You don't have to die to get money from your own life insurance policy. But the risks might outweigh the rewards
You may be familiar with some common ways to access life insurance cash before death, such as by taking a loan against a policy, surrendering the policy to the insurance company for a fixed sum, or, for those with a long-term or terminal illness, by seeking accelerated death benefits.
But in the last two decades, some older policyholders have been turning to a fourth option: life insurance settlements.
What is a life insurance settlement?
In a life insurance settlement, or life settlement, an individual—typically a senior someone who isn’t chronically or terminally ill and is expected to live awhile longer— sells his or her policy to a third party for cash. Generally, the settlement is more than the policy's cash surrender value, but less than what the policyholder’s beneficiaries would receive upon the policyholder’s death.
Settlements may be attractive to policyholders who are having trouble paying their insurance premiums and who might otherwise let their policies lapse. But this option is not without its risks.
How It Works
A policyholder might seek out bids on his or her policy by directly contacting so-called life settlement providers, or by working with a financial professional or life settlement broker that does that legwork on his or her behalf.
The value of those bids will depend on a number of factors, including the policyholder's health and life expectancy, his or her death benefit and the cost of the premiums.
Settlement providers want to know, "how much are those premiums going to be and how long are they going to have to pay them," said Darwin Bayston, president of the Life Insurance Settlement Association, a nonprofit association of life insurance settlement providers and life settlement brokers.
"The higher the premium payments, the less value that policy is going to have for the investor," he said.
Most original policyholders who take part in life insurance settlement are senior citizens with life expectancies of more than two years, according to a report by the Securities and Exchange Commission. And, generally, policyholders under age 70 without health impairments are unlikely to receive bids that are higher than the cash surrender value of their policies, according to Bayston.
Once the policyholder has some bids, he or she can decide to sell the policy for a lump sum to the highest bidder or, if he or she isn't satisfied with any of the offers, he or she can retain the policy instead.
If a policyholder goes ahead with a sale, the life insurance settlement provider who buys the policy might then resell it to an institutional investor such as a hedge fund or pension fund, or it might hold on to the policy in its own portfolio. The organization that ends up with the policy in the end is responsible for paying the policy’s premiums until the original policyholder dies. It is only then that the settlement investor collects on the death benefit.
The Risks and Costs
Regardless of your age, selling your policy benefits in a settlement isn’t without significant risk. It’s important to consider the following before making any final decision.
How much do you need life insurance?
Those who need life insurance coverage are generally advised against selling their existing policies. Even if you decide to pursue a new policy after selling your last one, the terms of your new policy may not be as favorable as the terms of your old policy due to your age or changes in your health. You shouldn’t feel pressured into making a decision on whether or not to proceed down this path.
Are you getting a fair price?
It may be difficult to assess whether a settlement bid represents a fair price because there is no transparent market for life insurance settlements. To get a reasonable offer, you might need to "shop around" and obtain bids from multiple providers.
Working with professionals, such as life settlement brokers, may make it easier to garner multiple offers, but their help isn't free. Brokers and other professionals are paid through commissions taken out of the original policyholder's lump sum payment. If you work with a professional to connect with life settlement providers, be sure to ask what his or her compensation will be. (For more questions to ask, check out FINRA’s investor alert, and if you are working with a securities broker, check out BrokerCheck to learn more about his or her professional history.)
What are the financial ramifications?
After you've received your lump sum payment, you may face taxes on your payout. A life insurance settlement may also affect your eligibility to participate in public assistance programs such as Medicaid.
It’s also important to consider the impact the settlement might have on your survivors and to consider whether their need for the benefits might change.
Before pursuing a life insurance settlement, consider consulting an accountant, attorney or other professional to understand the consequences of selling your life insurance policy.
Are you comfortable providing all necessary information?
In order to close a life insurance settlement transaction, you’ll often need to fill out a decent amount of paperwork with your personal information and to furnish your medical records (and in some cases, you may be subject to a medical exam). You may also be required to provide updates to that information over time.
Before you move forward with any settlement, it’s important to get a firm understanding of what information you’ll need to provide and determine if you are comfortable sharing that information with the life insurance investor. After all, the buyers will have an interest in your death.
Are there other options?
In working with a financial professional or other advisor, you can consider whether there might be alternative ways to fill your need for cash now. You might be able to borrow against your policy, or you might be eligible for accelerated death benefits, depending on your situation.