What is a Life Settlement?
A life settlement refers to the sale of an existing life insurance policy to a third-party for a one-time cash payment. The payment received is more than the policy’s surrender value, but less than the death benefit. The purchaser becomes the policy’s beneficiary and assumes payment of its premiums, ultimately receiving the death benefit when the insured party passes away.
A life settlement agreement is closely related to a viatical settlement agreement.
Key Insights
- Financial Empowerment: A life settlement provides the insured party with a lump-sum cash payment when they sell their policy.
- New Beneficiary: The policy purchaser becomes the new beneficiary and is responsible for paying premiums, receiving the death benefit upon the insured’s death.
- Multiple Uses: Reasons for opting for a life settlement include retirement needs, unaffordable premiums, and emergencies.
- Distinct from Viaticals: Life settlements and viatical settlements cater to different parties, typically based on health status.
- Legal Framework: Life settlements involve policyowner transfers, ensuring compliance with regulations against stranger-owned life insurance (STOLI).
How Life Settlements Work
When someone can no longer keep up with their insurance premiums, they have the option to sell the policy for cash, usually to an institutional investor. The transaction is generally tax-free to a considerable extent. The insured person hands over every aspect of the policy to the new owner, including the responsibility to pay premiums. Upon the insured’s death, the purchaser benefits from the policy’s death payout. Life settlements are generally legal and different from STOLI agreements, which are prohibited.
Reasons to Consider a Life Settlement
Financial Flexibility in Golden Years
Many seniors consider life settlements to supplement their retirement savings through a mostly tax-free payout. This extra income can be crucial in meeting financial needs during retirement.
Managing Premium Costs
For individuals facing the inability to pay premiums, a life settlement offers a way to gain value from their policy without it lapsing. This results in a higher cash payout compared to the surrender value.
Strategic Financial Moves
At times, the policy may no longer serve its initial purpose. Selling the policy can be a proactive move, especially if the coverage is no longer needed by dependents.
Address Emergency Needs
Life can bring unexpected expenses like home repairs, medical bills, or family needs. Selling a life insurance policy can offer quick financial relief in such emergencies.
Business Scenarios
Companies often hold key individual insurance policies on executives. When the insured no longer works for the company, a life settlement can turn an illiquid asset into cash.
Life Settlements vs. Viatical Settlements
The concept of selling insurance policies became more widely known during the AIDS crisis when viatical settlements were a lifeline for those expecting shorter lifespans. However, these have some distinctive features compared to life settlements.
A viatical settlement involves the sale of a life insurance policy by a terminally ill individual. The buyer assumes all future premium payments and eventually receives the death benefit. This type of settlement is riskier for investors since the payoff depends on the insured’s actual lifespan, which can be unpredictable.
Essential Considerations
Life settlements create a secondary market for life insurance policies, enabling broader financial strategies. This market has been legitimized over years, notably reinforced by the landmark 1911 U.S. Supreme Court case Grigsby v. Russell. This case established that life insurance policies can be considered transferrable property similar to stocks and bonds.
Policies can be collateralized, borrowed against, and sold with rights akin to other property forms, enhancing their flexibility.
Who Does a Life Settlement Broker Represent?
A life settlement broker represents the policy owner, finding the highest bidder and potentially bound by fiduciary duty to the owner.
Guarantees and Settlement Options
A structured life settlement, drafted as an annuity, guarantees payments until the beneficiary’s death. Conversely, in a single life settlement, payments cease upon the annuitant’s death, unlike joint life settlements which continue until the spouse also passes away, assuming survivorship.
Related Terms: Viatical Settlement, Life Insurance, Premium, Death Benefit, Cash Surrender Value.
