Life Settlement

A life settlement refers to the sale of an existing policy to a third party for a one-time cash payment. Payment is more than the surrender value but less than the actual death benefit. After the sale, the purchaser becomes the policy’s beneficiary and assumes payment of its premiums. By doing so, they receive the death benefit when the insured dies.

A life settlement agreement is closely related to a viatical agreement.

• A life settlement refers to the sale of an existing insurance policy to a third party for a one-time cash payment.
• The policy’s purchaser becomes its beneficiary and assumes payment of its premiums, and receives the death benefit when the insured dies.
• Some of the reasons why people choose life settlements include retirement, unaffordable premiums, and emergencies.

When an insured party can no longer afford their insurance policy, they can sell it for a certain amount of cash to an investor—usually an institutional investor. The cash payment is primarily tax-free for most policy owners. The insured person essentially transfers ownership of the policy to the investor. As we noted above, the insured party receives a cash payment in exchange for the policy—more than the surrender value, but less than the policy’s prescribed payout at death.

By selling it, the insured person transfers every aspect of the life insurance policy to the new owner. This means the investor who takes over the policy inherits and becomes responsible for everything related to the policy including premium payments along with the death benefit. So, once the insured party dies, the new owner—who becomes the beneficiary after the transfer—receives the payout.

Life settlements are legal for the most part in the U.S. Because life settlements involve a transfer by the policy owner, they do not amount to stranger-owned life insurance (STOLI), which is illegal.

There are many reasons why people choose to sell their life insurance policies and are usually only done when the insured person doesn’t have a known life-threatening illness. The majority of people who sell their policies for a life settlement tend to be older people—those who need money for retirement but haven’t been able to save up enough. That’s why life settlements are often called senior settlements. By receiving a cash payout, the insured party can supplement their retirement income with a largely tax-free payout.

Other reasons for choosing a life settlement include:

• The inability to afford premiums. Instead of letting the policy lapse and be canceled, an insured person can sell the policy using a life settlement. Failure to pay the premiums may net the insured a smaller cash surrender value—or none at all, depending on the terms. A life settlement on a current policy, though, usually results in a higher cash payment from the investor.
• The policy is no longer needed. There may come a time when the reasons for having the policy don’t exist anymore. The insured party may no longer need the policy for their dependents.
• Cases of emergencies. In cases where an unexpected event arises, such as the death or illness of a family member, the owner may need to sell the policy for cash to cover these expenses.
• Cases involving key individual insurance policies held by companies on executives. This is typical for people who no longer work for the company. By taking a life settlement, the company can cash out on a policy that was previously illiquid.

Life settlements generally net the seller more than the policy’s surrender value, but less than its death benefit.