What is a Life Settlement?
Imagine you have a life insurance policy that you want to cash out on early. This is how a life settlement process works.
A life settlement is the sale of a life insurance policy by its owner to a third party. The seller receives a cash payment that is greater than the cash surrender value of the policy but less than its death benefit. The buyer assumes payments of future premiums and receives the policy’s death benefit when the insured person dies.
Key Terms to Know
The stated dollar value of the life insurance policy, an amount that equals the policy’s death benefit.
The payment the beneficiary of a life insurance policy receives upon the death of the insured person.
Cash surrender value
The amount the insurance company pays a policy owner who voluntarily cancels, or surrenders, the policy. The cash surrender value is usually determined by subtracting a fee for the insurance company’s administrative costs from the policy’s current cash value, a figure that equals the policyholder’s accumulated premium payments plus any investment growth.
A type of financial arrangement available exclusively to life insurance policyholders with a chronic or terminal illness. It allows the policy owner to exchange an asset that is no longer useful for needed cash. The seller of the policy receives a cash amount that is less than the policy’s face value, while the buyer will receive the full death benefit when the insured person dies.
Why Sell Your Life Insurance Policy?
Maybe you’re a retiree who’s feeling overwhelmed by ongoing healthcare costs or a sudden financial emergency.
Perhaps you’re facing a serious or even terminal illness, so having money to cover your medical expenses and enhance the quality of your life is more useful to you and your family than a life insurance policy. Or maybe it’s just that your retirement living expenses have squeezed your budget, and you can no longer afford to keep up your life insurance premiums.
For any of these or other reasons, a life settlement may be an option worth considering. To decide whether a life settlement is a good idea for your situation, consider the potential benefits, drawbacks and financial risks.
Advantages of a Life Settlement
Selling your life insurance policy can offer many financial benefits.
It provides a higher cash payout than you would receive by simply canceling the policy in exchange for its cash surrender value. It takes away the burden of paying premiums on a policy you can no longer afford.
The money you gain from selling your life insurance policy can provide you with more funds for retirement or long-term care, more options when choosing doctors and healthcare facilities, and more opportunities to invest in assets that perform better at generating income.
Disadvantages and Risks of a Life Settlement
While the potential advantages of a life settlement are substantial, it’s not the right choice for everyone. Making an informed decision means being aware of the possible disadvantages. With most types of life settlements, perhaps the biggest drawback is that your life insurance policy’s beneficiaries won’t receive any money from policy after your death. A retained death benefit, however, will allow you to keep a portion of the death benefit for your original beneficiaries. Regardless, if you think your loved ones will need this money for their financial security, it might make sense to consider all the alternatives for generating cash for your current needs.
If you are enrolled or planning to enroll in Medicaid, the payment you get from the sale of your life insurance policy may put you over the program’s asset limit. To remain eligible for Medicaid, you would have to spend down some of your assets, such as by using the money for medical bills, home modifications and other items that don’t count toward your asset threshold.
If you have delinquent debt, your creditors may have a claim on the proceeds from the sale. You also should consider the tax implications, since Uncle Sam will likely claim a portion of that income as well.
Finally, the fees and taxes associated with life settlements constitute financial risks that can potentially reduce the rewards you gain from selling your policy. Transaction costs may include a broker’s commission and a provider’s fee. The proceeds from the sale of a life insurance policy are taxable in most cases, so that’s another likely expense that will affect your net gain. The good news is that life settlements are taxed as ordinary income rather than at the higher rate for capital gains.
Life Settlement Eligibility
You must be at least 65 to be eligible for a life settlement, and some life settlement companies require you to either be age 70 or older or have a severe medical condition. Along with your age, your life expectancy and health status factor greatly into whether your policy is likely to attract a buyer in the life settlements market. The shorter the insured person’s projected life span, the fewer premiums the buyer will pay after taking over your policy and, frankly, the less time they expect to wait to collect its death benefit.
The type of life insurance policy you have matters, too. You qualify if you hold a permanent whole or universal policy, or a variable or term policy than can be converted to permanent. In addition, a second-to-die policy -- which is usually held by a married couple and issues payments to beneficiaries only after the death of the last surviving person named as co-owner -- is eligible for a life settlement. Both group and individual policies that are either permanent or convertible qualify for life settlements.
The other major eligibility factor is how much your life insurance policy is worth. To be a candidate for a life settlement, your policy must have a market value that is greater than its cash surrender value – the amount you would be entitled to receive upon canceling the policy. Some life settlement companies set a specific dollar minimum for the policy’s value.
Why sell your Life Insurance?
The Structure of a Life Settlement
Life settlements are structured similarly to other types of insurance. For example, if you’re looking for home, health or auto insurance, you’re likely to come across both providers and brokers. Providers spend most of their time and money on advertising. They typically run large consumer response centers or divisions devoted to customer needs.
The Part Providers Play
A life settlement provider is a third-party company or investor that purchases life insurance policies from policyholders.
In basic terms, a life settlement provider is the entity that actually purchases the life insurance policy and provides a payment to the policyholder. It's important to note that all life settlement providers must be licensed by the Department of Insurance to facilitate the transfer of a policy, so make sure a provider is legitimate before working with them. Although individuals can work with providers directly, it is not typically recommended because doing so involves an excessive amount of legal paperwork and the policyholder may not receive the most money for their policy.
Instead, it's recommended to work with a broker who will shop the policy to multiple providers, or even better — a life settlement company such as Harbor Life who will handle all the paperwork and use their connections with brokers and providers to maximize a policy's potential value.
Brokers, on the other hand, take a much more personal approach to insurance. Instead of working for a specific company like a provider, they work for you.
Their hours are flexible, and they’ll offer multiple options that fit your needs and your budget. You’ll also likely speak to the same agent each time you initiate a call. Brokers work to negotiate life settlement contracts, ensuring you gain access to the best offers from providers for their policies. Unlike providers, brokers get paid a commission off of the purchase price so it is their best interest to get you the highest offer possible.
Brokers will shop the policy around to ensure the offers are stable, private, and provide you with a fair amount of money once commissions are taken. It is a broker’s job to maximize the price someone gets for selling their policy which is why it can be better to go with a broker than direct to a fund.
Life Insurance Settlement Options
In the traditional version of a life settlement, the buyer assumes full ownership of your policy. They take over the payment of any remaining premiums and receive the policy’s full death benefit upon the death of the person insured by the policy.
A viatical settlement is a life insurance policy sale designed to allow someone with a life-threatening or terminal illness to quickly get the money they need to cover medical expenses and make the best of whatever time they have left. If you’re facing this situation, it may make sense to sell your life insurance policy for a lump sum of cash to address your immediate needs. Unlike with traditional life settlements, there is no minimum age requirement for a viatical settlement, and most are not subject to federal income tax.
Retained Death Benefit
In this type of life settlement, the investor assumes the payment of your life insurance premiums but doesn’t pay you any cash directly. A portion of your policy’s death benefit will go to the investor, while the remaining portion is retained for your original beneficiaries.
Life Settlement Process
Several parties are involved in the transaction of a life settlement, starting with you, the policy owner.
The person who holds the life insurance policy and has the legal right to sell it and transfer its ownership to another. The policy owner may or may not be the same as the person who is insured by the policy.
The insurance agents or financial advisors who may provide you with access to a life settlement by connecting you to a life settlement company or broker.
Life Settlement Brokers
Individuals or firms who solicit bids on your life insurance policy from multiple buyers, negotiate the life settlement contract and receive a commission for their service.
Life Expectancy Underwriters
The experts who calculate your life expectancy by reviewing your medical history and other personal characteristics and comparing them to the average figures for a group with similar traits.
Life Settlement Providers
Third-party companies or individual investors that make bids on and purchase life insurance policies and are licensed by the Department of Insurance in the states where they operate. Put simply, life settlement providers are the buyers of life insurance policies.
Individuals and groups who purchase life insurance policies as financial assets.
Life Settlement Companies
Businesses that connect policy owners to life settlement brokers and guide them through most of the life settlement process. A life settlement company, such as Harbor Life, will underwrite your policy and present it to brokers, who in turn send any offers they receive to the life settlement company.
Life Settlement Transaction Steps
The process of executing a life settlement begins when you complete an application that includes detailed information about your life insurance policy.
Along with your application form, you will furnish the life settlement company with your medical records or a list of health care providers who can supply them.
The life settlement company reviews your application and sends your medical records to an independent life expectancy underwriter for an assessment to help determine how much your policy is worth.
Once your application and medical records have been reviewed, your policy will be matched with potential life settlement providers, with the goal of finding you the best price for your policy.
After analyzing the value of your life insurance policy and determining it to be a good investment, a life settlement provider will make an offer. You then have the right to either accept or decline the offer.
If you accept the purchase offer, the life settlement provider will assemble a package of documents that includes a purchase and sale agreement. You and your originally designated beneficiaries will sign the documents, which the life settlement provider will co-sign.
The life insurance carrier receives written notice that the life settlement provider is now the owner and beneficiary of the policy.
After receiving written verification of the policy’s change in ownership and beneficiary, the escrow agent – which holds the settlement payment in trust until the sale is finalized – releases the money to you.
How to Calculate the Value of a Policy
Whether the settlement provider offers to purchase your life insurance policy, and how much they offer, will depend on an assessment of its value.
To conduct a valuation, they will look at your life expectancy, the total amount of the expected future premiums and the amount of the policy’s death benefit. Tallying up those elements yourself will give you some idea of what the policy might be worth to an investor.
How are Life Settlements Taxed?
If you sell your life insurance policy, you will owe taxes on the difference between the payment you receive from the buyer and the total amount you’ve paid in insurance premiums. Any additional value to the policy that is not accounted for by your monthly premiums will also be taxed. Again, the money will be taxed as ordinary income, not as capital gains.
History of Life Settlements
Three historical events played pivotal roles in the creation and growth of the life settlements industry.
Grigsby v. Russell
This 1911 U.S. Supreme Court decision established the legal precedent for life settlements. Dr. A. H. Grigsby was a surgeon whose patient, John C. Burchard, needed money for an operation. To free up the cash, Burchard sold Grigsby his life insurance policy in exchange for $100 and an agreement that Grigsby would pay the policy’s remaining premiums. But when Burchard died a year later and Grigsby attempted to collect the death benefit, the executor of Burchard’s estate went to court and got the payment stopped. The case was appealed all the way to the U.S. Supreme Court, where Justice Oliver Wendell Holmes, Jr. delivered the deciding opinion in which Grigsby prevailed. Holmes said life insurance policies were like any other type of personal property that the owner had the right to sell at will. The court’s decision set the legal foundation for the later development of the life settlements industry.
Birth of Viatical Settlements
It was the U.S. AIDS epidemic in the 1980s that really provided the push for the life settlements industry to emerge. The crisis led to the creation of the first viatical settlements, arrangements in which terminally ill patients – in this case AIDS patients with extremely short life expectancies -- sell their life insurance policies for a lump sum of cash. Viatical settlements became less common as medical advancements began to improve the outlook for people living with AIDS and other serious illnesses. But the concept of selling life insurance policies for cash expanded to include those without either terminal or chronical illnesses who are age 65 or older. These more widely available transactions came to be known as life settlements.
Health Insurance Portability and Accountability Act (HIPAA)
Congressed passed the Health Insurance Portability and Accountability Act in 1996 and then-President Bill Clinton signed it into law. HIPAA gave insurance policyholders and beneficiaries the right to transfer ownership and/or beneficial interest to a third party. The law thus made the legal standing of life settlements even stronger than before.
Life Settlement Laws & Regulations
Most U.S. states, along with the territory of Puerto Rico, have enacted regulations of life settlements. State departments of insurance are typically in charge of enforcing those rules. In each state where regulations exist, a waiting period of two to five years is mandated before a life insurance policy owner may sell it. Most of those states also grant exceptions to the waiting period in some circumstances, such as terminal or chronic illness, divorce, retirement, the death of a spouse and physical or mental disability.
There also are state laws in place requiring transparency throughout the life settlement process. Anyone who received compensation for their role in the transaction must disclose the amount and the method of calculating their fee, while life settlement providers must disclose all offers, counter offers and rejections when a policy purchase is considered. State laws governing life settlements also typically require the disclosure of the fact that the proceeds of the sale are taxable and may be subject to creditors’ claims.
In most states, before any transaction begins, life settlement companies and brokers must provide the policy owner with information about the risks involved in making life settlements, the licensing of brokers and providers, and available alternatives to life settlements.
What Makes Harbor Life Settlements Different?
If you’re exploring the possibility of selling your life insurance policy, consider the advantages of choosing Harbor Life as your life settlement company.
– Harbor Life will provide you with a free estimate of your policy’s value.
– Harbor Life offers up to 60% of your policy value in cash, with no hidden fees and payouts, within weeks of approval.
– Harbor life will buy your policy in as little as 10 days, while other life settlement companies can take as long as six to nine months.