In insurance industry lingo, whole life,universal life and variable life policies are known as "permanent" policies. As opposed to term insurance, permanent policies are meant to stay in force for the lifetime of the insured individual.

But that's not always the case. In fact, that's often not the case. Policies purchased to fund buy-sell agreements become superfluous when the company is acquired or dissolved. Policies designed to provide estate liquidity might be deemed unnecessary as the federal estate tax exemption increases. And policies bought for family protection may seem pointless after the kids are grown and ample net worth has been accumulated.

For these and other reasons, financial planning clients may no longer want to pay premiums for life insurance, permanent as well as term. Traditional options for such clients include stopping premium payments or surrendering the policy to receive any cash value. Alternatively, clients with philanthropic intentions might donate the policy to charity, a tactic that offers tax advantages.

Life-Size Sales

Recently, yet another path to liquidity has opened: life settlements, the sale of existing policies to investors who pay the ongoing premiums, change the beneficiary designation and collect the proceeds at the death of the insured individual. The investment result is assured; the actual return is just a matter of time. "In 2007, between $12 billion and $15 billion worth of existing life insurance policies were sold," says Doug Head, executive director of the Life Insurance Settlement Association (LISA) in Orlando, Fla. "That figure is the face value of the insurance—the death benefits those policies will pay."

Admitting that his numbers are approximate, based on extrapolation from LISA members' reports, Head estimates that as much as $5 billion was paid for those policies. In many cases, he contends, sellers walk away with more cash than they'd receive from surrendering the policy, especially if they have medical conditions that shorten their life expectancy.

While many life settlements involve unwanted policies, sellers may have other motivations. "Some policies are sold so they can be replaced by newer, better policies," notes Lee Slavutin of Stern Slavutin-2, a life insurance agency in New York. In recent years, Slavutin reports, superior life insurance policies have emerged. "The two main reasons are improved life expectancy and changes in policy design," he says. "I've had clients sell their policies and put the cash they receive into a new policy. They've wound up with comparable coverage and much lower premium payments."

Eager sellers, in turn, have attracted buyers. Some major firms have entered the life settlements area on the investment side; for example, Goldman Sachs (45%), National Financial Partners (45%) and Genworth Financial (10%) have formed a joint venture, Institutional Life Services, which they describe as an investment marketplace for existing life insurance policies.

Stranger Danger

Enthusiasm over life settlements is far from universal, however. The business is rife with scams, and many clients will be turned off by the idea. Some life settlements involve STOLI, an acronym that stands for "stranger-originated life insurance." In these deals, someone applies for insurance on his or her own life with the intent of selling it and pocketing the profits.

Reportedly, about two dozen states have passed or are in the process of considering bills that would regulate STOLI. There might be a five-year wait before a policy can be sold, especially if the policy's initial payments were provided or arranged by the buyer.

Now, the adverse effects of STOLI might not be immediately apparent. Why shouldn't diabetic septuagenarian John Smith make a few thousand dollars simply by applying for a life-insurance policy and then selling it to a hedge fund? STOLI opponents mention the taxes that John might have to pay and his diminished ability to buy life insurance for his own purposes. But those issues may not be the real reasons STOLI stirs up such hostility.

"STOLI is an unsavory application of life insurance," says Steve Weisbart, vice president and chief economist at the Insurance Information Institute in New York. "Selling a policy for a quick financial gain to a buyer who is speculating on human life is an inappropriate use of a valuable product."

Among life insurers, there are fears that STOLI could damage the industry's reputation and lead to unwanted regulation; possible loss of tax benefits has been mentioned. Life settlement companies may also oppose STOLI (LISA, has come out strongly against the practice) for fear that anti-STOLI legislation could restrict what might be regarded as legitimate sales of existing policies.