What is a life settlement?
A life settlement is the sale to a third party of an existing insurance policy for more than its cash surrender value, but less than its net death benefit. In a life settlement, the insured is generally 65 years of age or older and does not have a terminal or chronic illness.
Life settlements benefit senior citizens by offering a valuable option for unneeded or unwanted life insurance policies over the alternative of surrendering it or allowing it to lapse.
Why would a policy owner sell his or her life insurance policy?
A life settlement may provide. a better alternative than allowing an unneeded policy to lapse or to be surrendered for its cash value. Life settlements are considered for a variety of reasons, such as:
- A policy is no longer needed or wanted (e.g., spouse dies, divorce, children are grown up and financially responsible, etc.)
- Changes in estate, tax or financial plans or changes in law, etc., occurring subsequent to policy issuance can cause an individual to consider lapse or surrender of a policy
- Funds are needed to pay for long-term care or healthcare costs;
- Premium payments have become unaffordable as policy owners grow older
- Investment in the insurance is no longer appropriate.
Who purchases life insurance policies in life settlements?
Today, multi-national banks, international corporate conglomerates, global insurance companies, pension funds, hedge funds and other major financial institutions—the same institutions that invest in life insurance companies—are purchasing life insurance policies through life settlements. Two of the largest insurance holding companies in the United States, Berkshire Hathaway and American International Group, have been significant purchasers of life insurance policies.
Overturning prior guidance, the Financial Accountability Standards Board issued a technical bulletin (FSP FTB 85-4-1) on March 27, 2006 to permit acquirers of life insurance policies to elect to account for their investments in life settlement contracts using either an investment method or fair value method. It is believed that FASB’s policy change will result in additional U.S. institutional investors participating in the secondary market for life insurance policies.
What types of policies can be purchased?
Most life insurance policy types qualify for a life settlement, including universal life, adjustable life, variable life, whole life, survivorship, joint first to die, portable group life, and even term life, if convertible (and assignable). Policies can be owned by individuals, corporations, partnerships, trusts and charities.
How much will the owner be paid for his or her policy?
The amount to be paid to the owner of the policy depends upon a number of factors, including the face amount of the policy, the amount of premiums that will have to be paid to keep the policy in force, and the cash surrender value of the policy.
Is the process confidential?
Yes. No medical, financial or personal information is disclosed to any person or entity without specific written consent, unless required by law.
If a policy is large, does all of it have to be sold?
No. Often the insurance company will allow you to divide the policy into multiple parts, the owner retains one part, and they may sell the other part as long as it has a death benefit of at least $250,000.
Are there any restrictions as to how I could use the settlement amount?
The selling policyholder is free to use the settlement as he, she or it chooses. Some owners use proceeds to purchase long-term care insurance. Others gift the money to family members and charities or fund investments. Still others use the money to enhance the quality of their lives.
Is the buying and selling of existing life insurance policies regulated?
Yes, in many states. The National Association of Insurance Commissioners, representing insurance commissioners from all 50 states, adopted a model act, the Model Viatical Settlement Act (the “Model Act”), that has been partially adopted in as many as 29 states, and legislation to regulate life settlements is currently pending in numerous other states. The Model Act was first introduced in 1993 to regulate the sale of life insurance policies by a protected class of terminally ill individuals, and was expanded in 2001 to regulate all persons selling life insurance policies. Regulation of life settlements is generally administered through the respective insurance departments of each state. In a number of states where life settlements are not regulated, members of the life settlement industry are working with state legislators to enact such regulation.
Life settlement statutes in most states require life settlement providers to obtain a license from the state in order to enter into life settlement transaction. Providers are required to submit extensive information on the company and its principals, all of which is reviewed by the state’s department of insurance, to obtain a license. In addition, all forms of application, purchase agreement, and other ancillary documents that a provider intends to use for a life settlement transaction must be approved for use by state regulators. Generally, life settlement providers must renew their licenses annually or biannually and must file an annual report in each state in which they are licensed.
The business of insurance, itself, is not federally or nationally regulated. Instead, the McCarran-Ferguson Act (15 U.S.C. §§ 1011-15) of 1945 gave continued authority to the states to regulate the business of insurance. While the states’ authority over the business of insurance has been limited by federal statutes enacted since the McCarran-Ferguson Act, states retain primary control over it.
How does a life settlement work?
Life settlements typically begin with the filing of a settlement application by a policy owner and insured, together with necessary documentation. A life settlement provider will verify the insurance coverage and the insured’s medical status, and will determine the policy’s viability for a life settlement (including reviewing the case for potential fraud). The life settlement provider will also determine suitability for funding and will match the policy with an appropriate institutional funding source that could acquire the policy. The life settlement provider will then relay an offer to the advisor of the insured or, if different, the owner of the policy. If the offer is accepted, a closing package will be delivered to the advisor of the insured or, if different, the policy owner. Signed documents are then returned to the life settlement provider and, assuming everything is complete, the insurance carrier is notified. Following written verification of the change of ownership of the policy, settlement funds are transferred to the insured or policy owner (as applicable) from escrow.
Are life settlements good for the consumer?
Yes. More than $9.7 trillion of individual life insurance was in force on 167.7 million policies at the end of 2004, according to the 2005 Life Insurers Fact Book, compiled by the American Council of Life Insurers, and almost 9 of 10 universal life insurance policies are lapsed or surrendered (approximately 40 percent in the first five years from the date of issuance of the policy).
The average life settlement pays a policyowner three to five times more than the cash surrender value of the policy, and often many times more. Since 2001 over a billion dollars in excess of the cash surrender value has been paid to senior citizens who chose to sell, rather than lapse or surrender, their life insurance policy.
The money that seniors receive may be used to improve a home, fund a grandchild’s education, start a small business, pay medical expenses, repay debts or deal with an unexpected life change. For those consumers, the ability to sell some or all of their life insurance policy provides flexibility to meet pressing financial needs with money that ultimately belongs to the policyowner.
Are life settlements common?
Legal and financial advisers, as well as insurance agents and brokers, are becoming more knowledgeable about life settlements, as are senior citizens. It is estimated that by the end of 2005 over $10 billion in face amount of life insurance had been sold and purchased through life settlements. This number is expected to grow steadily — according to analysts at Sanford C. Bernstein & Co., LLC, to more than $160 billion over the next several years—as more senior citizens and their advisers and agents, as well as institutional investors, learn about life settlements.
What are the tax implications of a life settlement?
It is generally understood that the amount of the settlement that equals one’s cost basis (usually the aggregate amount of premiums that have been paid) is not taxable. If one were to surrender one’s policy, the amount in excess of one’s cost basis up to the cash surrender value that one could get from the insurance company is taxed at ordinary income tax rates. The amount received in a life settlement in excess of the cash
surrender value is taxed as capital gain.
How long does it take to complete the transaction from start to finish?
Assessment of the policy can be completed in about one week. After that, the process depends on how fast the closing documents are completed. The process can take as little as two or three weeks but often takes longer.
Why is institutional funding for life settlements important?
Life settlements provide maximum protection from the fraudulent practices and personal privacy risks that too often plagued the viatical industry. The recent cases involving individual investor fraud have made clear the importance of large investors, which are experienced risk and case managers. Moreover, individuals are ensured greater privacy protection throughout the life of the policy. The influx of institutional sources of capital has expanded the life settlement market. This results in significant benefits to policyholders, life insurers and investors themselves. These sophisticated financial investors, including multi-national banks, international corporate conglomerates and global insurance companies, offer policyholders maximum value in a competitive market.
What is non-recourse premium financing?
Consumers have become increasingly aware that the market value of their life insurance policies includes the right to exercise the assignment clause by selling on the open market. This secondary market value is commonly exercised when a policyowner pledges the policy as collateral for a loan, such as a business loan or a personal loan.
Consumers are now able to use the market value of their life insurance policies to obtain financing to pay premiums for new or in-force life insurance. So-called “non-recourse” premium financing helps prospective policyowners and policyowners obtain and maintain needed life insurance. Non-recourse premium financing uses only the market value of the policy itself as collateral to support the loan.