What is a lifetime settlement?
A life settlement refers to the sale of an existing insurance policy to a third party for a single cash payment. The payment is greater than the cash surrender value, but less than the actual death benefit. After the sale, the buyer becomes the beneficiary of the contract and assumes the payment of his premiums. In doing so, he receives the death benefit upon the death of the insured.
Key points to remember
- A life settlement refers to the sale of an existing insurance policy to a third party for a single cash payment.
- The payment is greater than the cash surrender value, but less than the actual death benefit.
- The purchaser of the policy becomes his beneficiary and assumes the payment of his premiums and receives the death benefit when the insured dies.
- Some of the reasons why people choose lifetime settlements include retirement, unaffordable premiums and emergencies.
How living establishments work
When an insured person can no longer pay for his insurance policy, he can sell it for a certain amount in cash to an investor – usually an institutional investor. Cash payment is mainly tax-exempt for most policyholders. The insured essentially transfers ownership of the contract to the investor. As noted above, the insured receives a cash payment in exchange for the policy – more than the cash surrender value, but less than the prescribed payment of the policy upon death.
By selling it, the insured person transfers all aspects of the policy to the new owner. This means that the investor who takes over the policy inherits and becomes responsible for everything related to the policy, including the payment of premiums and the death benefit. Once the insured dies, the new owner – who becomes the beneficiary after the transfer – receives payment.
There are many reasons why people choose to sell their life insurance policies and usually only do so when the insured person does not have a known life-threatening illness. The majority of people who sell their policies for a lifetime settlement are generally the elderly – those who need retirement money but have been unable to save enough. This is why living establishments are often called higher establishments. By receiving a cash payment, the insured can supplement their retirement income with a largely non-taxable payment.
Other reasons for choosing a lifetime settlement include:
- The inability to afford bonuses. Instead of letting the policy expire and be canceled, an insured person can sell the policy using a lifetime settlement. Failure to pay premiums may result in less or no cash surrender value for the insured, depending on the conditions. A lifetime settlement on a current policy, however, usually results in a higher cash payment from the investor.
- Politics is no longer necessary. There may come a time when the reasons for having politics no longer exist. The insured may no longer need the policy for their dependents.
- Emergency cases. In cases where an unforeseen event occurs, such as the death or illness of a family member, the owner may need to sell the policy in cash to cover these expenses.
- Cases involving key individual insurance policies held by companies on officers. This is typical of people who no longer work for the company. By making a settlement for life, the company can cash out a policy that was not liquid before.
Life settlements generally pay the seller more than the cash surrender value, but less than his death benefit.
Life settlements effectively create a secondary market for life insurance policies. This secondary market has been in development for years. A number of court decisions have legitimized the market – one of the most notable being the 1911 United States Supreme Court case in Grigsby v. Russell.
John Burchard was unable to maintain payment of the premiums on his life insurance policy and sold it to his doctor, A. H. Grigsby. Upon Burchard’s death, Grigsby attempted to collect the death benefit. Burchard’s executor sued Grigsby for the money and won. But the case ended up in the Supreme Court. In his ruling, Supreme Court Justice Oliver Wendell Holmes compared life insurance to ordinary property. He believed that the policy could be transferred at will by the owner and had the same legal value as other types of property such as stocks and bonds. In addition, he said that life insurance as property has rights:
- The owner can change the beneficiary unless the insurer has restrictions in place.
- The policy can be used as collateral for a loan.
- Homeowners can borrow against the insurance policy.
- Policies can be sold to another person or entity.
Life establishments and viatic establishments
Sales of policies became popular in the 1980s, when people living with AIDS had life insurance they didn’t need. This has led to another part of the industry – the hospital industry, where people with terminal illness sell their policies for cash. This part of the industry has lost its luster after people with AIDS have started living longer.
When someone is terminally ill and has a very short lifespan, they can sell their life insurance to someone else. In exchange for a large sum of money, the buyer takes over the payment of premiums, thus becoming the new owner of the policy. After the death of the insured, the new owner receives the death benefit.
Amicable settlements are generally more risky because the investor essentially speculates on the death of the insured. Even though the owner of the original policy may be sick, there is no way of knowing when he or she will die. If the insured person lives longer, the policy becomes cheaper, but the actual return becomes lower after taking into account the premiums over time.