursing homes or in-home care, providing a valuable financial resource in later life.

##8 Limitations and Criticisms

While life settlements offer benefits, they also come with limitations and criticisms that potential sellers and investors should consider.

One significant limitation for sellers is the potential for receiving less than the fair market value of their policy due to a lack of transparency in the life settlement market. The process can be complex, and it is crucial for sellers to work with a reputable financial advisor to understand all implications.

For investors, life settlements carry considerable risk tolerance. The primary risk is longevity risk: if the insured lives longer than their projected life expectancy, the investor will incur more premiums than anticipated, which can significantly reduce or even eliminate their return on investment. The Securities and Exchange Commission (SEC) has issued investor alerts warning about the risks associated with investing in life settlements, highlighting concerns such as potential fraud, misrepresentations about guaranteed returns, and the illiquidity of these investments.,,,,7 6A5d4d3itionally, the actual returns can be unpredictable, making them unsuitable for investors seeking short-term gains or high liquidity.

##2 Death Play vs. Viatical Settlement

While often used interchangeably, "death play" (or life settlement) and viatical settlement have a key distinction. Both involve selling an existing life insurance policy to a third party for a cash sum. However, a viatical settlement specifically refers to the sale of a life insurance policy by an insured individual who is terminally or chronically ill and has a shortened life expectancy, typically two years or less. The primary motivation for a viatical settlement is often to cover significant medical expenses or to improve the quality of life during a terminal illness.

In contrast, a death play, or life settlement, generally involves policyholders who are typically seniors, but are not necessarily terminally ill. Their motivations might include no longer needing the coverage, being unable to afford the premiums, or simply wishing to access the policy's value for other financial needs. The cash surrender value for both is less than the payout received from a settlement. While a viatical settlement focuses on immediate need due to severe illness, a life settlement is a broader financial transaction for various situations.

FAQs

Who typically buys life insurance policies in a death play?

Policies in a death play are typically purchased by institutional investors, such as hedge funds, pension funds, or specialized life settlement companies. These entities acquire policies as investments, aiming to profit from the death benefit when the insured passes away.

Is a death play taxable?

The tax implications of a life settlement for the seller can be complex and depend on various factors, including the policy's cash surrender value and the premiums paid. Generally, the portion of the payout that exceeds the cost basis (premiums paid) may be subject to income tax. It is essential for sellers to consult with a tax professional regarding their specific situation.

What happens if the insured lives longer than expected after a death play?

If the insured lives longer than their initial life expectancy projection, the investor who purchased the policy will have to pay premiums for a longer period. This increases the total cost of the investment for the buyer and can reduce their overall return on investment. In some cases, it may even lead to a financial loss for the investor.

Are death plays regulated?

The regulation of life settlements varies by state and whether the transaction is deemed a security. Many states have specific regulations governing life settlement providers and brokers to protect consumers. Additionally, if life settlements are structured as securities, they may fall under the oversight of federal bodies like the Securities and Exchange Commission (SEC), which has issued guidance and warnings to investors.

##1# Can anyone sell their life insurance policy in a death play?

Not all life insurance policies qualify for a life settlement, and not everyone is an ideal candidate. Typically, policies with a higher death benefit (often over $100,000) and insureds over a certain age (e.g., 65 or older) or who have experienced a change in health are more likely to qualify. The decision to enter a life settlement should be made in consultation with a financial advisor who can assess the policyholder's individual circumstances and alternatives.