A life settlement is the sale of a life insurance policy to a third-party buyer. The payment may be in the form of cash, a new policy with no future premiums, or a combination of both. The total amount of cash received is more than the policy’s cash surrender value but less than the death benefit. In short, a life settlement is an alternative to a lapse or surrender.
In this article
How Life Settlements Work
History of Life Settlements
Why Life Settlements?
Risks of Life Settlements and How to Protect Yourself
Life Settlement Terms to Understand
- Life settlement – The sale of life insurance policy to a third-party buyer, normally for cash.
- Face value – The documented dollar amount that beneficiaries will receive upon the policy owner’s death. This amount is determined when the policy is issued.
- Death benefit – This is the same figure as the face value. The amount of money the beneficiaries will receive when the policy owner passes.
- Premium – The amount of money owed to the insurance company, typically due on a monthly or annual basis, to keep the policy active.
- Cash surrender value – The amount of money an insurance company will pay a policy owner to cancel the policy before it fully matures.
- Viatical settlement – A type of life settlement that is only available for policyholders with a chronic or terminal illness.
How Life Settlements Work
When policyowners can no longer afford their life insurance policy or they no longer need it due to changes in their financial needs, they can now sell their policy to a licensed provider––typically an institution like Coventry. The individual effectively transfers ownership of the policy to the buyer in return for a payment greater than the surrender value but less than the total death benefit.
The buyer will take over all premium obligations and in return will receive the death benefit when the insured passes. If you need to maintain some level of coverage, you can sell or trade in a portion of your existing policy for a new policy with no future premium obligations, a transaction known as a Retained Death Benefit.
Qualifying candidates are generally aged sixty-five or older and own a policy with a face value of $100,000 or more. Eligibility may vary depending on factors such as the policy size and type, the age and health of the insured, and the needs of the purchaser.
Life Settlement Options
While some may think of them as a singular financing option, life settlements come in several varieties. After deciding to sell a life insurance policy, policyowners have to determine which type of life settlement they should pursue. This decision depends on several factors such as the insured person’s health and their dependents’ need for the policy’s death benefits. In this section, learn all you need to know about how to differentiate among the three life settlement options, from their various qualifications and tax implications to the timelines of their payouts.
Learn more about the tax implications of cashing in a life insurance policy.
Traditional Life Settlement
A traditional life settlement is likely what first comes to mind when considering how to sell your life insurance. This type of sale is open to anyone who owns a policy with $100,000 or more in death benefits, though sellers are most often seniors who are looking to enhance their retirement income. When a policyowner sells their life insurance through a traditional life settlement, they receive a significant—and tax-advantaged—payout. The tax implications of a traditional life settlement can be divided into three categories:
- Tax-Free: All of the proceeds from a traditional life settlement less than or equal to the sum of the policyowner’s paid premiums (also known as the tax basis) are free from taxation.
- Ordinary Income: The portion of the life settlement payout greater than the tax basis and less than the policy’s cash surrender value is taxed as ordinary income.
- Capital Gains: Any remaining sales proceeds are taxed as capital gains.
The timeline of this type of life settlement primarily depends on how quickly the policyowner and insured person can coordinate the transfer of medical and insurance information to the life settlement provider. Working quickly with your insurance company and physician to send the necessary details to the provider can help accelerate the traditional life settlement process.
Viatical Life Settlement
Viatical settlements are the tax-free counterpart of traditional life settlements and are designated for those with severely declining health. To qualify for a viatical life settlement, the insured person must be either chronically ill or terminally ill as defined by their state. These two criteria have specific definitions and each requires a physician’s confirmation. Chronically ill individuals are those who are unable to perform at least two activities of daily living (ADLs) without assistance such as bathing, dressing and eating. Terminally ill individuals are typically those with life expectancies of 24 months or less. When the insured person falls into either of these two categories, they may qualify for a viatical settlement and can potentially receive their life settlement proceeds completely tax-free.
Though the process of obtaining a viatical settlement is nearly identical to that of a traditional life settlement, their timelines can differ. Given the precarious nature of the insured person’s health, life settlement providers are often willing to speed up the viatical settlement process in order to complete the transaction as quickly as possible.
Retained Death Benefit
Whereas both traditional life settlements and viatical life settlements entail giving up an entire death benefit for a generous payout, a retained death benefit (RDB) settlement allows policyowners to preserve a portion of these benefits with no future premiums. By essentially sharing the life insurance benefits with an investor, the policyowner can escape costly premiums and still maintain some of the death benefit, albeit at a reduced amount.
A retained death benefit settlement has no special health qualifications and offers the opportunity to combine the benefits of a traditional life settlement with those of life insurance—providing a potential cash payout to the holder, ending future premium payments, and leaving some coverage for beneficiaries. The tax implications for the cash payout are the same as those for the traditional life settlement, though the RDB cash payout will be less than that of a traditional settlement.
If the insured person would like to decrease the burden of retirement costs while still passing some money down to their loved ones, a retained death benefit settlement may be the right choice. See if you qualify for retained death benefits today.
Steps to the Life Settlement Process
The policy evaluation process involves gathering information on the policy and the insured in order to determine whether the policy economics will work for a life settlement. The process usually follows these steps:
1. Evaluation
The first step is to have your policy evaluated. This entails providing basic information on both the policy and the insured. If you do not meet the minimum qualifying factors, the process will end here.
2. Authorization
If there is a good chance you may qualify, you’ll be required to provide an authorization for Coventry to gather additional information on the insured’s medical history and the specifics of the policy.
3. In-Depth Analysis
Once all supporting documentation and information have been compiled, Coventry will complete a comprehensive review of your case to determine if you qualify for a life settlement.
4. Offer
If you qualify for a life settlement, Coventry will provide you with an offer based on the policy value and other factors.
5. Closing
If an offer is made and accepted, proceeds from the sale will be placed in escrow while the closing documents are completed and the policy officially changes ownership at the carrier. Once confirmed, your funds are immediately released from escrow.
History of Life Settlements
The foundation for life settlements date back more than 100 years to a 1911 decision by the U.S. Supreme Court in which the court ruled that life insurance is an asset that can be sold. The case revolved around Dr. A.H. Grigsby’s purchase of Mr. John C. Burchard’s life insurance policy for $100 in order for Mr. Burchard to pay for a medical procedure.
After Mr. Burchard’s death several years later, Dr. Grigsby’s claim for the policy’s death benefit was challenged by Mr. Burchard’s executor, Mr. R.L. Russell. Despite Mr. Burchard winning his challenge in a lower court, the U.S. Supreme Court ultimately ruled in Dr. Grigsby’s favor.
“So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.” – U.S. Supreme Court, Grigsby v. Russell, 1911.
Nearly eighty years later when the AIDS epidemic took hold of the American psyche, the concept of cashing in on life insurance policies resurfaced in the form of viatical settlements. While viatical settlements allowed countless AIDS patients to realize cash from their policies, it wasn’t until Coventry coined the term “life settlements” in the late 90s that the industry really took shape.
Today, life settlements are regulated in 43 states and Puerto Rico, with more than 90% of Americans living in states with life settlement regulations. According to The Deal, a business intelligence and news service, 2018 saw a 28% rise in the number of policies sold. Since its inception, Coventry has structured or funded more than $40 billion in longevity-linked transactions.
For more information on the history of life settlements, please see:
Reasons to Sell Your Life Insurance Policy & Consider a Life Settlement
As financial needs change over time, so does your need for life insurance. A policy that served your needs adequately many years ago may have become a burden now that your children are grown, you’ve outlived your beneficiary, or your policy has simply become unaffordable.
There are countless reasons policyowners choose to sell their policy. Most often, it’s because the policyowner’s current financial situation requires liquidity over coverage. Here are some examples of why policyholders choose a life settlement:
The policy is no longer needed
Circumstances change over time, and so should your financial plan. As your children become financially independent, your estate needs evolve, your lifestyle shifts, or your budgeting needs are prioritized, it may not make sense to continue maintaining a policy that’s no longer needed.
The policy is too expensive
Over time, life insurance premiums can become prohibitively high for many, making life settlements an excellent alternative to a surrender or lapse. Life settlements provide, on average, four times more money than you’d get from the cash surrender value.
You have new unexpected expenses
Life is full of surprises, and new expenses seem to appear from out of nowhere. If you are faced with unexpected financial challenges or you simply prefer cash now over coverage later, a life settlement can provide an immediate cash injection.
You’d like a better retirement
Market volatility has had a drastic impact on many seniors’ retirement savings. If you’re unable to live the retirement lifestyle you always planned, turning to your life insurance policy may help give you a better retirement.
Your term policy is approaching its expiration date
If your term policy is approaching its expiration date, a life settlement may be a great way to recoup some of your premium payments and may even allow you to maintain coverage with no future premiums.
Risks of Life Settlements and How to Protect Yourself
Life settlements are regulated in 43 states and Puerto Rico. While you don’t have a risk in terms of loss, there are some precautions you should take.
Privacy
In order for life settlement providers to make a purchase decision, they need to access the insured’s medical records and specifics related to the policy itself. To mitigate the risk of your private information being abused, always make sure you are working with a reputable and licensed provider.
Fees and Commission
Fees and commissions can greatly affect the final payout of a life settlement. Most states require detailed disclosures of these costs, which could approach 30% of the total settlement offer. If you pursue a life settlement with a broker, you could owe a significant portion of your settlement to them. Because Coventry is a direct buyer, there are no fees or commissions.
Taxes
Though the proceeds generated from life settlements are often partially tax free, policyowners should always discuss their potential tax liability with a professional tax adviser.
Leaving Beneficiaries With Less
A life settlement can provide a welcomed cash windfall. It also introduces a risk of leaving less for your loved ones after you die.
No Coverage
Unless you have another policy, or elect to receive a Retained Death Benefit, you’ll lack any coverage. While this may not be an issue for you, it’s something to consider.
Updated April 8, 2022