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A Cheat Sheet to Knowing Everything About Life Settlements

Friday, August 3, 2018

Life insurance offers a number of benefits, and this includes life settlements. While a life settlement can prove to be a convenient financial aid, lots of people don’t know much about it or how it works. A life settlement can help you survive after your retirement. The terms and conditions and the process involved in setting up life settlements may seem a bit complicated at first. However, once you are familiarized with the details you need, it’s easier to understand already. Here’s everything you need to know about life settlements.

What is a Life Settlement?

A life settlement is the sale of an existing life insurance policy to a third party for whatever reason you may have. When you sell your life insurance, you will get the compensation that is lesser than the death benefit. As a person sells life insurance to a third party, the investor starts making further annual premium payments for the seller’s life insurance. When the seller passes away, the investor gets the death benefit of the policy.

Why Opt for a Life Settlement?

It might come to you as a shock that about 88 percent of universal life insurances stay unclaimed. As a result, whatever money you have been paying annually doesn’t fetch you or the beneficiary any profit. At the end of the day, what you consider as your asset becomes the asset of the insurance company. This is why at some point, a lot of people who previously invested in life insurance decide to go for a life settlement.

 Life insurance is somehow a form of investment. However, it cannot be liquidated. However, life settlements have a liquidity characteristic as well. Life settlements can be converted into cash for the insured individuals.

 A lot of people struggle to keep up with the expense of premium payment. This is one of the cases wherein a life settlement can be a good option. Besides this, there are also people who would opt for a life settlement and get cash in exchange for their life insurance when they want to take care of a debt.

Viatical Settlement vs Life Settlement

Many might have come across the term ‘viatical settlement’ and confuse it with life settlements. The only similarity between these two settlements is that the insured sells his/her policy to a third party in both cases. However, an insured is only eligible for a viatical settlement if he/she is terminally ill and has a life expectancy of two to four years left. Viatical settlement companies can give you more information about viatical settlements. Having said this, it is essential to know which kind of settlement is appropriate for you.

 While these are the key reasons why life settlement should or can be opted, there still are conditions as to when you would qualify for an exchange. We will be discussing this as well later in this article.

Who Buys Your Life Insurance?

When we talk about selling a person’s life insurance, there’s one thing you should know. You won’t find any fancy advertisements or massive hoardings screaming about their services. However, there are two distinct kinds of over-the-counter life settlement professionals that operate here - brokers and providers. Let’s take a look at who they are and the key differences between both.

Life Settlement Providers

Life settlement providers are the licensed parties or companies that purchase life insurances. A life settlement provider can either be the investor or seller of the policy to another party (given that they have the needed license). Since providers are licensed professionals, they hold expertise in analyzing your life insurance policy, along with other factors, like your life expectancy, interest rate, etc.

Life Settlement Brokers

A life settlement broker is a mediator between the policy owner and buyer. The broker represents the policy owner. What a broker does is to collect all the information pertaining to the policy and the policy holder’s health. Using the gathered info, the broker will then proceed to look for a buyer. The buyer can also be a life settlement providing company. However, a broker negotiates for you at a price. Typically, this would range anywhere between 25-35 percent of the value of the insurance. However, nowadays, brokers demand a lot more than 30 percent. This could eat up your profit.

 If you look for a broker, make sure that your chosen broker charges what he is supposed to and holds an authentic license for your state. Besides that, also make sure to have a written agreement stating that the broker would keep the information confidential.

Providers or Brokers?

 Whether you choose a broker or a provider, there’s always going to be a person who will collect information. While brokers charge a hefty amount for the same job, it's inclusive of the services provided by a life settlement provider. Plus, life settlement companies are more reliable. At the end of each year, these companies have to report the purchases they make. So, they keep consistent pricing for their clients.

 Most Common Concerns of Clients

For years, people have been quite doubtful on whether or not life settlement is a reliable alternative. As more and more information is provided everywhere about life settlements, the perception has changed. However, some people who want a life settlement still have some concerns. We’ve listed three of the most common concerns of clients and how to deal with them.

   1. Being Overcharged

 Life settlements are supposed to come as a relief when you sell your life insurance for any reason. However, one of the biggest reasons why people do not find life settlements to be a wise alternative is for what is deducted as the broker’s commission. 

When you seek a broker’s services, many of them will charge an unreasonably high amount of commission. Some even charge half of what your life settlement would cost. This has spoilt the reputation of the life settlement industry for most people. This is precisely why the best way to liquidate your life insurance to cash is with the help of a licensed life settlement company. A lot has changed over time, and it’s quite evident why life settlement providers have become a preferred choice for people.

   2. Privacy Concerns

 When you sell your life insurance, you have to inevitably provide specific pieces of information about yourself that are too personal. Information, like your medical history and everything about your policy, has to be disclosed. In fact, even after you sell your life insurance, you might get frequent calls from the life settlement provider inquiring about your health status. In cases where personal information is involved, it is expected that people would demand confidentiality.

 To make sure that whatever information you provide stays confidential, make it a point to proceed with any of the services only after obtaining a complete privacy policy. Also, in case your information is made accessible to someone else, you should be informed about it.

  3. Life Security

 Selling your life insurance to a third party means that the latter would be able to reap the benefits of your policy after you pass away. This would make most people feel insecure, which is justified. This is why policies are sold to an investor in bundles. As a result, the investor will not get the benefits solely from your policy. While this is an effort to mitigate the risk, foul play has never been reported about a life settlement.

 However, to still be on the safer side, make sure you don’t sell your policy directly to an investor. You can trust life settlement providers in selling your life insurance since they have a proper license and are recognized by the state.

Eligibility Criteria for Life Settlements

When you plan to sell your life insurance, you have to meet specific criteria to ensure your eligibility to sell your policy.

     ● Type of Policy

You can consider selling your life insurance only when what you have is a convertible term life policy, universal life policy. Group policies like convertible term policies or permanent policies also qualify for a life settlement. However, premium financed and standard term policies cannot get you a life settlement.

     ● Age

A person aged 65 and above is an ideal candidate for selling his/her policies. This is obvious because the third party gets benefited only when the seller passes away. This factor affects the amount of money you would get in exchange for your policy upon calculation of the life settlement offer.

    ● Life Expectancy

For it to be differentiated from a viatical settlement, life expectancy for a life settlement should be above two years. However, the lesser the life expectancy, the more valuable the life settlement is.

    ● Age of the Policy

There is also a certain amount of time for which you should own the policy before you can sell it. This is more of a variable criterion since the minimum period differs from state to state. You can expect an exception for cases like divorce, passing away of a spouse, retirement, etc. However, even the limitations would depend on the state you belong to. 

    ● Policy Value

A policy should have at least $100,000 of the death benefit if it has to be sold. As of yet, buyers have a well-defined structure that accommodates bigger policies. This is why they would exclude any policy that offers a death benefit lesser than what has been mentioned above. However, as the industry grows, it's expected that the minimum value of a policy might come down in the future.

When can You Sell Your Life Insurance

Some situations make it more ideal for you to opt for a life settlement. Here are certain cases where it is better to sell your life insurance and get a life settlement.

When Coverage Isn’t Needed

When the beneficiary of the insured is someone who no longer needs insurance, that person can opt for a life settlement.

Any Emergency Situation

In situations like a medical emergency or urgently having to pay off a debt, you can think of going for a life settlement.

Unaffordable Premiums

When we talk about universal life insurance policies, as the insured ages, the costs also shoot up. This is one of the situations when you might want to stop paying a high price. However, even as such, if your financial condition doesn’t allow you to pay premiums anymore, you can opt for a life settlement.

Calculating the Worth of Your Life Insurance

One of the most important questions people ask related to life settlement is “how much is my life insurance policy worth?” Many aspects should be taken into account when calculating the estimate of your policy’s worth. Indicated below are the following elements:

    1. Policy Size

It might seem apparent that bigger policy size equates to a more significant policy benefit. This also means that you can get a more valuable life settlement. However, as of now, a policy has to be at least worth $100,000 for it to be eligible for a life settlement. 

    2. Premium Amount

Generally, lower premium amounts add more value to a life settlement. Anyone who buys your life insurance would want to spend the least amount of money to maintain the policy.

    3. Life Expectancy

Lower life expectancy means more valuable life settlement. This is because the buyer would get the benefit without having to make too many premium payments. Life expectancy depends on two factors – health and age of the person. Life expectancy is calculated by using the insured’s medical records and age.

   4. Market Rate of Return

When the investor raises capital to buy policies, he incurs a certain amount of interest for the capital. When the rate of interest is less, he can invest more. This is also the case where an investor can even tolerate lower returns. 

   5. Cash Value

A lot of people ask “what is my life insurance cash value?” Since the concept of a cash value can seem confusing, people may get confused when it is discussed without showing a visual of the figures. To help in clearing possible confusions, here is an example of how to calculate the cash value of life insurance.

Sample Life Settlement Calculation

Policy type: Universal life insurance policy

Life Expectancy: 10 Years

Annual Premium Amount: $8,000

Death Benefit: $200000

Discount Rate: 8%

                Policy Value                   $38,958

Based on the cash flow analysis that you see in the table, the policy value is $38,958. While the death benefit, in this case, exceeds the total of premium payments, it's not a definite trend for each case. If the life expectancy of the person changes from 10 years to 15 years, as the table below suggests, policy value becomes $5427, even with other values are held constant. However, as a death benefit is lesser than the current value of premium payments, this policy would not be eligible to be sold.

Policy type: Universal life insurance policy

Life Expectancy: 15 Years

Annual Premium Amount: $8,000

Death Benefit: $200000

Discount Rate: 8%

                Policy Value               $5427

Click here to download the Excel spreadsheet used for the sample calculations above.

Taxes

life settlement taxable

One of the most common questions people may ask is whether life settlements are taxable. The answer is a simple Yes. Concerns related to taxes on life insurance policies are best to be explained by a tax advisor. However, here’s a general overview of how your life insurance policy is taxable and how life settlement taxation works. For this purpose, let’s break down some terms related to life insurance.

        1. Premium - what you pay.

       2. Cash surrender value- the amount of money that the beneficiary gets after you pass away.

       3. Life settlement transaction rate- the amount of money you get when you sell your policy. 

Now that you know these terms, it's easy to understand how your policy would incur taxes. Since the cash surrender value is something that the beneficiary receives, it doesn’t incur tax. However, when you sell your policy, the amount of money you get beyond the cash surrender value is your profit value. This profit value is what incurs tax that you have to pay for.

Let’s assume that you paid a premium worth $128,000 and your cash surrender value is $156,000. In this case, when you pass away, your beneficiary would get $28,000.

However, if you get a life settlement worth $160,000, the profit beyond the cash surrender value would account for $32,000. This means you have a gain of $4000. For this amount of gain, you are required to pay taxes.

While this is a basic idea of how taxes work for a life settlement, you can also use a settlement tax calculator to compute the estimated amount. However, still make it a point to get the calculations done right with the help of a tax advisor.

The Whole Process

life settlement transaction process

Now that you know the basics of what a life settlement is, you’re good to go for a life settlement transaction. Breaking down the process into small and understandable steps, here’s all that you need to know:

 Analysis

When you decide to go for a life settlement, the very first step is to analyze a few essential things. First of all, know what kind of life insurance policy you own. Find out if it qualifies for a life settlement. Besides this, check all the other criteria that have already been mentioned under the criteria of eligibility for life settlement and see if you meet the conditions. You can also get an estimate of how much cash your policy can give you. 

Research

Now that you know quite a lot about how much money you would incur when you exchange your policy, you have to figure out who will do the task for you. Search for the best life settlement companies or brokers and do your research. Your list of the best life settlement companies may come from word of mouth or extensive research. Once you have made your choice, you are ready to dive into the next step. 

Information Gathering

This is the task that is carried out by the life settlement provider or broker. The information gatherer gets your medical history and the details about your policy. Your life expectancy is calculated to weigh the costs that the policy is worth. 

Deciding the Offer

As the life settlement provider goes through the death benefit value of your policy, your life-expectancy, and all the other factors, he will then make inferences. These inferences are analyzed, and the provider would see if the offer is appropriate. Once he analyses this, he would decide to bring the proposal formally to your table. 

Evaluating the Offer

After framing the offer, the provider or the broker would explain the proposal to you. Whether the offer seems to be a fair deal or not, you have to take a decision and communicate it to your life settlement provider.

Closing Package

Once you accept the offer, the provider will get you a closing package with all the necessary documents. The provider will also explain these documents to you. You and the beneficiary of your policy need to sign these documents to accept the offer formally. After you sign them, they go back to the life settlement provider to be processed.

Transfer of Ownership

After the service, the provider receives all the documents and processes them. He then sends them to the insurance company. This is like sending a formal request to the company to transfer the ownership from the insured to the provider or buyer. Once the documents are signed, they are handed over to an escrow agent. This agent would keep the documents safely until the entire procedure of transferring the ownership is completed.

Closure

Once the insurance company records the transfer of ownership, a confirmation is sent to you, settlement provider, and the escrow agent. Upon receiving the request, the escrow agent would release the funds in the form of payment.

 While this information aims at providing you a general idea of how life settlement works and what the factors involved are, seeking professional advice is of great importance.

         

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