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What Is a Life Settlement?
Let me explain what a life settlement really is. It's when you sell your existing life insurance policy to a third party for a one-time cash payment. This payment is more than what you'd get if you just surrendered the policy, but it's less than the full death benefit. Once the sale goes through, the buyer takes over as the beneficiary and starts paying the premiums. That means when the insured person—you or whoever is covered—passes away, the buyer collects the death benefit.
You should know that a life settlement is pretty similar to a viatical settlement, but I'll get into the differences later.
Key Takeaways
To sum it up quickly, a life settlement is about selling your policy for cash to someone else who then pays the premiums and gets the death benefit. People do this for reasons like retirement needs, premiums they can't afford anymore, or emergencies. It's not the same as viatical agreements, which are for terminally ill folks, and since it's a transfer from the owner, it doesn't count as illegal stranger-owned life insurance (STOLI).
How Life Settlements Work
Here's how it actually operates. If you can't afford your insurance policy anymore, you can sell it to an investor—often an institutional one—for some cash. For most policy owners, this cash is largely tax-free. You're basically handing over full ownership of the policy to the investor. In return, you get a payment that's better than the surrender value but not as much as the death benefit payout.
By selling, you transfer everything about the policy to the new owner. They take on all responsibilities, including paying premiums, and they get the death benefit when you die. Life settlements are legal in most of the U.S., and because it's you as the owner making the transfer, it's not considered STOLI, which is against the law.
Why Choose a Life Settlement
You might wonder why someone would go for this. Typically, it's when the insured doesn't have a life-threatening illness, and it's common among older people who need retirement money but didn't save enough. That's why they're sometimes called senior settlements. The cash you get can boost your retirement income, and it's mostly tax-free.
Other situations include when premiums are just too high—if you let the policy lapse, you might get a small surrender value or nothing at all, but selling via a life settlement usually gets you more from an investor. Or maybe you don't need the policy anymore because your dependents are set. Emergencies, like a family member's death or illness, can also push you to sell for quick cash. Even companies might do this with key person policies on former executives to liquidate an otherwise illiquid asset.
Remember, a life settlement generally gives you more than the surrender value but less than the death benefit.
Life Settlements vs. Viatical Settlements
Let's compare this to viatical settlements. These got big in the 1980s with AIDS patients who had policies they didn't need. In a viatical, if you're terminally ill with a short life expectancy, you sell your policy for a lump sum. The buyer pays the premiums and gets the death benefit when you pass.
Viaticals are riskier for the buyer because they're betting on how soon you'll die. If you live longer than expected, the policy costs more in premiums, and the return drops. Life settlements, on the other hand, aren't tied to terminal illness—they're for anyone looking to cash out.
Special Considerations
Life settlements have created a secondary market for life insurance policies, and it's been building for years through court rulings. A key one was the 1911 Supreme Court case Grigsby v. Russell, where Justice Oliver Wendell Holmes ruled that life insurance is like any property—you can transfer it, change beneficiaries (unless restricted), use it as collateral, borrow against it, or sell it to anyone.
In that case, a guy sold his policy to his doctor because he couldn't pay premiums, and the court upheld it as valid property transfer.
Who Does a Life Settlement Broker Represent?
If you're dealing with a broker, know that they represent you, the policy owner, and they might have a fiduciary duty to get you the best deal. Their role is to find the highest bidder for your policy.
Which Life Insurance Settlement Option Guarantees Payments?
You can structure a life settlement as an annuity, which guarantees payments until the beneficiary dies.
What Is a Single Life Settlement Option?
In a single life settlement, payments stop when the annuitant or beneficiary dies. A joint life version keeps paying until the surviving spouse passes, if they outlive the annuitant.
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