What Is a Life Settlement?
A life settlement involves selling an existing life insurance policy to a third party for a lump sum payment. This payment is typically higher than the surrender value but lower than the death benefit. The purchaser of the policy becomes the beneficiary and takes on the responsibility of paying the premiums, eventually receiving the death benefit upon the insured individual’s passing.
A life settlement agreement is similar to a viatical agreement.
Key Takeaways:
- A life settlement is the sale of an existing insurance policy for a one-time cash payment.
- The purchaser becomes the policy’s beneficiary, pays premiums, and receives the death benefit when the insured passes away.
- Common reasons for considering life settlements include retirement, unaffordable premiums, and financial emergencies.
- Viaticals are comparable to life settlement agreements.
- Life settlements don’t constitute stranger-owned life insurance (STOLI) as they involve a transfer by the policy owner.
How Life Settlements Work
When an insured individual can no longer afford their insurance policy, they have the option to sell it to an investor, often an institutional entity, for a cash amount. This transaction is generally tax-free for most policyholders. The ownership of the policy transfers to the investor, who pays more than the surrender value but less than the eventual death benefit.
By selling the policy, the insured person transfers all aspects of it to the new owner, who then assumes responsibility for premiums and receives the death benefit upon the insured party’s demise.
Life settlements are predominantly legal in the U.S. since they involve a transfer by the policy owner, distinguishing them from STOLI arrangements, which are illegal.
Why Choose a Life Settlement
Several motivations drive individuals to sell their life insurance policies, typically when the insured person is not terminally ill. These transactions are often pursued by older individuals, especially those looking to boost their retirement savings. Receiving a cash payout through a life settlement enables them to enhance their retirement income with minimal tax implications.
Other reasons for opting for life settlements include:
- Financial inability to sustain premium payments.
- No longer needing the policy.
- Emergency situations requiring immediate cash.
- Corporate-held key person insurance circumstances for former executives.
Life settlements typically yield more than the surrender value but less than the death benefit of the policy.
Life Settlements vs. Viatical Settlements
The popularity of policy sales rose in the 1980s, particularly among individuals with AIDS, leading to the emergence of the viatical settlement industry aimed at terminal illness patients. This segment saw a decline as individuals with AIDS started living longer lives.
In a viatical settlement, those with a terminal illness sell their policies for a lump sum payment, with the buyer assuming premium payments and receiving the death benefit upon the insured party’s passing.
Viatical settlements pose higher risks as investors speculate on the insured individual’s death, with uncertain timing affecting potential returns. The longer the insured person lives, the lower the return when factoring in premium payments.
Special Considerations
Life settlements establish a secondary market for life insurance policies, backed by legal precedents such as the groundbreaking 1911 U.S. Supreme Court case of Grigsby v. Russell.
This case affirmed that life insurance policies can be freely transferred and treated similarly to other forms of property like stocks and bonds. This transfer confers specific rights, including changing beneficiaries, using the policy as loan collateral, and selling it to third parties.
Who Does a Life Settlement Broker Represent?
A life settlement broker represents the policy owner and may have a fiduciary duty towards them, aiming to secure the best offer for the policy.
Which Life Insurance Settlement Option Guarantees Payments?
A life settlement can be structured as an annuity with guaranteed payments until the beneficiaries’ death.
What Is a Single Life Settlement Option?
In a single life settlement, payments cease upon the annuitant’s or beneficiary’s death. Conversely, a joint life settlement continues until the annuitant’s spouse also passes away.