Life Settlement definition
Life settlements are part of what is defined as “a secondary market for existing life insurance.”
The original sale of the life insurance policy by the insurer to the policy owner takes place in the primary market. People buy life insurance for estate protection, income protection, key-man coverage, buy-sell agreements, and a variety of other reasons. Over time, as the original need for a life insurance policy changes, moving that policy into the secondary market may become prudent.
In the secondary market, the life settlement opportunity is the most prevalent. This is where investors and financial professionals with clients who are selling their policy operate.
Life Insurance Settlement Brokers vs. Companies
If you want to sell your life insurance policy, you could try to do so on your own, but that might prove to be extremely difficult. There are brokers and companies whose sole business is to help people sell life insurance policies they no longer want or need.
Here are a few key differences between life settlement brokers and companies.
Settlement brokers are licensed professionals who:
- Can help you find ways to sell your policy. They negotiate for you and help you throughout the sales process.
- Have a fiduciary responsibility to you.
- Take a commission that can be negotiated but typically runs from 10% to 30% of the proceeds of the sale.
Settlement companies (also called providers):
- Are usually the buyer. In some cases, they might represent a third party who is the buyer.
- Have no fiduciary responsibility to you.
Is it better to use a broker or go straight to the company?
It’s difficult to say which route is best. A broker can generally get you a higher price, but you will have to pay a fee in the form of a commission. A settlement company, on the other hand, is more likely to devalue your policy and offer an amount that’s less than the market value.
Alternatives to a Life Settlement
If you have a policy that you no longer want or need, seeking a life settlement might be a worthwhile course of action. It all depends on your situation. It’s helpful to know what your other options are so that you can make an informed decision.
You could maintain your policy, perhaps with lower premiums
If continuing to pay the premiums is not an issue, you might be able to decrease the face amount of your life insurance policy to lower the premium. Keep in mind that if you opt for a life settlement, there’s a type of offer called a retained death benefit (RDB). This type of life settlement allows a policy owner to maintain a portion of the life insurance policy face amount with no obligation to continue paying the premiums. An RDB offer is typically higher than a cash offer because it pays out when the policy matures and is taken out of the life insurance policy face amount payment.
You could let the policy lapse
Another alternative is to simply stop making the premium payments and let your life insurance policy lapse for no value. While there’s no guarantee that you would receive a life settlement offer, if you meet the eligibility criteria, you very well might obtain an offer. It’s hard to justify letting a life insurance policy lapse for no value without at least considering a life settlement that could provide significant value.
You could surrender your policy
If your life insurance policy has cash surrender value (CSV), you can surrender it in exchange for a payout of the CSV from the insurance carrier. Unless a life settlement offer exceeds the CSV, you would be better off surrendering the policy to the insurance carrier.
For term life policies that are nearing the conversion deadline:
A conversion transitions a life insurance policy from a term life product to a permanent product, which increases the premium. The higher premium could make converting the policy cost prohibitive. If you have a policy conversion deadline looming, it’s a good opportunity to discuss conversion options and a potential life settlement.
Partial term conversions are a great life settlement opportunity. If you convert only a portion of your existing term policy, the remaining term coverage can be sold.
You might be planning to hold on to your term policy past the conversion deadline and just let the policy lapse if you live past the end of the term. You can certainly do that, but it’s important to consider if you need the same amount of insurance before the conversion deadline. If you no longer need the full face amount, you could keep the amount of term insurance you need until the end of the term and try to sell the remaining portion before the conversion deadline.
In most cases, if a term policy passes the conversion deadline, it’s extremely difficult to get an offer. Therefore, you really need to be vigilant when it comes to conversion deadlines and be sure you understand your conversion options.
Life Settlements vs. Viatical Settlements
The Life Insurance Settlement Association defines a life settlement as “the sale of an existing life insurance policy to a third party for more than its cash surrender value, but less than its net death benefit.”
There are several reasons that policy owners may choose to sell their life insurance policy. They may no longer need or want the policy. They might want to purchase a different kind of life insurance policy. Or, maybe the premium payments are no longer affordable.
A viatical settlement is a term that’s typically used for a settlement involving an insured person (also known as a viator, in this case) who is terminally or chronically ill. Generally, a person is considered chronically ill if her or she: (1) is unable to perform at least two activities of daily living, such as eating, using the toilet, bathing, or dressing; (2) requires substantial supervision to protect him- or herself from threats to health and safety because of severe cognitive impairment; or (3) has a level of disability similar to that described in (1), as determined by the Department of Health and Human Services. In most cases, a person is terminally ill if he or she has an illness or sickness that can reasonably be expected to result in death within two years.
Viatical settlements are similar to, but not the same as, life settlements.
Outlook for the Life Insurance Settlement Market
In the U.S., there’s an estimated $17 trillion1 in existing life insurance policies, and seniors own a substantial portion of that total. People over the age of 70 held more than $257 billion in whole life insurance, more than $370 billion in universal life, and more than $60 billion in variable universal life, according to a 2014 report.2
The Life Insurance Settlement Association (LISA) says a “significant” number of these seniors allow their policies to lapse. In fact, more than 700,000 policies are surrendered or allowed to lapse each year among adults who are 70 or older. Those policies have a combined face value of more than $57 billion.3 If you include adults ages 65 or older, the value of lapsed and surrendered policies could easily be twice that amount.4
And that’s where the life settlement market comes into play. LISA notes that the overwhelming majority of seniors — approximately 90% — would consider selling their policy through a life settlement instead of surrendering them or letting them lapse — if they knew that life settlement was an option.5
Nonetheless, the life settlement market produces an estimated $7 million a day, offering policy owners cash for policies they no longer want or need.6 A report from 2018 stated that the market had grown an average of 34% in recent years7, and there’s no reason to believe that growth will slow as more people and financial advisers become aware of a life settlement as an option.
Projected 2018 market data:8
- Average policy face value: $1.24 million
- Total settlements: 2,722
- Total face value of settled policies: $3.4 billion
- Top providers:
- Magna Life Settlements
- Berkshire Settlements
- Abacus Settlements
- Q Capital
History of Life Settlements
The life settlement option has been available for over 100 years. In 1911, the Supreme Court issued a landmark decision that recognized the rights of policy owners to transfer ownership of their life insurance policies. While life settlement was technically an option soon after that, the industry truly began to be recognized in the 1980s.
During this time, viatical settlements helped thousands of patients with AIDS obtain the cash they so badly needed, but policy owners weren’t always treated fairly. Eventually, as drugs were developed to treat AIDS and survival rates began to improve, many investors were left holding unprofitable policies. Between the unfair treatment of policyholders and the lack of profit for so many investors, the life settlement industry had less than a sterling reputation for a while. Some people may still have negative associations with life settlements and viatical settlements because of this unfortunate period in the industry’s history.
In 1993, the National Association of Insurance Commissioners (NAIC) established the Living Benefits Model Act, and states began implementing regulations to protect policy owners and investors. In 2000, the National Conference of Insurance Legislators adopted the Life Settlements Model Act, which further regulated the industry. By 2005, life settlements were regulated in 25 states; by 2007, 35 states had adopted some form of life settlement regulations.
The industry flourished until 2008 when the recession (led by the real estate meltdown) decreased investor capital, which in turn diminished the ability of life settlement funds to buy new policies. But by 2011, capital markets had renewed their interest in life settlements, and the industry has seen steady growth in the years since then. Now, there’s a shortage of life insurance policies (supply) rather than a lack of life insurance funds (demand).
Today, nearly every state has enacted laws to regulate the secondary market for sales of life insurance policies. Some states are even starting to require life insurance carriers to disclose to policy owners that there is an alternative to allowing their life insurance to lapse — before the policy lapses. All trends point to a bright and vibrant future for the life settlement industry.
- Conning Life Settlements, 2014.