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Life insurance and the secondary market

Deciding whether a policy insuring someone's life is valid depends on whether the person who pays the premium has an insurance interest in the life. There's a general rule that "strangers" cannot insure a life. This is treated as if it was a wagering contract, betting on how long someone might live. To be valid, the person taking out the policy must be acting in good faith. This usually means you are insuring your own life, the life of a member of the family, or someone in whom you have a financial interest. For these purposes, the family relationship can be by blood or based on a stable state of affairs, i.e. a couple live together for a number of years. As to financial interests, a business can insure a key employee or a movie company can insure the life of one of the stars currently filming. The test is whether a real financial loss will be incurred should the person no longer be available to continue work.

Assuming the person holding the policy has an insurable interest (always the case when you insure your own life), the policy can be traded on a secondary market. This gives a much better return than the surrender value offered by almost every insurance company. Should you be short of cash, you can "sell" the policy and have a reasonably good lump sum to deal with your immediate problems. This sale means the person who then pays the premium will be a "stranger" but this is a valid transaction so long as the creation of the policy was valid. Most valid contracts can be assigned or the benefits transferred to a third party.

So, suppose an older man takes out a policy on his own life with a big sum assured. A few years later, he trades the policy on the secondary market and gets his lump sum. If this was his plan from the beginning, his purchase of the policy was not in good faith and the insurance company can refuse to pay out. The problem is how the insurance company might prove this intention. Many people can take out a policy and then find it too expensive a few years later. The courts have tended to side with the insurance companies in any disputes, finding people misrepresented their intentions when applying for the policy. So, if you are in this situation, it may be better to struggle on a few extra years before trying to sell. If it genuinely is too much of a burden, put together a detailed financial profile showing how much disposable income was available when you took out the policy and then how much is available now. If an emergency arises like an accident requiring medical treatment, collect the evidence into a convenient file. This can be the difference between getting a good price for your life insurance policy and being refused a sale.

For the record, the courts have been particularly hostile to hedge funds and professional investors who try to buy into the market by setting up plans to allow people to insure their own lives and then sell the policies on. Life insurance companies have been very quick to take action when such plans are discovered. Do not be tempted by such schemes. You will lose all the premiums you pay.


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