A Roadmap to Life Settlements

A Quick and Informational Guide for Financial Professionals


In the insurance world, “life settlement” transactions are a new trend gaining popularity. Virtually every insurance professional has heard about this industry in the news, online, or through other professional forums. This innovative and fast growing market has seized the attention of financial markets, insurance professionals, and senior consumers all over America. Yet, BGA’s, MGA’s, and other interested parties seeking to learn more about life settlements are puzzled by the overwhelming, yet fragmentary, information emerging from all types of sources. A simple Google search for “life settlements” instantly yields over 4 million results. Where to start? This article provides financial professionals a good place to begin. Here, you will find basic definitions and explanations to help develop a simple and clear picture of life settlements.

A life settlement is a financial transaction in which a policyowner possessing an unneeded or unwanted life insurance policy sells the policy to a third party. The policy is sold for more than the cash value offered by the life insurance company but for less than its death benefit. The purchaser becomes the new beneficiary of the policy and is responsible for all subsequent premium payments

Will this benefit my client?

There are countless scenarios that might encourage a policyholder to exit a life insurance arrangement. Insurance companies mainly offer their customers two choices: lapse or surrender. A life settlement is a third option available to some. This type of transaction is a revolutionary option for a growing number of policyowners. A life insurance policy is a form of property such as a car or a house. Policyowners are free to sell and transfer ownership of their policies. Rather than continuing to pay premiums on a policy that no longer serves its original purpose, life settlements offer payoffs that can be significantly greater than surrendering a policy.

According to a report issued in July 2010 by the Government Accountability Office (GAO), American consumers benefit from the existence of a regulated life settlement market, documenting that life insurance policyowners received an average of 7 times more in a life settlement than if they had surrendered their policies back to the insurance company.  Unquestionably, life settlements offer a rational and profitable exit strategy that addresses the financial objectives of policyholders.

Investors are attracted to life settlements for a number of reasons. This type of investment provides reasonable expectations of higher-than-market returns and is not affected by the performance of financial markets.

A Life Settlement is not an option for every policyowner.

The usual candidate for a life settlement is age 65 or older and owns a life policy with a face amount of $250 thousand or more. A settlement is only possible when the policy’s market value exceeds the cash surrender value. The key factors determining the market value of a policy are the death benefit, cost of premiums, and the life expectancy of the insured. The life expectancy is usually the key driver in determining the market value. In simple terms: the lower the premium and life expectancy, the higher the market value.

Market value of policy = present value of death benefit – (present value of future premiums + acquisition costs)

What to look for when considering a Life Settlement?

Life settlements are complex financial transactions and are generally conducted on behalf of clients by experienced professional advisors. When representing a client, financial professionals have a fiduciary duty to represent the best interests of that client. Compensation for service can be paid by fee or, if licensed, by commission.

Financial professionals must also recognize that life settlements regulation varies by state. It is important to find out what regulations regarding life settlements – if any – apply to their state. The key regulations tend to concern licensing rules and whether brokers and providers must provide certain legal disclosures.

The next consideration is whether to work with a life settlement broker or a life settlement provider. It is possible to engage in a life settlement through either option. However, most settlements are conducted through a broker, who can then solicit multiple competitive bids on behalf of the insured. The advantage of working directly with a provider – which is only responsible for its own bid – is that intermediaries are eliminated from the process. The ultimate goal is to obtain the best possible settlement on the best possible terms.

Steps to settle a policy

Application - After choosing proper representation to settle a policy, the client must fill out an application and provide proper documentation.

Documentation - The settlement broker or provider will then review the documentation, such as insurance and medical records. Settlement companies can work with the advisor or directly with the policyowner.

Review - The settlement company submits the insured’s medical records to be reviewed by an independent life expectancy company. Life expectancy companies calculate the probable life expectancy of an insured by using actuarial and physician experts who apply probability theory, actuarial methodology, and medical analysis using the records of the insured.

Policy Match - At this stage, the settlement firm calculates the probable market value and determines suitability for sale. If the policy has no market value, the process ends.

Offer - Having determined that the policy has enough market value for a settlement, the provider relays the offer to the client’s advisor. If the offer is declined, the policyholder can seek other offers with other settlement providers. If working with a life settlement broker, the broker must seek offers from different providers and present all offers to the seller of the policy.

Closing Package - If the seller accepts an offer, the provider that made the offer sends a closing package to the advisor or client for review and signatures. The funds for the settlement transaction are then placed in an escrow account.

Notification - When the signed documents are returned, the insurance carrier is notified of policy ownership transfer.

Funds Transfer - Upon written verification of the change of ownership, the escrow account releases the settlement payment to the seller of the policy and, if applicable, the commission payment to the appropriate parties.

Other Considerations

Note that some or all of the proceeds of a life settlement may be taxable. Generally, the proceeds of a life settlement are treated on three different levels. The amount recouped up to the cumulative premiums paid is tax free. Additional money up to the cash surrender value option is treated as ordinary income. Any excess cash above the cash surrender value is considered capital gains. Assistance should be sought from a professional tax advisor. The proceeds of a life settlement could also be subject to the claims of creditors. If the seller is within two years of death, other laws may apply.