Life insurance is one of the most widely utilized financial products in the United States. As of 2009, there were more than 153 million individual life insurance policies insuring U.S. citizens with a total face value of over $10 Trillion. Additionally, group life insurance accounts for another 113 million policies valued at more than $7 Trillion.
Considering those statistics, it is fair to say that the importance of owning a life insurance policy to provide financial security for our loved ones is embedded in the financial plan of Americans. However, there is a little known fact about lapse rates that life insurance companies do not want to publicize. According to the Life Insurance Settlement Association, “an estimated 90% of all life insurance policies issued lapse before paying a claim.”
While many of these life insurance consumers lapse or surrender a policy that holds little to no present day economic value, some Americans may have walked away from a valuable asset worth a significant sum of cash. Unfortunately, these consumers were unaware that a fair market value may have been available for their life insurance policy through a state regulated secondary market called life settlements. This secondary market for life insurance policies provides qualified policyholders with an alternative option other than those offered by the life insurance company. Life Settlements are about CHOICE – and that choice is now in the hands of the American consumer instead of the life insurance company.
What is a Life Settlement?
A life settlement enables qualified life insurance policyholders to convert their life insurance coverage into cash by selling it to a state licensed financial institution. The sale of the policy is similar to the sale of a home or car, all rights, title and future interest in the asset are legally transferred from the seller to the buyer. The buyer is then responsible for all future premium payments and owns the rights to the future death benefit. These buyers are part of a secondary market for life insurance policies that developed due to the limited options offered by life insurance companies for those consumers who have had changing life circumstances or who could no longer afford their premiums. Life settlements give consumers a choice, when previously only limited options existed which were dictated by the life insurance company. Now, thanks to the Life Settlement Industry, policyholders have the choice to sell their asset for a fair market value, instead of lapsing a policy with no value received or surrendering it for an amount below fair market value. The life settlement option allows the seller of the policy to use the proceeds to help pay for long-term care needs, living expenses or anything else they desire.
Over the past decade, thousands of Americans have taken advantage of this new financial option. According to a 2010 Life Settlement Study conducted by the U.S Government Accountability Office, between 2006 – 2009 life settlements provided consumers with $5.62 Billion more cash than the comparable amount offered by the life insurance company. An average of 800% more value!
How did the secondary market for life insurance start?
The sale of a life insurance policy to a third party was established as a legal right for consumers in 1911 based on the Supreme Court ruling in Grigsby v. Russell, 222 U.S. 149 (1911). Mr. Justice Holmes said it best, “To deny the right to sell except to persons having such an (insurable) interest is to diminish appreciably the value of the contract in the owner’s hands.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks, bonds and real estate. As with these other types of property, a life insurance policy can be transferred to another person at the discretion of the policy owner. This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
- Name the policy beneficiary
- Change the beneficiary designation (unless subject to restrictions)
- Assign the policy as collateral for a loan
- Borrow against the policy
- Sell the policy to another party
Although this ruling established the right for life insurance consumers to sell or trade their life insurance policies, the practice did not become common until the late 1980’s with the start of the viatical settlement industry, which was the precursor to the life settlement market.
How are Life Settlements Regulated?
Life settlements are a highly regulated market that requires life settlement brokers and providers (buyers) to be licensed on a state-by-state basis. Consumer protections have been passed in more than 45 states and are typically regulated by the State Department of Insurance.
What to know about Life Settlements
According to the Life Insurance Settlement Association, more than 90% of all life insurance coverage lapses with no death benefit ever paid out. In an effort to protect profitability and reduce future death claim commitments, many life insurance companies actually prohibit their captive agents from discussing life settlements because they do not want policy owners to find out the option exists. Fortunately, some state regulators have started to catch on to these anti-consumer practices and are forcing life insurance carriers to notify consumers that there are alternatives to lapsing or surrendering a policy, including the life settlement option. These consumer disclosure laws now exist in six states.
In addition to requiring life insurance companies to disclose the life settlement option, some state governments have recognized the secondary market value of life insurance as an important tool for long-term care. In May 2013, the state of Texas officially passed legislation requiring Medicaid applicants to assign their life insurance policies to the state if the face value is above $10,000 or sell the policy to the life settlement market for a fair value – Many other states that are considering similar laws.
Life Settlement Eligibility
General guidelines for life settlement qualification include insureds over the age of 65 with chronic health conditions, or those younger with severe or end stage health issues. Any type of policy can qualify for a settlement such as universal life, variable life, whole life, convertible term life, or even group life. The policy owner can be the insured, his/her family, a trust, a corporation, or any other entity that might hold the rights to the policy. Face values on qualified policies can range anywhere from $50,000 to more than $20 million or higher. If you are not sure if you qualify, please feel free to call us for a free personal consultation or complete our Quick Online Qualifier.
When Should a Policyholder Consider Selling A Life Insurance Policy
- The policy premiums are too costly and have become a financial burden
- The original need for the life insurance policy no longer exists, i.e. children are no longer dependents, so lapsing or surrendering the policy is under consideration
- The beneficiary of the policy is deceased and life settlement proceeds would improve the policyholder’s financial situation
- The policyholder requires additional income to fund long-term care needs
- The policyholder wishes to make a cash donation to a charity
- A “key man” policy held is no longer necessary as the employee has left the company
- The insured is required to assign the policy to a state in order to obtain Medicaid coverage
Other Options to Life Settlements
Your insurance company may offer alternative options, such as accelerated death benefits, loans, or a cash surrender value. Before entering into a life settlement, you should contact your insurance company or agent to see what options are available to you. These include:
- Accelerated Death Benefit – some life insurance policies include a rider that provides the policy owner with the option to accelerate a portion of the death benefit payment. This option typically requires the insured to have a certified life expectancy of less than 24 month from their attending physician. Unfortunately, very few life settlement candidates qualify for the accelerated death benefit option; this is the primary reason why the secondary market exists.
- Disability Waiver of Premium – a feature in some life insurance policies that will allow the policy to remain in force in the event the Insured becomes disabled. The carrier will reduce or eliminate the premium required as long as the Insured qualifies for this provision. Some life insurance companies will require an annual qualification form to be completed and approved, while others have set periods for recertification of disability.
- Discontinuing Premium Payments – cash value policies may allow a policy owner to discontinue paying premiums if there is sufficient account value in the life insurance policy to cover the cost of insurance charged by the insurance company. This is typically only a short-term solution.
- Reduction in Face Value – a life insurance company may allow the policy owner to lower the death benefit of the policy in order to decrease premium payments.
- Reduced Paid Up Policy – if there is a significant amount of cash value in the life insurance policy, the carrier may offer a reduced death benefit and waive future premiums in exchange for the cash value.
- Policy Loan – if a life insurance policy has accumulated account value, the life insurance company may allow you to borrow against a portion of it. Policy owners may opt for this type of loan because interest rates are generally better than bank rates. The amount borrowed will be deducted from the death benefit until the loan is repaid. Interest will accrue on a monthly/quarterly/semi-annually/annually basis per the life insurance company’s contracted process. Review a copy of the policy for specific details.
- Cash Surrender Value – the sum of money a life insurance company will pay to the life insurance policy owner when the policy is voluntarily terminated before the policy’s maturity date or before the death of the insured. The cash surrender value is determined by deducting any applicable cash surrender charges from the Accumulation Value (the savings component of most permanent life insurance policies).
- Policy Lapse – the termination of a life insurance policy resulting from non-payment of premiums within the specified timeframe. Often times a policy will enter a grace period prior to lapsing, granting the policy owner the ability to reinstate the policy if all required payments are made.
When is a Life Settlement NOT the Best Option
Life settlements are not always the right choice. Keeping your life insurance coverage may be a better decision for your family, under the following circumstances:
- if you have a continuing need for life insurance coverage in the future;
- if you or a family member can afford to pay the premiums; or
- if you or a family member can secure a loan to pay the premiums.
These are just a few reasons to keep your coverage. Individual circumstances vary and seeking consultation from a financial advisor or CPA who can provide personal advice based on your financial status and goals is advisable. If you do not have an advisor or CPA, please feel free to contact us to recommend a non-affiliated advisor in your local area.
The Life Settlement Process
The life settlement transaction itself is simple. The policy owner and insured must complete an application, which includes important transactional disclosures and authorizations. A copy of the policy under consideration for sale as well as a premium illustration and the insured’s medical records must be obtained.
There are no out-of-pocket fees to receive an offer and there is absolutely no obligation to sell the policy.
Here is a quick summary of the step-by-step life settlement process:
- Call and speak with Mike Smith or Kathy Donnelly to discuss the parameters of your life policy
- Review important disclosures to ensure you understand the process and requirements
- Complete our formal application with Welcome Funds
- Our staff will then expedite the requests for the necessary documents required to prepare your case for market submission
- Your case is then submitted to our National Buyer Network through Welcome Funds
- Offers & declines are received from buyers and negotiations are conducted to maximize the offers
- A final bid is secured when the highest bidder is identified
- Policyholder accepts or declines the bid. If acceptable, the closing process begins
- Closing documents are prepared by the buyer and sent to the policyholder & insured for signatures
- Policy title, values and other pertinent information is verified
- Official transfer of ownership and beneficiary rights are completed with the life insurance company
- Funds are released from escrow to the policyholder
Is the Life Settlement Process Confidential
All personal information is confidential and only disclosed, per authorization, to parties involved in the life settlement process such as licensed life settlement companies, life expectancy underwriters and servicing providers, each who are obligated to abide by state law pertaining to life settlements and consumer privacy.
How Much is my Policy Worth?
Buyers in the life settlement market have different investment parameters, much as mortgage lenders have different guidelines and requirements for their loans. Therefore, life settlement offers vary significantly from buyer to buyer. The bidding process generates competition among these buyers and ensures that the highest offer is secured for the sale of a life insurance policy.
Factors that will contribute to the value of a life insurance policy will include:
- Insured’s Health – age & gender, current health status and family medical history; future medical prognosis; and varying opinions from independent life expectancy experts;
- Life Insurance Policy – face value of the policy; future premium requirements to maintain coverage; life insurance carrier rating; claims risks due to potential application fraud or misstatements;
- Investment Risks – purchasers or investors of life settlement policies take on the risks of future medical advances promoting longevity; credit risk from declines in life insurance carrier ratings; risk of cost of insurance increases by the life insurance carrier; and other typical investment risks.
How Long Does the Process Take?
A traditional life settlement transaction takes anywhere between 2 to 4 months. This timeframe is highly dependent on outside parties fulfilling our requests in a timely manner, i.e. insured’s medical records, policy statements, premium history and illustrations, etc. Hancock Brokerage and Welcome Funds has processed thousands of applications and has dedicated departments that specialize in securing these documents expeditiously. If you require a faster process due to extenuating circumstances, we may have a simplified application program available if you qualify. Please contact us for specific details.
Are the Proceeds from a Life Settlement Taxable?
Just like the sale of other personal assets, the income generated from a life settlement transaction may be taxable. Life settlement transactions typically result in a capital gain. In rare circumstances, a portion of the settlement proceeds may be treated as ordinary income. This would only occur if the policy’s cash surrender value were greater than the total cost of premiums paid into the policy. However, it is also possible that there are no federal tax consequences if the settlement proceeds are less than or equal to the adjusted basis in the policy. For further clarification, click here for the IRS Bulletin.
Additionally, any tax implications for capital gains realized from a life settlement transaction could be offset by tax deductions based on “the entire cost of maintenance in a nursing home or home for the aged” (sec. 1016 U.S. Master Tax Code 2008). In the case of a viatical settlement where the insured has a terminal diagnosis with a certified physician’s prognosis of 24 months or less, the proceeds may be tax-free at the federal level (see Health Insurance Portability and Accountability Act of 1996).
How Do Life Settlements Compare to Other Possible Financing or Funding Options for Seniors?
- There are no restrictions on the use of life settlement proceeds
- A life settlement is not a loan
- There are no requirements for re-payment
- There are no upfront fees and no credit score or income level requirements
- There is absolutely no obligation to accept a contingent offer