Life Settlements: How to Sell Unwanted Life Insurance
December 11, 2020
If you have an unwanted life insurance policy that no longer serves your financial objectives, a life settlement may be the right solution. Here’s a closer look at what life settlement transactions entail when they might be the right fit, and important considerations before seeking a life settlement.
What is a Life Settlement?
A life settlement is an alternative to a lapse or surrender of an existing life insurance policy.
Life settlements have been around since the 80s. They’ve been known as buy ethical settlements or life insurance settlements, but the easiest thing to call them is a life settlement.
A life settlement involves the sale of an existing life insurance policy, generally on the life of a senior over 70 years old, and typically there’s been a change in health from the time the policy was issued to the time of the life settlement.
Why Clients Might Choose a Life Settlement
People do life settlements for a variety of reasons. They’re usually because of a change in some circumstances.
For example, somebody’s had a change in wealth where their finances are less than they used to be and they need some instant cash, or their estate planning has changed where the laws now are over $20 million of exemption for payment of federal estate tax. These policies may have been purchased for the purpose of payment of an estate tax. So if you no longer need that policy, the policy could be a candidate for a life settlement.
Or, some people just want to stop paying premiums on life insurance policies and this is an alternative.
How a Life Settlement Transaction Works
Let’s say someone has an existing policy with a million-dollar death benefit and $50,000 in cash value. And let’s say they’re considering lapsing or surrendering the policy for the $50,000 of cash value.
Instead of the insurance company paying $50,000 directly to the owner of the policy, a life settlement is the sale of that policy for greater than that $50,000 in cash value and less than the $1 million death benefit. It’s like an auction is created where buyers will (if interested) make a bid on that policy. Maybe $75,000, $100,000, or $150,000. We’re going to go with the buyer who makes the highest bid on the policy.
Once we arrive at the highest bid and the client says, “Yes, I want to sell the policy,” Schechter will help to close that transaction, get all the paperwork together, prepare that paperwork for the client, and ultimately see through to the end of that process, which is the change of ownership and beneficiary and the client receives their money.
What Schechter Looks for When Considering a Life Settlement
Oftentimes, Schechter identifies life settlement opportunities through the process of a general insurance portfolio review. Advisors sit down with a client once a year or at least once every other year. In this process, the firm looks at the client’s permanent insurance policy, looking at the objectives for which they purchased that policy, its performance, the cash value, and talking about the client’s needs at the time.
Oftentimes there are changes in circumstances for a client. Let’s say their estate or net worth is different than it was when they bought the policy. Maybe they no longer need that policy. They may have issues where they need instant cash and this is a source of liquidity or other changes in personal or business circumstances.
What Policies Qualify?
In general, the policies that qualify for life settlements are permanent policies that include universal life index, universal life variable, universal life first-to-die, or second-to-die. Sometimes people think, “Well, I have term insurance, which is not permanent, so that’s not going to be a life settlement candidate.” The good news is if that policy can still be converted to a permanent policy–a universal life or one of the other policies–you can then transact a life settlement.
In general, whole life insurance policies are a favored type of insurance in the life settlement market unless the insured is very unhealthy.
Common Concerns for Clients
Some concerns in the settlement market that clients have expressed are things like, “I have a stranger owning a policy on my life now, I don’t have control of the policy anymore, and somebody I don’t know owns the policy.” The truth is, the client is like a mortgage holder in a portfolio of mortgages. These buyers buy hundreds to thousands of life insurance policies.
One of the other considerations in a life settlement is the tax impact. To return to the previous example, let’s say you are a client with a $50,000 cash value and you’ve paid $100,000 into the policy over the life of the policy and you decide to sell that policy for $200,000 in the settlement market. The taxes are long-term capital gains tax above the cost basis, or the premiums paid into the policy.
Schechter also advises every client that this is a serious transaction. There’s legal paperwork that’s produced, and the firm would like the client’s attorney and accountant to be involved if at all possible to give advice and ask questions. Schechter is happy to work with advisors for clients to decide if this transaction is in their best interest.