The National Association of Securities Dealers issued an investor alert today to seniors about the potential pitfalls of selling their existing life insurance polices for cash in transactions known as “life settlements” or “senior settlements.”

The transaction involves selling a life insurance policy that’s no longer wanted or needed to a third party – a person or business entity other than the insurance company that issued the policy – typically for more than the policy’s cash surrender value but less than its net death benefit, the NASD explains.

“Generally, the purchasers of life insurance policies are institutions called life settlement companies or life settlement providers. They may hold the policies to maturity (that is, the death of the insured person) and collect the net death benefits, or they may resell the policies, or they may sell interests in multiple policies to hedge funds or other investors,” the NASD explains. “The investor selling his or her policy receives a lump sum payment – and the amount of that payment will depend on a range of factors including the investor’s age, health and the terms and conditions of the life insurance policy. The purchaser agrees to pay any additional premiums required to keep the policy in effect and receives the death benefit when the investor dies.”

The NASD says that the life settlement market has expanded rapidly in recent years, “because life settlements have proven profitable not only for institutional investors that purchase policies, but also for the life settlement companies and brokers handling these transactions.” It adds, “Some studies suggest the potential market exceeds US$100 billion. As a result, competition among life settlement companies has become increasingly intense, making that market prone to aggressive sales tactics and abuse.”

“Life settlements are not for everyone,” said NASD chairman and CEO Mary Schapiro. “While they can be a valuable source of liquidity for people who no longer want or need their current policies, life settlements can have high transaction costs and can have negative consequences for your financial situation. And it is very difficult to determine whether you’re getting a fair price for your policy. The best advice is to proceed with caution.”