Life Settlement Definition
A life settlement is the sale, by the policyholder, of their life insurance policy to a third party in exchange for a lump sum of cash.
Sellers of their life insurance policies typically have a shortened life expectancy, but are not terminally ill. The purchaser of the policy pays all future premiums and collects the death benefits (this is also referred to as the face value) upon maturity. In other words, the policy buyer becomes the beneficiary of the policy. A life settlement differs slightly from the related viatical settlement, in which the seller of the policy is terminally ill and has a defined life expectancy, typically less than two years. Life settlements are also referred to as senior settlements.
Pros & Cons / Program Details
If an elderly person is fortunate enough to have a life insurance policy, then a life settlement is a good source of funds to pay for long-term care when compared to accepting the cash surrender value (CSV) of the policy. The CSV is the amount of cash a policyholder receives from the life insurance company if they terminate the policy before it becomes payable. Life settlements are sales to third party companies that can net the policy seller much more than the cash surrender value. (The purchaser pays more than the CSV for the policy, but less than the face value). In addition to receiving an immediate lump sum, the policyholder also benefits from no longer having to pay the monthly insurance premiums.
The following make a life insurance policy more attractive to buyers, and therefore, generate higher purchase amounts during a life settlement:
- Greater age of the insured.
- Shorter life expectancy of insured.
- Lower cash surrender value as a percent of coverage amount.
- Lower annual premiums as a percent of coverage amount.
Most life settlements involve the use of a life settlement broker who shops the policy around to multiple buyers and charges a fee. It is possible for a policyholder to manage their own sale, but brokers often get higher prices for a policy than an individual seller can. Therefore, it can be easy to justify their fees.
The seller of the policy receives a lump sum cash payment that can be used for any purpose such as to re-model a home to allow a senior to continue living independently, to pay for in-home care or to pay for assisted living.
Qualifications for Life Settlements
Life insurance settlements require a buyer and each buyer of life settlements has their own qualifications. The information below is typical but be aware that exceptions exist. There are requirements related to the individual and to their policy.
Individual Qualifications
- The policyholder generally must be at least 65 years of age, although most are closer to 75.
- The life expectancy of the policyholder is usually less than 20 years. Some buyers require the insured to have a medical exam; others will simply review the senior’s medical records.
Policy Qualifications
- Not all types of life insurance are eligible, but the following types of policies usually are: Universal Life, Whole Life, Variable Universal Life, Term, Convertible Term Life and Second-to-Die.
- Most life settlement companies require the policy to have been in place for two or more years.
- Policies must have a minimum face value of $100,000.
Benefits of Life Settlements
Payments and Tax Consequences
Life settlements are paid out in a single lump sum and there are no restrictions on how a life settlement payment may be used. The proceeds can be taxable. Usually the life settlement amount minus the total premiums paid is considered as a capital gain or possibly as income. However, if the proceeds of a life settlement are used to pay for the costs of long term care, tax deductions may apply.
Policy sellers should be aware that life settlements can be taxable and that receiving a lump sum of cash can disqualify them for Medicaid.
Amounts & Limits
Life settlements do not have hard limits, but payouts are limited by the face value of the policy and a variety of other factors. These factors include the age and life expectancy of the policyholder, as well as the cash surrender value of the policy. A life settlement may pay 2-7 times more than the cash surrender value.
Life Settlement Costs
Insurance companies do not charge a policyholder to sell their policy and receive a life settlement. However, as mentioned before, many policy sellers will use the service of a broker to get the best possible payout for their policy. Brokers charge fees and provide a valuable service, and their efforts can pay for themselves. That said, seniors should be selective if and when they choose a life settlement broker.
There are three different methods that broker’s generally use to establish their fee structure. In the majority of states, a broker cannot take a commission higher than 30% of the settlement amount.
1. Percentage of the policy’s face value (approximately 6%)
2. Percentage of the life settlement amount (estimated at 25%)
3. Percentage of life settlement amount minus the cash surrender value (perhaps 30%)
The table below provides examples of each. It is important to note that the percentages can be negotiated so that the fees for each model are about the same, but the 3rd method most closely aligns the interest of the broker with that of the policyholder. Therefore, a senior can be confident that the broker using this method is working in their best interests.
| Life Settlement Broker’s Fees |
| Broker’s Fee Method | Face Value
of Policy | Cash Surrender Value | Life Settlement Amount | Broker’s
Fees
Structure | Broker’s
Fee Amount | Policy
Holder’s
Amount |
| 1) % of Policy’s Face Value | $500,000 | $50,000 | $150,000 | 6% of Face Value | $30,000 | $120,000 |
| 2) % of Settlement Amount | $500,000 | $50,000 | $150,000 | 25% of Settlement | $37,500 | $112,500 |
| 3) % of Settlement – CSV | $500,000 | $50,000 | $150,000 | 30% of Settlement minus the Cash Surrender Value | $30,000 | $120,000 |
Application Process
What to Expect
Life settlements are usually paid out within 6-12 weeks after the insured or their broker begins the sales process. Policyholders should be aware that they may be required to undergo a medical exam or at a minimum, share their medical records. Waiting for doctors to provide medical information is usually the largest factor in delaying a life settlement process.
How to Apply
The vast majority of people interested in life settlements use the service of a broker. Brokers provide two major advantages over attempting to sell a life insurance policy oneself. They manage what is a complicated process and they take the policy to multiple companies, get multiple, competing offers and therefore can receive higher bids than individuals attempting to sell a policy themselves.
It is generally accepted that using a broker pays for itself, but there are always contrarian opinions. Without question, brokers make the process considerably easier and for that reason alone they are recommended. Initiating a conversation with a broker is highly informative, free of charge and puts an individual under no obligation. Do not work with any broker who charges a fee for a consultation.
