I was talking to a CPA that asked if I had ever seen a "life settlement" strategy used in a pension plan. I'm actually unfamiliar with that technique with life insurance, but as I understand it, after a policy has passed it's contestability period, the owner of the policy has the ability to sell the policy to someone else. The owner receives a larger than expected amount for selling the policy, and the third party collects on the death benefit at the insured's demise.

Does anyone have any idea how this works or would work or would be forbidden in a defined benefit plan?

Thanks!

Honestly I know next to nothing about it, so I'm really tossing out a random thought or two. This sounds like a proposed sale to a "viatical" settlement company. I wouldn't dream of attempting to explain the ins and outs, because I don't know them, but it does seem to me that these are apparently under increasing scrutiny by the IRS, at least in a non-qualified arena. I recently read a blurb about a Wuliger (sp?) case and whether or not there was a valid insurable interest where the policy was entered into with the apparently sole intention of a subsequent resale. Subject is way out of my limited area of knowledge, so I'll back out and leave further discussion to anyone who actually knows something about it!!

There is a difference between viatical settlements (where the insured has a terminal condition and chooses to sell the policy) and life settlements. The organization whose members engage in this practice is called the Life Insurance Settlement Association LISA.
I see no problems if an executive who has an insurance policy provided through the qualified plan takes a distribution and does not choose to receive the policy as an asset. The plan may then choose to retain the policy until the executive dies, surrender the policy or sell it to a life settlement fund without concerns with ERISA.
The insurable interest requirement is apparently satisfied with respect to executives, but not for rank and file employees. The trustee, therefore, upon the retirement or severance of a non-executive, should cancel or surrender the policy. (See the WalMart from about 4 years ago.)

Several questions arise if a qualified plan decides to purchase such contracts. Is the investment prudent? Are there legal risks as well as economic? Does paying for the right give the plan an insurable interest? Is the investment sufficiently liquid if the insured lives another 40 years?
There are life settlement funds which are registered as securities and operate like mutual funds, i.e., provide liquidity. However, the groups that purchase the policies and bundle them together into such a fund usually take most of the profit out of the transaction, leaving the investor with another mediocre investment.