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Have you been considering a life settlement? You need to make sure it’s a good idea for you before you sign anything.
What Is a Life Settlement?
A life settlement consists of the cash sale of an individual’s life insurance policy to a third party. This is similar to the 1980s stop-gap known as a viatical settlement, which developed during the AIDS epidemic. At that time, many policy holders chose to sell their life insurance when they learned they wouldn’t live as long as they had expected when they initially bought the policy.
When medical advances changed the needs of the community living with AIDS and viatical settlements became less useful, the life settlement industry arose. A life settlement does not involve terminal illness; it’s just a sale of the policy to a third-party. Basically, a firm will pay you more than the cash surrender value of your policy, but less than the full benefit amount. The third party will then pay all your premiums from that point on, and receive the full death benefit.
A life settlement does not involve terminal illness; it is just a sale of the policy to a third-party.
Two types of “middlemen” are often involved in the life settlement business: life settlement brokers and life settlement providers. The life settlement broker represents you as the seller of the policy and has a duty to you. The broker’s job is like a realtor’s; they “shop” your policy around from provider to provider. This interaction with providers (who represent purchasers) are how brokers earn their fee.
Like realtors, brokers have the obligation to help you look at the offer price, the funding source, the overall gain you’ll get from the sale, tax concerns, and privacy issues arising from the sale. Make sure before you work with a broker that you know exactly what their fee is. In most states, working as a life settlement broker requires a license, and brokers must take continuing education courses.
How do investors decide when to buy and for how much? Obviously, investors buy these policies to make a profit. If the cost of the ongoing premiums plus the price at which they can buy your policy is less than the death benefit, then it’s a good deal for them. It could be a good deal for you, but only if you can’t do better in any other way.
The life settlements industry, according to the Life Insurance Settlements Association (LISA), has experienced impressive growth. In 2008, Conning Research reported that the business generated by these kinds of settlements showed a 19% compound growth rate over the previous decade.
Sound morbid or sketchy? It isn’t illegal, but there are serious qualifiers that govern this area.
What Are the Risks and Benefits?
It’s not easy to list all the legal risks that can arise from life settlements, but in general there are at least five risks to watch out for:
- Compliance with regulatory laws: Regulation in this area is new, and it differs from state to state.
- Fraud: The market of seniors who need cash urgently is a very vulnerable one, and it attracts fraudsters.
- “Insurable interest” legal issues: Insurable interest in this context means the right to benefit from life insurance; viatical and life settlement agreements have been recognized as an exception along with charitable donations, but this goes against the conventional wisdom.
- Structure of settlements: Life insurance settlements are most profitable for buyers, brokers and, in the case of policies bought late in life for high premiums, insurers. They are least profitable for sellers.
- Viability of life settlement funds (when used): There are many questions you ought to ask of these investment funds before getting involved with them; check out this resource list.
Today’s policies sell at anywhere from 10% to 70% of their total value; the big winner in terms of gain is still the policy you hold on to.
The United States Senate Special Committee on Aging, the U.S. Government and Accountability Office, and the Wharton School of the University of Pennsylvania have each concluded that, on average, life settlements yield more for consumers than cash surrender values.
The Wharton study also concluded that the life settlement trend inflates the cost of life insurance generally. Furthermore, today’s policies sell at anywhere from 10% to 70% of the their total value; the big winner in terms of gain is still the policy that gets held onto. And these studies do not discuss the possibility of accelerated benefits.
Watch Out for Bad Practices and Bad Deals
By 2007, the life settlement industry had attracted the attention of the SEC and lawmakers. Various individuals and companies without any insurance or investment knowledge or experience had jumped into the life settlements industry and rendered it unsafe. The more recent advances towards regulation of the industry have protected many from bad practices, but bad deals are still common.
These practices are typical “predatory” behaviors in the life settlement industry:
- Unfair pricing on policies that does not reflect competitive market prices.
- Failure to ensure that the policyholder has all of the information on other options.
- Use of settlement forms and closing documents that are unfair or obtuse.
- Making unreasonable promises to the policyholder or insured.
What Are My Options?
Accelerated Death Benefits
If you fit into one of four categories that indicate to insurers you’re toward the end of your life, there is a good chance you can get accelerated death benefits. This means the insurer will pay you partial benefits before you die. The amount of the advanced benefits vary based in large part of whether the policyholder is current. But since the benefits can be as high as 80%, this is important to investigate.
Typically there are four situations where accelerated death benefits come into play:
- Where there is a terminal diagnosis with a life expectancy of 6 months to two years
- Where the policyholder is permanently in need of nursing care facility
- Where the insured is unable to perform day to day living activities or otherwise care for themselves
- Where there is a diagnosis of an awful disease like cancer – but not necessarily a terminal disease
Remember, today’s policies sell at anywhere from 10% to 70% of the their total value, and the average is only 20%.
Alternative Maintenance of Existing Policies
If your heirs can afford to maintain your policy with their own money, this will bring the highest dollar amount for your policy. If they have enough to make up your current cash deficit, you should consider this option.
The biggest thing to realize is that as well as investors do with your policy, your children or other heirs do better. If you—or they, with their own money—keep the policy alive, they will gain as much death benefit as the investors, and will not have to pay income taxes on that money. It’s worth noting that your estate may owe federal estate taxes. Your beneficiaries can preserve this tax-free, high-yield asset by investing their own money into your needs and/or assuming the premiums on the policy.
This all means that you can often maximize your estate value by selling off other assets and keeping your life policy. Life insurance policies that have been maintained are very valuable towards the end of life—this is why investors are after them. Creative alternatives to selling a policy should be your top priority before making any decisions.
Life insurance policies that have been maintained are very valuable toward the end of life… Creative alternatives to selling a policy should be your top priority before making any decisions.
The Bottom Line
Research shows that the life settlement market is inefficient, especially for sellers, because of the costs of the sales transaction itself. Research also indicates that when policyholders receive better insight into the issues surrounding transactions, the actual market that benefits from life settlements will be much smaller than the current number of sales would suggest. That’s because a life settlement is only the best option for people without any beneficiaries or estate deficits. Almost everyone has some kind of family or charitable needs, so this is a very limited market.
- A firm might pay you more than the cash surrender value of your policy, but it will be less than the full benefit amount; investors buy these policies to make a profit.
- Today’s policies sell at anywhere from 10% to 70% of the their total value; the big winner in terms of gain is still the policy that gets held onto.
a life settlement is only the best option for people without any beneficiaries or estate deficits
- Watch out for unfair pricing, failure to tell you about alternatives, use of settlement forms and closing documents that are unfair or obtuse, and unreasonable promises.
- You may be able to get accelerated death benefits of up to 80% of your policy’s value.
- You can often maximize your estate value by selling off other assets and keeping your life policy.