What Are Life Settlements and How Do They Work?
Here's a look at the pros and cons of cashing out your life insurance before its prime (or yours).
We have bad news. You and everyone you know are going to die one day.
Some of them may have died already. While most people do not enjoy thinking about death, you or your loved ones will be much better off if you do. That is why life insurance policies exist.
What is life insurance?
With a life insurance policy, the policyholder (the owner of the policy) makes regular premium payments in exchange for a payout to a designated recipient (called a beneficiary) upon the holder’s death.
Life insurance policies come with various restrictions to prevent payment of the death benefit before the life insurance company makes its money. That is why the life settlement market emerged — so people could sell their existing life insurance policy for an early cash payment.
A look at life insurance settlements
“A life settlement is when you sell your life insurance policy to a third party for cash,” says debt resolution attorney Leslie H. Tayne Esq. “The cash you receive is generally more than what your policy is worth in that moment, but not as much as it would be worth at the time of your death.”
Tayne explains when you sell your life insurance policy, the third-party investor — also now the new policyholder — pays all future premiums and receives the payout upon the original policy owner’s death. In a sense, upon purchasing the policy, the third-party investor becomes the new beneficiary.
The legal basis for the secondary market around buying life insurance originated in the 1911 Supreme Court case Grigsby v. Russell. After Dr. Grigsby bought a life insurance policy from one of his patients, the company refused to pay out. Lower courts ruled against the doctor, but once it reached the U.S. Supreme Court, Justice Oliver Wendell Holmes delivered the court’s opinion that the ownership of the policy should be transferable like other kinds of property.
Settling for a life settlement
It is reasonable to view this kind of arrangement with some skepticism. Given that it can already be uncomfortable to attach a cash value to your own life, involving a third party life settlement company may only add to the discomfort. You will also have to provide your medical records for review, which can feel like a privacy violation.
Additionally, you might worry that a sketchy life settlement provider will get impatient and try to receive its lump sum sooner (if you know what we mean). Perhaps you have concerns the provider will try to shorten your life expectancy by dropping a cartoon anvil from a window as you pass below. It’s unlikely — but impossible?
As with any financial transaction, you will want to do your research on the specific broker you plan to use as well as the life settlement industry, in general. If you do choose to sell your life policy through a life settlement broker represented by the Life Insurance Settlement Association (LISA), you may take some comfort in knowing your personal information should remain confidential to the new policyholder. That policyholder will also likely be a company with a portfolio of various investments, rather than a single individual.
If you are feeling skeptical, know that selling your life insurance policy is a gradual process with multiple opportunities to back out before the deal is done. You are not obligated to accept an offer, LISA’s website says.
Is a life settlement a good choice for you?
It depends. On one hand, “There are no upfront fees, credit score, or income level requirements,” according to LISA’s website, so this could be an alternative to a no credit check loan. On the other hand, the process can be slow.
“Most life settlement agreements require many documents to be signed and can take weeks or months to complete,” says Mike Raines, owner of insurance company Raines Insurance Group and Special Risk Term, a life insurance company for higher-risk clients.
However, even if you have a life insurance policy, you might not be able to sell it. If it was that easy, anyone could just buy a new policy and immediately sell it for a cash payment.
“The buyer of the policy is looking to pay a discounted price on the policy for what they feel will return a greater amount than what they paid for it when the insured passes away,” Raines explains.
In other words: Life settlements work for buyers when the initial holder is older or has a terminal illness.
Can I sell my life insurance policy?
The type of policy you have as a seller may also impact whether it can be sold and for how much. Certain types of plans, such as convertible term and universal life policies, are more popular, says Gordon E. Conwell III, owner of the American Term insurance agency, because they will not expire after a certain amount of time. This differs from a term life insurance policy that may not pay out if the original policyholder lives long enough.
Of course, you are never going to get more money from a sale than the policy’s death benefit offers, so odds are you would only consider a life settlement if the beneficiary no longer needs it or if you are having trouble making payments. If you do not think you can keep making your payments, then a life settlement would be an alternative to a policy lapse.
One last warning: The payment you receive from selling your life insurance policy may not be tax free and may compromise other government benefits you receive. “If you currently receive government benefits, such as Medicaid, selling your policy could impact your ability to qualify,” Tayne says.
Consider talking to a financial adviser to understand the tax implications of a life settlement, as well as how it could affect your public assistance options.
Can I return my life insurance policy?
There are options available for squeezing money out of a life insurance policy, but those options will depend on your policy and provider. One option may be asking your provider about your policy’s cash surrender value. In other words, you may be able to give up your policy in exchange for a portion of the premiums you have already paid.
Ultimately up to you
As long as you do your research and work with a reputable broker, a life settlement could be a good choice if your credit situation is in dire straights. Will you get the same payout from the sale of a life insurance policy? Not necessarily, but it is a good example of why you should explore all of your options and why the settlement process may be worth considering.
Gordon E. Conwell III owns American Term insurance agency and specializes in obtaining life insurance for higher-risk individuals. He also offers life settlements to clients and others looking to sell their policies.
Mike Raines is the owner of Raines Insurance Group, an independent life insurance agency located in metro Atlanta, GA. He entered the life insurance business in 1986, and began his career working with the oldest life brokerage firm in the United States, specializing in securing affordable protection for those with pre-existing medical conditions or high-risk jobs and hobbies.
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