Cover for sale

A recent court judgement might help investors buy out somebody else's life insurance policy and reap rich dividends.

There’s a new entrant in the world of tradable instruments—your life. Following a recent Bombay High Court ruling, life insurance policies can be traded and assigned freely. Simply put, the protection on your life can now serve as investment for the buyer.

Until now, the beneficiaries of a life insurance policy were its nominees. Except in cases where a policyholder borrowed against it. Often in such cases the lender would ask the policy to be assigned to them as collateral. Tradable insurance policy (TIP) is one step ahead of the same concept. Here, the investor does not take out a policy on his own life but reaps rewards by buying an existing policy. On procuring a TIP, the insurance company is notified of the change in ownership, and a copy of the legal assignment is registered to protect the new owner’s rights.

For high net worth individuals (HNIs) looking for safe, high-return investment opportunities amid falling interest rates, TIP is the new buzzword. Though the life cover remains in the name of the original policyolder, the benefits (both tax exemption on premiums as well as the maturity benefit) accrue to the person to whom the policy is assigned. Moreover, that insurance policy proceeds are tax free under Section 10(10D) makes them tax efficient in the long run.

While this move will place perhaps the most illiquid asset (insurance) in the same bracket as shares and mutual funds, not everybody is happy. Says Gaurav Mashruwala, a certified financial planner: “It’s a discomforting suggestion, and lives will be traded like commodities. All one has to pay is a consideration to an existing policyholder to revive his policy, and even pay the past premiums to get it assigned to them.” This worked well for all those high-yielding assured return schemes that LIC doled through the 1990s.

On one condition though—the buyer must have an insurable interest in the life of the person whose policy he is buying. When one buys insurance on own life, it is assumed to have an insurable interest. Says Swami Saran Sharma, risk management expert; “If you want to buy a life insurance policy on someone else’s life you must have an interest in that person remaining alive, or expect emotional or financial loss from that person’s death.”

Typically, insurable interest is established when there exists a sufficiently strong relationship with the insured person based on blood, marriage, or monetary interest. Husband-wife, parent-child, grandparent- grandchild and sibling relationships are frequently considered sufficient for establishing an insurable interest.

Certain relationships founded on monetary interests can also create insurable interests. “For example, a creditor is considered to have an insurable interest in a debtor’s life. Even though death doesn’t extinguish the debtor's obligation to repay a loan, the creditor faces potential harm if the debtor’s estate cannot repay the loan,” explains Sharma. There are other examples that include the relationship between a business and a key employee, or that among partners in a closely held corporation.

a closely held corporation. The insurable interest requirement prevents people from buying a life insurance policy on someone and then causing or hastening that person’s death. Without this requirement, it would be very easy to make a living by purchasing life insurance policies on elderly strangers and then collecting the proceeds when they died.

But, there is a hole in this argument. According to the court ruling insurable interest does not have to be proved at the time of the insured person’s death. Insurers insist on the need for insurable interest at the time one enters into the life insurance contract, not at the time of the loss or harm.

Changes would be required in the Insurance Act, Property Act and Income Tax Act to make the ruling effective. A lot will depend on the stance India’s biggest insurer Life Insurance Corporation of India takes. In 2004 it was vocal to suggest trading in insurance policies, especially if that enabled opening of policies that had lapsed

While the US and the UK have a system that allows insurance policies being traded, in India social repercussions of the rule have to be considered. There are chances that this opportunity will be exploited by many who might insure the gullible and ignorant for extracting benefits at the expense of the insurers’ lives.

The real picture will only emerge when the ruling is brought to practise. However, retaining your life insurance policies may be a good idea. They might translate into returns in this lifetime.