How Coventry First Threatens Life Insurance's Tax Exemption

Today's WSJ has a very good article on the fast-growing secondary market in life insurance policies, centering on the asset class's undisputed leader, Coventry. It mentions that this market is objected to by the life insurance industry:

Life settlements also threaten the business model for life insurers. Each year, about 6% of life-insurance policies lapse, according to the Insurance Information Institute, a trade group, as people forget about them or decide they don't need them anymore. Coventry and its rivals raise the prospect that fewer policies will be abandoned, leaving insurers to pay out more in death benefits. Meanwhile, insurers already pay an often-small sum to policyholders who cancel coverage, but they may have to find a way to pay more to compete with life-settlement firms' payouts. "That would drive the premiums through the roof," says MetLife's chief executive, Rob Henrikson.

Left unmentioned is the elephant in the room – something neither Coventry nor the life insurers really wants to talk about – which is that life insurance depends for its very existence on being one big tax dodge. All the money invested by a life insurance company is exempt from taxation. As wikipedia says, "for this reason, insurance policies can be a legal and legitimate tax shelter wherein savings can increase without taxation until the owner withdraws the money from the policy".

If life insurance policies become tradeable assets, however, rather than simply protection for surviving family members, then the case for their tax-exempt status weakens significantly. And losing that would truly devastate the life-insurance industry.