Older Americans looking to stretch their financial reserves through their golden years might find help from a surprising resource — their own deaths. Or more specifically, the sale of life insurance policies to investors hoping to profit from bets on when original policyholders die.
Life insurance policies generally pay someone else — a beneficiary — upon the death of the insured person, but a newly-resurgent investment category has created an opportunity for policyholders to benefit from life insurance while they are still living. The sale of a life insurance policy to a third party investor is are known as a “life settlement.”
What is a life settlement?
The idea sounds straightforward enough: Investors buy others’ life insurance policies, hoping for big payouts when the insured persons pass away. Meanwhile, the original policyholder gets cash for health expenses, or fun, or simply relief from premium payments. The main risk for investors is if the original policyholders outlive their life expectancies and they pay premiums longer than they anticipated.
But, as with all financial opportunities, caveats abound. The big one: Policyholders (and their families) often end 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, there are situations where life settlements might be appropriate for some policyholders.
While life settlements are enjoying a bit of a renaissance today due to better life expectancy predictions and standardization around regulation, the concept for the product has been around for more than 100 years. Back in 1911, the U.S. Supreme Court declared in Grigsby v. Russell that life insurance was a piece of property that could be transferred. That opened the door to life settlements.
They didn’t catch on until the 1980s and the AIDS epidemic when – then generally known as viatical settlements – the pacts became common to help terminally ill patients deal with expensive end-of-life care. A viatical settlement involves a terminally ill insured with a life expectancy 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 own natural death, as life expectancies of AIDS patients and other sick policies holders grew, and investor returns diminished.
A decade later, fresh life was breathed into the concept by stronger regulations requiring greater transparency for consumers, as well as better tools for estimating life expectancy. Today, 43 states regulate life settlements, according to The Life Insurance Settlement Association (LISA). A life settlement involves insureds over age 65 who have experienced some deterioration in health or are now uninsurable. Rules generally require disclosure of sales commissions and minimum holding periods before the policies are sold. That provision avoids what’s known as the STOLI problem – Stranger-Owned Life Insurance. That involves the “flipping” of life policies, in which a consumer buys life insurance with the sole purpose of selling it to a stranger. The morbid incentives involved in STOLI speak for themselves.
Life settlement investments enjoyed their peak popularity during the last decade, with a total of $12 billion worth of policies changing hands during 2008, according to LISA. The industry took a major hit during the recession, but is again in comeback mode, with sales growing from $2.8 billion in 2017 to an estimated $3.4 billion in 2018, according to Magna Life Settlements.
How a life 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 is now uninsurable may be eligible for a life settlement.
What policyholders get in a life settlement
It’s hard to say. Typically it’s an amount above the cash surrender value of the policy and below the death benefit. So many factors go into this calculation that’s it’s not smart to speculate. Chief among them: How healthy is the policyholder? Investors will pay someone expected to die within a couple of years much more than someone likely to live for a decade or more, for obvious reasons. (People who are terminally ill can still consider viatical settlements.)
How much life settlements cost
There are many reasons why life settlements should be a tool of last resort, however. Sales commissions are high – as high as 30 percent, which obviously cuts into the life settlement payment. There are significant tax implications because the policyholder might have to pay taxes on the life settlement payment. There’s also the strange situation of having someone you don’t know benefit from your death. (Really unsavory practices, such as canvassing doctors for unhealthy patients, have been regulated out of practice.)
When a life settlement might make sense
Life settlements can be better than simply surrendering a policy for the cash value. Older consumers who can’t afford the monthly premiums, with few other options for cash, a big death benefit, and significant health care bills might want to consider a life settlement.
Alternatives to life settlements
There are other options to life settlements. First among them: Ask beneficiaries to help with the life insurance premiums. That will preserve the tax benefit and the payout.
Sometimes, borrowing against the life insurance policy is a better strategy than settling for a life settlement. In some cases, these kinds of loans don’t have to be paid back by the policyholder; they are paid off with the death benefit. However, you should understand how much interest is being paid on the loan.
The insurance company might offer other creative solutions, such as revising the policy to reduce the death benefit in exchange for reducing or ending monthly premiums or simply getting accelerated death benefits. Getting a new life insurance policy is an option, too. The IRS lets consumers buy new life insurance policies with old policy money and avoid taxes through an instrument called a 1035 exchange, but be sure to consult a tax adviser before doing that (or any of these tactics).
If your main goal is to rid yourself of the premiums, life insurance policies can also be donated to a charitable organization – which might feel good, and create a tax deduction.
Finally, it’s possible to split the baby – to take a life settlement for a portion of the death benefit, but preserve the rest of it for the beneficiary, something known as a Retained Death Benefit.
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What to know when you sell your life insurance policy
If you plan to do a life settlement, these tips will help you through the process:
Check their license
Make sure the person offering to purchase your policy is a licensed life settlement broker, required in most states. Visit your state’s insurance commissioner website to make sure the broker you are dealing with is licensed.
Know their agenda
In the past, investment professionals made a lot of money by convincing consumers to use the proceeds of a life settlement to buy other financial instruments – double-dipping on commissions they received, according to a warning from the Financial Industry Regulatory Authority. Make sure you understand what the person selling you the life settlement will gain from the sale and related financial recommendations.
Don’t succumb to sales pressure tactics
If you, or someone you love, feels rushed into a complex financial transaction like this, call a time-out. There are many options available for seniors with life insurance facing a cash crunch. Take time to consider them all.
Review all the costs
Make sure you see in writing the full extent of all transaction costs. This is required in most states.
Guard your privacy
A lot of personal information is exchanged in a life settlement transaction. After all, investors want to know how healthy their “investments” are. Policies are pooled, so investors aren’t supposed to know which individual former policyholders are in their portfolios, but for obvious reasons, privacy is paramount. Read carefully and understand all the entities that will have access to your intimate details.
Understand how a life settlement will affect your beneficiaries
Make sure you think through the impact that a life settlement will have on the policy beneficiaries and their loved ones.
It’s tough to determine what a fair price is for a life insurance settlement – there aren’t great calculators online to estimate what consumers can expect for offers. There’s only one way to do that: Get multiple offers from multiple places. And be sure to compare it against the policy’s cash surrender value and other offers the current insurance company might make.
It’s not just easier life insurance, it’s an easier life.
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Bob Sullivan is a veteran journalist and the author of five books, including the 2008 New York Times Best-Seller, “Gotcha Capitalism,” and the 2010 New York Times Best Seller, “Stop Getting Ripped Off!” He specializes in computer crime and consumer fraud stories. He has won the Society of Professional Journalists Public Service Award, a Peabody award, and the Consumer Federation of America Betty Furness Consumer Media Service Award. He’s now a syndicated columnist and frequent TV guest. He is also co-host of the podcast Breach, which examines history’s biggest hacking stories. Opinions are his own.
Haven Life doesn’t provide tax, legal or investment advice. This discussion is intended as general education only. We encourage you to work with your own personal tax or legal professionals and your financial advisor. Opinions expressed by the author are their own and do not necessarily represent the views of Haven Life.