What is a life settlement?

Unlock the value in a life insurance policy that would have been forfeited

A life settlement is the sale of a life insurance policy to another party for more than the cash value but less than the amount of the net death benefit.

Life settlements are not to be confused with viatical settlements, which were pioneered in the 1980s as a way for terminally ill people to gain access to a large portion of a policy’s death benefit prior to their death.

With a life settlement, an insured individual must be in less than ideal health but not terminal. In other words, if the life expectancy is too long or too short, a life settlement won’t work.

I’ve been watching the life settlement industry for more than 10 years and have seen both the maturation, regulation and sophistication of the industry grow measurably. In that time, billions of dollars of death benefits have not been “let go,” but instead turned into a tangible asset for the owner that otherwise would never have been realized had the owner of the policy not sold it, but instead terminated coverage by either surrendering the policy for whatever cash value had accrued or lapsing the coverage by not paying the policy premiums. When the latter happens, the policy gets canceled by the insurance company, which it loves because a death claim doesn’t have to be paid.

Term life insurance, which has no cash value by design, can be considered for a life settlement. At some point it is converted to a permanent life insurance product. Not all term policies allow for conversion but most do.

Why would owners of a life insurance policy consider selling it?

• They cannot continue to pay the premiums to keep the coverage in force. For example in the case of a term life policy, they are coming to the point where premiums as a rule skyrocket to absurd amounts.

• They do not want to pay the premiums to keep the coverage in force.

• They no longer need the protection the life insurance provides.

• The size of an estate no longer justifies the amount of death benefit and the carrying cost of it.

• “Vanishing premium” payments have not vanished.

• Divorce.

• The policy owner outlives the beneficiary.

The general parameters for a policy to be considered for a settlement include:

• Death benefit amount of $100,000 and up.

• Policies with low cash values (but any amount can be considered).

• “Low” premiums relative to the death benefit.

• The insured person is over 65 but most any age can be considered if the medical issues present are substantial enough.

• If the insured has experienced a substantive decline in health since the Policy was issued.

• Usually life expectancies of 15 years or less.

• Policy must be past the initial two-year incontestability period.

It is imperative that anyone owning or controlling a life insurance policy they think would be suitable for a life settlement “shops it,” meaning getting at least three quotes.

Producers have a fiduciary obligation to the owner of the policy. Brokers act as a clearinghouse for producers and also have a fiduciary obligation. Providers are the actual purchaser of the policy and their obligation is to themselves.

Note that every transaction is unique, so there is no way to determine what it is worth until it is valued by a buyer. And what is paid to the owner involves analyzing many variables.

It is also possible to sell only a portion of the death benefit, keeping some of the coverage for needs you might still have. Taxation of proceeds is a topic for another day.

The bottom line: Letting a life insurance policy terminate for any reason without getting it appraised first is a mistake, because any possible cash that could have been extracted from it is permanently lost. As consumers and businesses come to realize that life insurance really is an asset in every sense of the word, they will see the potential of a life settlement.

Hans Hug Jr., an Exeter-based independent insurance producer/broker licensed in five states, can be reached at 603-778-8939 or hhug@apache1.net.