Older Americans seeking to stretch their financial reserves through their golden years will dsicover the aid of a surprising resource – their very own deaths. Or more specifically, the sale of life insurance policies to investors looking to profit from bets on when original policyholders die.
Life insurance plans generally pay someone else – a beneficiary – upon the death of the insured person, but a newly-resurgent investment category has established an opportunity for policyholders to benefit from life insurance while they're living. The sale of a life insurance policy to some 3rd party investor is are classified as a “life settlement.”
What is a life settlement?
The idea sounds straightforward enough: Investors buy others' life insurance policies, dreaming about big payouts when the insured persons perish. Meanwhile, the initial policyholder gets cash for health expenses, or fun, or just respite from premium payments. The main risk for investors is that if the original policyholders outlive their life expectancies and they pay premiums more than they anticipated.
But, as with every financial opportunities, caveats abound. The large one: Policyholders (as well as their families) often wind up can end of receiving far less than the life insurance policy payout, compared to the life insurance policy payout, known as the death benefit. Still, you will find situations where life settlements may be appropriate for some policyholders.
While life settlements are enjoying a small renaissance today due to better life span predictions and standardization around regulation, the concept for the product has existed in excess of 100 years. In 1911, the U.S. Top court declared in Grigsby v. Russell that life insurance coverage would be a bit of property that could be transferred. That opened the door to life settlements.
They didn’t catch on before the 1980s and the AIDS epidemic when – then generally known as viatical settlements – the pacts became common to help crictally ill patients cope with expensive end-of-life care. A viatical settlement involves a crictally ill insured with a life span of less than two years. Stories about high fees and opaque sales tactics sullied the concept back then, but viatical settlements seemed to die their very own natural death, as life expectancies of AIDS patients along with other sick policies holders grew, and investor returns diminished.
A decade later, fresh life was breathed in to the concept by stronger regulations requiring greater transparency for consumers, as well as better tools for estimating life span. Today, 43 states regulate life settlements, based on the Life Insurance Settlement Association (LISA). An existence settlement involves insureds over age 65 who have experienced some deterioration in health or are actually uninsurable. Rules generally require disclosure of sales commissions and minimum holding periods before the coverage is sold. That provision avoids what is known as the STOLI problem – Stranger-Owned Life insurance coverage. Which involves the “flipping” of life policies, in which a consumer buys life insurance with the sole purpose of selling it to some stranger. The morbid incentives involved with STOLI speak on their own.
Life settlement investments enjoyed their peak popularity over the past decade, with a total of $12 billion price of policies changing hands during 2008, according to LISA. The took a significant hit throughout the recession, but is again in comeback mode, with sales growing from $2.8 billion in 2021 to an estimated $3.4 billion in 2021, based on Magna Life Settlements.
How an existence settlement works
Generally, someone over 65, who own a policy with a face amount of $100,000 or more, and who has experienced some deterioration in health or perhaps is now uninsurable may qualify for any life settlement.
What policyholders enter an existence settlement
It’s difficult to say. Typically it's an amount above the cash surrender worth of the insurance policy and underneath the death benefit. So many factors get into this calculation that’s it’s not smart to speculate. Chief included in this: How healthy may be the policyholder? Investors will pay someone expected to die inside a few years a lot more than someone prone to live for a decade or more, for self-evident reasons. (People who are crictally ill can continue to consider viatical settlements.)
How much life settlements cost
There are lots of reasons why life settlements ought to be a tool of last resort, however. Commissions are high – as high as 30 %, which obviously cuts in to the life settlement payment. You will find significant tax implications since the policyholder might have to pay taxes around the life settlement payment. There’s also the strange situation of having someone you don’t know take advantage of your death. (Really unsavory practices, for example canvassing doctors for unhealthy patients, have been regulated out of practice.)
When an existence settlement will make sense
Life settlements can beat simply surrendering a policy for the cash value. Older consumers who can't afford the payments, with hardly any other options for cash, a large death benefit, and significant health care bills may want to think about a life settlement.
Alternatives alive settlements
There are other options to life settlements. First among them: Ask beneficiaries to help with the life insurance premiums. Which will preserve the tax benefit and also the payout.
Sometimes, borrowing against the life insurance policy is a better strategy than compromising for a life settlement. In some instances, these types of loans don't have to be paid back through the policyholder; they're paid off using the death benefit. However, you should understand the amount of interest is being paid on the loan.
The insurance provider might offer other creative solutions, such as revising the insurance policy to lessen the death benefit in return for reducing or ending monthly premiums or simply getting accelerated death benefits. Getting a new life insurance coverage is definitely an option, too. The government lets consumers buy new life insurance policies with old policy money and steer clear of taxes with an instrument known as a 1035 exchange, but be sure to consult a tax adviser prior to doing that (or any of these tactics).
If your primary aim is to get rid of the premiums, life insurance policies can also be donated to a charitable organization – which might feel great, and make up a tax deduction.
Finally, it's possible to split the baby – to consider an existence settlement for any portion of the death benefit, but preserve the remainder of it for that beneficiary, something known as a Retained Death Benefit.
What to know when you sell your lifetime insurance policy
If you plan to execute a life settlement, these pointers can help you with the process:
Check their license
Make sure the individual offering to buy your policy is really a licensed life settlement broker, needed in most states. Go to your state's insurance commissioner web site to make sure the broker you are coping with is licensed.
Know their agenda
In the past, investment professionals made a lot of money by convincing consumers to make use of the proceeds of the life settlement to buy other financial instruments – double-dipping on commissions they received, based on an alert from the Financial Industry Regulatory Authority. Make sure you understand what the individual selling you the life settlement will profit from the sale and related financial recommendations.
Don't succumb to sales pressure tactics
If you, or a loved one, feels rushed right into a complex financial transaction such as this, call a time-out. There are many options available for seniors with life insurance facing a cash crunch. Make time to consider them all.
Review all of the costs
Make sure you see on paper the entire extent of transaction costs. This is required in most states.
Guard your privacy
A large amount of private information is exchanged inside a life settlement transaction. After all, investors want to know how healthy their “investments” are. Coverage is pooled, so investors aren't supposed to know which individual former policyholders have been in their portfolios, however for obvious reasons, privacy is paramount. Read carefully and understand all the entities that will get access to your intimate details.
Understand how a life settlement will affect your beneficiaries
Make sure you think with the impact that the life settlement may have on the policy beneficiaries and their loved ones.
It's difficult to figure out what a fair price is for a life insurance settlement – there's not great calculators online to estimate what consumers can get for offers. There's just one method of doing that: Get multiple offers from multiple places. And be sure to check it against the policy's cash surrender value along with other provides the current insurance provider might make.