What is a life settlement?
A ‘life settlement’ is when an individual sells their life insurance policy to a third-party buyer in exchange for a lump-sum cash payment. The policy can then be resold on the secondary market, oftentimes to institutional investors who hold them as part of diversified financial portfolios.
“Selling” a life insurance policy technically means that the policyholder agrees to transfer ownership of their policy — including the death benefit and monthly premiums — to the buyer. The buyer then assumes responsibility for paying these future premiums (in order to keep the policy active), and in exchange, receives the cash payout when the policy matures.
The amount one receives for the sale of a life insurance policy differs based on a number of factors — primarily the size of the policy and the life expectancy of the insured individual. Policyholders will typically receive around four times more cash from a life settlement than from the cash surrender value of the life insurance policy.
Life settlements go by a number of names, including “senior settlement”, and “reverse life insurance.” Occasionally they will also be referred to as “viatical settlements,” but this more accurately a type of life settlement designed for terminally and chronically ill policyholders.
Terms to understand
There are some terms common in the life settlement industry that you should know before continuing on.
Life settlement provider: A life settlement provider is a company or third-party investor who purchases life insurance policies from policy owners. These are also referred to as life settlement companies.
Life insurance policy owner: This is the individual who owns the life insurance policy – almost always the individual whose life is insured. If you are selling a life insurance policy, you are the policy owner.
Policy value/face value/death benefit: The policy value is the amount of money the beneficiaries receive upon the death of the insured individual. This is also often referred to as the “death benefit,” and is most often a tax-free, lump-sum payment. This is not the same as the cash payout you receive from a life settlement.
Premium payments: Premiums are the monthly payments one pays to keep an insurance policy active. When you sell your life insurance policy, you are handing over responsibility of future premiums to the purchaser of the policy.
Cash surrender value: The cash surrender value is the payment one receives from the life insurance company for canceling their policy.
Insurable interest: Insurable interest can be defined as the amount of hardship that someone will face if they lose something or someone that they have insured. It can be a financial hardship or other kinds of hardship, depending upon what or who was insured.
Underwriters: A life insurance underwriter is responsible for processing a life insurance application. Underwriters collect personal information to determine the risk of the individual. This process ultimately dictates how high premium payments will be for the insured. The higher risk an applicant is, the higher their premium payments will be.
Accelerated death benefits: Accelerated death benefit riders (ADBs) pay out a portion of the death benefit in an insurance policy as a living benefit before the insured passes away. This can happen when the insured needs cash to cover certain types of expenses. They should not be confused with life or viatical settlements, where the insured sells his or her policy to a life settlement company in exchange for a lump sum cash payment up front.
Why sell your life insurance?
The main reason an individual would sell their life insurance policy is their present need for cash is greater than the future need of their beneficiary. We cover some specific reasons for this below:
- The policyholder can no longer afford premium payments. Every year over $100 billion in life insurance policy value is lost due to individuals who let their policies “lapse” through non-payment. If you cannot afford to keep a life insurance policy active, selling it allows you to get some of the money back that you paid over the years in premiums.
- The beneficiary is no longer in the picture. Life insurance policies are typically bought for the interest of spouses or children, to provide financial assistance in the event of the policyholder’s untimely death. If there are no longer any close loved ones or children to name as beneficiaries in the policy, there may not be a reason to hold onto it.
- Large end-of-life expenses. Many individuals cash in their life insurance policies to pay for unexpected life expenses such as medical bills or long-term care, which can often be quite expensive. For example, a private room in a nursing home can cost up to $7,698 per month. Life settlements can help pay for these costs.
- Expiring term policy. If a term life insurance policy is approaching its expiration date—typically around 20 or 30 years—some individuals may not want to renew, as it has expensive replacement costs. Like lapsing due to non-payment, selling a life insurance policy rather than allowing it to expire lets you financially benefit off years of premium payments.
No matter what your specific reason, it’s important to keep in mind that selling your life insurance policy is a major financial decision, and you should make sure to have a discussion with your beneficiaries and a financial advisor before proceeding.
Life settlement eligibility
While there are many life settlement companies with many different standards for who they accept, the vast majority of eligible policies meet three criteria:
- The policyholder is over age 65
- The policyholder is not in perfect health
- The face value of the life insurance policy is over $50,000
While this criteria generally holds, there can be exceptions on the age limit and policy value for those facing serious illness. Some life insurance policyholders are able to conduct life settlement transactions as young as 60. On the flip side, a senior over age 70 in excellent health may have difficulty qualifying for a life settlement. Certain states will also have mandatory waiting periods between when a life insurance policy is issued and when it may be sold.
How how much is my life insurance policy worth?
According to the Life Insurance Settlement Association (LISA), four main factors determine how much of you will receive from your life settlement:
- The death benefit amount.
- Life expectancy of the insured.
- The remaining premium payments.
- The discount rate (or investor required rate of return).
The typical payout range tends to be 10-50% of the policy’s value, with 20-25% being the most common range.
For example, if a policy has a face value of $1m, you could likely expect a life settlement of $100,000 to $250,000 dollars. This tends to be much more than the cash surrender value of a policy.
What type of life insurance policy can I sell?
Most life settlement companies will accept sales of term, universal life, and whole life insurance policies. To understand this we’ll first briefly explain each type of life insurance.
Term life insurance. This is the most traditional form of insurance, where one pays a flat monthly premium, in order to cover themselves for a length of time known as a “term.” Terms can be any length of time, but typically are 10-30 years.
Whole life insurance. Also known as “permanent life insurance,” a whole life policy is one that has a cash value built in, which can act as a savings and investment vehicle. This means that unlike a term policy, a whole life policy has cash value outside of a settlement, and you can borrow against this value or access it directly. This makes the decision on whether or not to sell it a bit more difficult.
Universal life insurance. Universal life insurance is similar to whole life insurance, except there is much more flexibility in how you pay premiums. You can decrease the monthly amount or death benefit while the policy is still active, and some universal life policies even let you pay all your premium in one single lump-sum premium.
While whole life insurance is currently the most popular type of policy among individuals, term life insurance tends to be easier for life settlements. This is again because there is no cash value component, meaning the insured individual makes no money from a term life policy while they’re still living. If you have whole life insurance, you need to factor in the cash withdrawal value, or the amount you can borrow against the policy’s value and factor that against the value of a potential settlement.
How long does a life settlement transaction take?
The length of the life settlement transaction process differs by state and life settlement provider, but it will almost never be no faster than 30 days, and will typically take around 2-4 months. Keep in mind, you’ll often want to send out multiple applications to get the best offer, so how long the process takes depends on the life settlement companies you apply to.
A typical process normally involves three phases: application, review, and close. We break these down in detail below:
The application process usually begins with a life settlement quote or estimate, such as from a life insurance calculator, followed by a formal application which asks for your basic personal information and questions about your policy.
It’s important during this initial phase to check that you are eligible for the standards of your life settlement provider, and that the provider is able to operate in your state.
Once the application process is officially started, you will be asked to sign HIPAA medical release forms and an in-force policy illustration (this is information from your insurance company about what policy cost will be moving forward). In addition to signing forms with the life settlement provider, you may need to confirm with your doctor’s office and health insurance provider that it’s okay to release your medical records.
Once you apply, the life insurance company will need to decide whether they want to purchase your life insurance policy, and what they believe it’s worth. If the life settlement company approves the application, they will extend a payout offer either to you or the broker. These offers are often negotiable, and you are not locked into any offer you do not like.
In order to complete the life settlement transaction and disperse funds, you will need to sign a number of documents related to the transfer of ownership. These include Verification of Coverage, Life Settlement Contract, Letter of Competency, Life Expectancy Report, Change of Ownership Form, and Change of Beneficiary form.
You don’t need to memorize any of these documents now, but rather keep in mind the time cost involved with documentation for completing the process. Paperwork will be the most time-consuming process of selling a life insurance policy.
Is my life settlement taxed?
The short answer to this question is yes. Life settlements may be taxed, but whether or not they are largely depends on the amount of the payout.
Typically, a life settlement is tax-free up until it equals the total amount you’ve paid in monthly premiums. This is referred to as the “tax basis.”
Amounts greater than the tax basis but less than the policy’s cash surrender value are taxed at your regular income tax brackets. Payout amounts greater than the cash surrender value of the policy are taxed as capital gains.
While these are general guidelines, we strongly recommend consulting a tax professional, as tax rates will depend on a number of factors including income level and personal life circumstances.
Are life settlements regulated?
Life settlements are regulated on a state-by-state basis, with current legislation covering 90% of policies across 43 states and the territory of Puerto Rico. Regulations are created by each state’s department of insurance, and monitor things such as disclosures of risks and taxations, licensing of brokers and agents, and waiting periods for selling a policy.
For example, 31 states have mandatory two-year waiting periods between when an individual is issued their life insurance policy and when they can sell it. Another 10 states have five-year waiting periods and Minnesota has a four-year waiting period. Most states allow exceptions where a policyholder can sell their policy before the waiting period if they meet certain criteria — such as chronic or terminal illness, a life event such as divorce, retirement, or a disability.
Most states require that consumers receive all offers and counter offer alternatives related to their to life settlement. They also require an explanation of risks related to taxation and ineligibility for government assistance programs, such as Medicaid.
These regulations have made life settlements one of the most transparent and well-regulated industries, with the National Association of Insurance Commissioners only reporting two complaints nationwide since the start of 2012. All complaints with the NAIC are public and can be searched in their Consumer Insurance Search database.
The following states have no life settlement regulation at all: Alabama, Hawaii, Missouri, South Carolina, South Dakota, Wyoming. You’ll most likely want a life settlement broker in these states to ensure you’re making the best decision. Additionally, Michigan and New Mexico only regulate viatical settlements.
What is a life settlement broker?
A life settlement broker is a licensed professional who acts as a middleman between life insurance policy sellers, and life insurance purchaser. Their responsibilities are negotiating the best rate for your policy, handling the application process including medical paperwork, and contacting multiple buyers in the life settlement market on behalf of the seller.
Unlike life settlement providers, life settlement brokers have a fiduciary responsibility, meaning they are legally required to act in the best interest of the party they represent.
While brokers are very helpful in the life settlement process, they can also be quite expensive. A common broker fee is a commission equal to 6% of the death benefit. Keep in mind gross payouts tend to be roughly 10-30% of the policy’s death benefit (this is also referred to as the policy’s face value) meaning their commission is around 15 to 30% of your net proceeds.
Life settlement brokers can be individuals or companies. In the process of handling your paperwork, life settlement brokers will often require you to sign HIPAA forms allowing them to gather documents on your behalf.
In researching a life settlement broker, you’ll often want to ask them about their previous history, including how many life settlement transactions they’ve conducted, what fees they charged, and what the average sale price was relative to the policy’s face value.
What to be aware of when completing a life settlement transaction
To ensure you maximize your return, there are things you should be aware of throughout the life settlement transaction process. These are the most crucial:
While life insurance brokers can be very useful at negotiating better rates and helping you with paperwork during the application process, they charge hefty rates that often are listed as a percentage of your death benefit. As you are receiving only a portion of the value of your policy in a life settlement, this percentage can be much higher than expected.
While most proceeds from life settlements are tax free, this is not true of amounts above your tax basis, and is particularly true of whole life insurance policies that may have accrued value through investments.
Selling a life settlement policy will often net you a considerable amount of cash, which can often put you over the asset limit amount for Medicaid, which is roughly $2,000 in most states. To become eligible for Medicaid, you are often required to “spend down” your assets until you are below the asset limit, and then re-apply. However, some states such as taxes have exempted life insurance policies up to a certain amount as an asset disqualifier for Medicaid, so you’ll want to check with your state’s local laws.
Leaving your beneficiaries with nothing
When you sell a life insurance policy, you are technically naming the purchasing party as the new beneficiary of your policy, meaning your previous beneficiary receives none of the proceeds. You’re also usually prevented from buying more than one life policy per insured individual, so you will not be able to purchase a new life insurance policy for yourself while someone owns your existing life insurance policy. You’ll want to ensure your beneficiary is aware of this.
Statistics on the life settlement industry
- According to the Life Insurance Settlement Association (LISA), every year $100 billion in life insurance policies are lapsed by individuals over age 65. This translates to over $22 billion annually that’s left on the table.
- A survey by the Insurance Studies Institute indicated that 90 percent of seniors who let a policy lapse would have considered selling if they had known life settlements were an option.
- According to Magna Life Settlements, the average policy value sold in a settlement in 2018 was $1.24 million, and the total face value of all setted policies was $3.4 billion.
- According to Magna Life Settlements, the average face value of a life insurance policy issued in 2018 was $149,000
- The total amount of life settlements policies sold in 2018 was 2,722. This is compared to 2,027 settlements in 2017, a growth rate of 34%.
- The most recent figures have identified 28 life settlement providers, with the top 6 providers holding 75% of the total market share.
- According to the Insurance Studies Institute, more than 500,000 seniors lapse their life insurance policy and only 1,250 complete a life settlement. This means only 0.25% of seniors are taking advantage of this asset.
A brief history of life settlements
The legal precedent for the sale of a life insurance policy goes back to 1911, where a US Supreme Court case, Grigsby v. Russell, established that life insurance was an asset, including all attendant rights of valuation and sale. United States Supreme Court Justice, Oliver Wendell Holmes, made the ruling.
But it wasn’t until the AIDS epidemic that the insured began taking advantage of this ruling. When terminally ill patients were looking for ways to cover their medical expenses, it was life settlements they turned to. Since then, life settlements have spurred a multi-billion dollar industry, and with it, countless regulations ensuring that insured Americans have safe access to one of their most valuable assets.
Get a free policy valuation
We at Dawn believe in the financial power of life settlements, and expect them to be an increasingly popular option of needed cash for seniors. However, with this power comes a responsibility, and we firmly believe in doing your research and reaching out to insurance agents, brokers, and tax professionals before making a decision.
Want to see how much you could earn with a life settlement? Try our instant life settlement calculator.