Life Settlement Guide
Chapter 1: An Introduction to Life Settlements
A life settlement, the sale of a life insurance policy for an amount greater than the surrender value but less than the death benefit, can provide significant financial value to policyholders who no longer need or who can no longer afford their policy. This chapter offers a quick history and overview of life settlements.
Life Settlements, Since 1911
A 1911 decision of the US Supreme Court, Grigsby v. Russell, is often referenced as establishing legal basis for the life settlement market. The case revolved around a life insurance policy taken out by John C. Burchard.
In need of a surgical procedure, Mr. Burchard sold the policy for $100 to his physician, Grigsby. When Burchard passed away a year later, Grigbsy’s death benefit claim was challenged by Russell, the executor of the Buchard estate.
The case decision ultimately reached the US Supreme Court which established that a life insurance is private property, and as such can be assigned, or sold.
Judge Oliver Wendell Holmes, who delivered the court’s opinion, stated:
“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.”
This decision was handed down over a century ago. The idea that life insurance is personal property which may be assigned or sold at the will of the owner is well established. Your life insurance policy is a valuable part of your financial plan, and it may be useful well before you pass.
The history of the modern life settlement industry begins with the AIDS crisis in the 1980s. Facing short life expectancies, life insurance policy sales in these circumstances were known as viatical settlements. The term continues to be used for life settlements by those facing chronic or terminal illness and limited life expectancies, typically two years or less.
The industry has expanded since these early years from viatical settlements to what is known today as a life settlement, generally considering individuals aged 70 and older but not terminally or chronically ill.
Purchasers of policies have changed as well. Burchard sold his policy to another individual, his doctor. Today, life settlements are part of an alternative investment asset class known as longevity-linked or insurance-linked assets. The institutional investors of the modern era, for example pension funds or private equity firms, more closely resemble your insurance carrier than they do your doctor.
In addition, regulation has been adopted in most states, with approximately 90% of the population afforded protection under comprehensive laws and regulations when entering into a life settlement transaction. Both the National Council of Insurance Legislators and the National Association of Insurance Commissioners have established model regulation for life settlement transactions, which is the basis for most states’ regulatory scheme.
We can see from the history of life settlements that the need for life insurance coverage can change as personal priorities shift through life. The Supreme Court of the United States established life insurance as personal property which, like any other asset, can be sold. State regulation applies to the vast majority of transactions. Certainly, if a life insurance policy is no longer needed or cannot be afforded, a life settlement is one option policy owner should be aware they can consider.
The Key: A Life Settlement Brings Immediate Cash Value
A life settlement is the sale of an existing life insurance policy to a third party. It is the sale of the life insurance policy contract, including the future premium obligations and death benefit to an institutional investor in exchange for a lump sum of cash, greater than the surrender value but less than the future death benefit. It can be a great alternative to surrendering or lapsing a policy.
Chapter 2: Should I Keep my Life Insurance Policy?
Yes! Keeping an existing life insurance policy will provide the greatest benefit for your heirs.
However, as Grigsby v. Russell demonstrated, life’s circumstances can change. Sometimes, changes are expected. An example is coverage purchased to protect a family from the loss of a breadwinner’s income. At some point, the need for protection may diminish – the children have left home, established their own careers and families. Or changes can be unplanned and unexpected, such as financial difficulty or a need for long term care.
Each individual’s situation is a unique case. Consider the reasons you purchased the insurance coverage. Evaluate your circumstance today. If your life insurance policy is no longer needed or has become unaffordable, look more closely into the options available to you.
What are the most common reasons to consider selling?
The specific circumstance and reasons individuals have for selling their life insurance policy vary considerably one person to the next. Nonetheless, most transactions fall broadly into the following categories, one of which might match your situation.
Your policy premiums are no longer affordable
You may find yourself unable to support ongoing premium payments. This may have occurred due to a decline in income or because other financial needs have taken a priority. Or the policy itself has become more expensive, perhaps because the interest crediting rate has trailed the assumption utilized at the time of purchase. In other cases, the insurance company has raised the cost of premium payments to keep the policy in force.
Funds are needed for medical expenses or assistance with daily living
There are plenty of reports reviewing the rising cost of health care, and this is a factor for some. More often, funds are needed to pay for certain treatments, medications or therapy costs which fall outside of a coverage plan. For others, the need for the services of a home health aid or an assisted living facility create a more immediate need for cash.
The policy’s risk protection is no longer necessary
Through the years, the risk protection a life insurance policy has provided may no longer be necessary. In this scenario, beneficiaries no longer rely on the expected benefit for financial security. Some family related examples are empty nests, where children have grown and established their own families, loss of a spouse or divorce. Changes in estate planning, perhaps related to updates in estate tax projections, fall into this category. As does the sale of a business, and protection associated with a buy-sell agreement, for example. Where there is more than one policy on the same insured, we commonly see the sale of one policy to fund a remaining policy.
You are looking to reduce your cash outlay and supplement retirement income
Sometimes the decision to sell a policy is related simply reducing your annual financial outlay. Eliminating policy premiums can free cash for other purposes, whether simply creating some cushion in the retirement budget or funding lifestyle expenditures.
The time period to convert your term to permanent is closing
Most term life policies offer a conversion window, a feature of the policy that allows the term contract to be converted to a permanent policy without additional underwriting. Typically, these windows close at the end of the policy term and include insured age restrictions. Policy owners must decide whether to continue the term policy on an annual renewable basis, convert to a permanent policy or end coverage.
The common denominator in choosing a life settlement
Those who elect to sell a life insurance policy have in common a preference for current benefits, a lump sum of cash, which outweighs need for a future benefit, the policy payout. Each individual weighs their options carefully, each situation unique to circumstance. The key here is to know your option and make an informed decision.
What are my options?
If you have a life insurance policy that is no longer needed or has become unaffordable, there are several different options available for consideration.
Discontinue payment of premiums; lapse policy
If you discontinue premium payments, the policy coverage wll lapse. For a permanent policy, premiums will be paid from the cash value, if any, until exhausted, at which time the policy coverage will terminate.
Surrender policy to the life insurance company
A permanent policy may be surrendered for the accumulated cash value of the policy. Surrender charges may apply, and amounts will be detailed in your policy contract.
Loans
You may be able to borrow against your policy by taking a loan, using the the cash value as collateral. The loan amount cannot exceed the amount of the policy’s cash value. While this strategy may make available cash, it does not eliminate the need to continue paying premiums. The loan amount, and any accumulated interest charges, are deducted from the death benefit payout.
Accelerated death benefit riders
Some policy contracts include a feature that allows the insured, in certain circumstances, to receive a portion of the death benefit immediately. The portion of the death benefit available and under what conditions will be detailed in your contract. Typically, benefits are available to those with a terminal or chronic condition resulting in a short life expectancy.
Premiums assumed by beneficiaries or family
In some cases, the beneficiaries or family members may wish to assume the premium obligation and keep the policy in-force. This alternative relieves the premium burden for the owner and maintains the future death benefit.
Life Settlement
The sale of a life insurance policy to a third party for more than the cash surrender value, but less than the death benefit, this alternative provides a lump sum of cash today and elimination of the premium obligation. The purchaser of the policy assumes the premium obligation and will collect the death benefit in the future.
Chapter 3: Life Settlement Eligibility
A life settlement can be a valuable financial option for a life insurance policy which may not be wanted or needed any longer. A cash settlement may be used, for example, to boost your retirement nest egg, fund a second life insurance policy or pay medical or ongoing care costs.
But not all insureds and not all policies qualify for a life settlement transaction. In this chapter, we will cover the basic requirements for life settlement eligibility.
Age: Generally, 70 years and older
The average age of an insured selling a life insurance policy is 78. An average, of course, suggests some are older and some younger. So, there is more to consider than simply birth dates.
Health and Underwriting
Just like your health was underwritten to issue your policy, your health will be underwritten for a life settlement. Typically three to five years medical records are reviewed by an actuary who will determine a life expectancy.
Life expectancy is a statistical calculation which takes into consideration the various health conditions of the individual being underwritten. This is standard in the life insurance industry, and similar methodologies were utilized when the policy was issued to set the policy rating and premium level. Importantly, no medical examinations are required for life settlement underwriting.
Your Life Insurance Policy
Life insurance is issued by many different carriers, each offering multiple types of insurance products. Your contract features will be evaluated as part of the underwriting process, but there are a few common elements to all policies that create an average policy profile.
Policy Size
Also known as the face value of the policy, $100,000 is generally the minimum size considered for a life settlements. However, there are exceptions, particularly for applicants with very serious health conditions.
Policy Type
Universal life, including guaranteed and survivorship universal life, is the most common life insurance product considered for a life settlement.
Term policies usually provide coverage for a set period of time, and often have options available to convert to permanent coverage. Term policies are typically converted to a permanent policy for a life settlement transaction, although in the case of an insured with serious health considerations, the policy may remain a term.
Whole life is difficult to transact because the product is designed to build cash high values, often resulting in the market value of policy equal to the cash value.
Policy Premiums
Naturally, lower premium levels are more favorable for the value of your policy in a life settlement transaction. Generally, an annual premium at a level of 5% of the face value or lower is preferred. However, more expensive policies can still find market value depending upon other variables considered.
Chapter 4: Life Settlement Valuation
How is the value of a life settlement calculated?
The market value of a life insurance policy depends upon many factors including, as discussed in the previous chapter, the amount of death benefit, premium level and life expectancies. However, pricing is more complicated than three simple metrics.
Today’s market standard employs asset specific probabilistic and deterministic pricing models. The models take into consideration the required cash flows, primarily premium and fee amounts, and the timing of those costs, along with policy contract features, the insured’s individual actuarial underwriting and discount rate assumptions to determine a net present value.
More simply, the primary factors influencing the value of a life insurance policy are the ongoing cost of the policy, the length of time payments will be made, which is estimated utilizing the insured’s underwriting, and the size of the policy benefit.
It stands to reason that if an insured had two policies, one with more expensive premium requirements than the other, the expensive policy would have a lower market value when comparing the two policies.
Similarly, if two different insureds both happened to own the same life insurance product and coverage, the policy insuring the individual with the shorter life expectancy would be the more valuable of the two.
So, generally, the greater your life expectancy and the more expensive your policy, the lower your policy’s life settlement value.
Life Settlement Guide: Chapter 5
How does the Life Settlement process work
Selling one’s life insurance is in many ways similar to selling many other assets – there are some specific steps that make it unique however, and we’ll go through all of them.
Traditionally the life settlement process has been a time-consuming and expensive. At The Secure Group we are significantly simplifying this process – allowing you to focus on what’s important.
We can describe our life settlement process in three steps as shown below:
Step 1: Application
Completing the online application is the first step to receiving a life settlement offer. It allows us to build your case with all the required information including details about your life insurance policy and your health status. Our application process is very intuitive – you can be complete it in less than two minutes.
Step 2: Sharing Your Case
This is where we share your case with life settlement buyers. We make sure to match you with licensed, reputable and trusted buyers in your area. Providers will conduct an analysis of the value of your policy.
Step 3: Receive offers
Life Settlement Buyers will reach out to you directly with their offers. You have no obligation to accept anything. You should review the offer details, and discuss them with your family, friends and financial advisor. Once you are convinced an offer meets your needs, you can agree to the terms of the sale and close the transaction.
By simplifying the application, The Secure Group helps shave months off of the typical process. We only match you with life settlement providers from our trusted network.
After you close your life settlement transaction, you should review additional requirements such as regular (e.g. yearly) disclosures to the buyer.
Chapter 6: Life Settlement Taxation
How are life settlements taxed?
Generally speaking, gross income includes income from all sources, including gains from the sale of a life insurance contract. For tax purposes, the proceeds of a life settlement, fall into one of three categories:
- Sale proceeds up to the tax basis are free of income tax
- Sale proceeds in excess of the tax basis up to the amount of cash surrender value are taxed as ordinary income rates
- And sale proceeds in excess of the cash value are taxed at capital gains rates.
The basis of a life insurance policy is generally the premiums paid less withdrawals and dividends taken from the policy.
Recent Developments
The 2017 Tax Cuts and Jobs Act contains an important reform to the way life settlement transactions are taxed. Indeed, the new tax law overturns a 2009 ruling that required policy sellers to reduce their tax basis in a life insurance policy by deducting the cost of insurance charges over the elapsed term of the policy.
This was a significant hurdle, as it is particularly difficult for individuals to obtain the policy’s cost of insurance prior to a sale. With the ruling overturned, life settlements are now treated similarly to surrendered life insurance policies.
A real-life example
Bobby is a 79-year old retiree who decides to sell his $800,000 life insurance policy to pay down outstanding debts. At the time of settlement, Bobby had paid total premiums of €60,000 and the policy has a cash surrender value of €25,000. The policy sold for €100,000.
- Up to the policy basis there is no tax obligation.
€100,000 (sale price) – €60,000 (policy basis) = €40,000 (taxable gain) - Proceeds in excess of the tax basis up the the surrender value are ordinary gains.
€25,000 (surrender value) – €100,000(sale price) = <0 (no ordinary gains) - The remaining tabable proceeds are capital gains.
€40,000 (taxable gain) – 0 (ordinary gains) = €40,000 (capital gains)
The taxation of proceeds from a life settlement should be considered when deciding whether or not to sell your policy. We recommend you consult with your accountant or tax advisor.
Are there exceptions?
Yes – for those suffering from chronic or terminal illness.
The Internal Revenue Code has a different treatment for life settlements where the insured qualifies for tax purposes as chronically or terminally ill. These transactions, known as viatical settlements, are considered more like accelerated access to the death benefits. Generally, life expectancy in these transactions are two years or less and the do not trigger tax obligations.
Chapter 7: Life Settlement Alternatives
What are my alternatives to a Life Settlement?
A life settlement can be very attractive way to tap into an asset that you own. However it is important to be aware of alternatives to a life settlement – we’ve compiled a short list of these alternatives in this chapter.
Consider them carefully before moving forward.
Accelerated Death Benefit
The most common of alternatives to a life settlement is known as an Accelerated Death Benefit (ADB). An ADB, also called “Living Benefit”, allows you to receive a portion of your death benefit from your insurance company. However, your insurer may have certain requirements for you to qualify – such as having to be terminally ill which usually implies a life expectancy that is less than two years.
Also note that you can’t stop paying your premiums even after receiving your ADB. You are still required to make your policy’s premium payments while you receive portions of your benefits which will be considered as a loan you won’t have to repay. Insurance companies will deduct Accelerated Death Benefits from your policy’s face value when you pass away.
Viatical Settlement
We introduced viatical settlements in the first chapter of this guidebook. Like ADB, a viatical settlement is meant for terminally ill policy holders. However, unlike ADB, you can receive a lump sum settlement upon the sale of your life insurance policy to a third party. You are therefore no longer required to pay the monthly premiums.
Policy Cash Value / Death Benefit Loan
If you are a whole-life policyholder, you may tap into the cash value has built up in your policy over time. You can either borrow against your policy’s cash value or use it as collateral for secured loans.
A Death Benefit Loan means borrowing against your policy’s cash value. When the death benefit is due, your insurer deducts the loan amount, its interests and other fees from the full death benefits.
Note however that you cannot take out as a loan more than the cash value of your policy, which is typically a small fraction of your benefit.
Policy Surrender Value
If you do not intend to own your policy any longer, you can cash it for its surrender value. This amount is usually significantly lower than a life settlement.
Remember not to treat your life insurance policy as a long-term commitment that you need to pay rather than an investment that has the growth potential like any other property you invest in. Your policy is an investment, a convertible asset, and can be a significant part of your net worth.