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There are alternatives for disposing of an unwanted or unneeded life insurance policy, but it’s important to understand the benefits and risks of these transactions.

Personal finance

Life Settlements Offer Alternative to Surrendering a Life Insurance Policy

  • Frank Zawlocki
  • 12/29/2016

Life insurance is a financial vehicle that consumers acquire to address individual, business, and estate planning needs. When that need no longer exists or the insurance is no longer affordable, the most common action is to terminate or surrender the policy. But there is an alternative that more people are exploring before taking the traditional approach: selling the policy to a third party in a transaction known as a life settlement.

More than a century ago, the U. S. Supreme Court ruled that a life insurance policy is private property that can be assigned as the owner sees fit.

In a life settlement, your life policy is sold to a third party, usually for more than its cash surrender value but less than the death benefit. The purchaser of the policy then becomes the owner and beneficiary of the policy upon the death of the insured.

There are several reasons for considering a life settlement:

  • Your policy is no longer needed or wanted; maybe the original reason for purchasing the policy is gone (such as a business owner who has sold their business), or personal circumstances have changed (marriage, divorce, birth or death of a child, death of a spouse, employment circumstances)
  • The policy is no longer affordable
  • You wish to purchase a different kind of life insurance policy
  • There is a current need for cash that outweighs the need for the future life insurance death benefit

While the thought of another party maintaining an insurance policy on someone’s life may seem odd, the option to sell may be a viable alternative to terminating the coverage. The policy will remain in force, but the owner of the policy will change. The buyer will take over premium payments and will receive the death proceeds upon the death of the insured.

Sellers should also be aware that they will be required to provide complete access to their medical history and other information that may affect life expectancy. Even after the sale, there may be an ongoing obligation to disclose additional information at a later date. A life settlement may also affect the seller’s eligibility for public assistance programs such as Medicaid, and there may be tax consequences.

Development of the life settlement industry

The secondary market for life insurance is relatively new, but its history goes back to 1911, when the U.S. Supreme Court ruled in Grigsby vs Russell. In this case, Dr. A.H. Grigsby treated a patient named John C. Burchard. Burchard was in need of a surgical procedure and offered to sell Dr. Grigsby his life insurance policy for $100 and an agreement to pay the remaining premiums. Dr. Grigsby agreed and the transaction was completed.

When Mr. Burchard passed away a year later, Dr. Grigsby tried to collect the benefits, but an executor of Burchard’s estate (R.L. Russell) challenged him in court and won. The case eventually reached the high court, where Justice Oliver Wendell Holmes Jr. delivered the majority opinion. In it, he established the fundamental principle upon which the life settlement industry would eventually be based: a life insurance policy is private property that can be assigned as the owner sees fit.

This legal precedent has been reinforced in the decades since, most recently with the passage of the Health Insurance Portability and Accountability Act (HIPAA). Signed into law by President Clinton in 1996, HIPAA allowed the owner and/or beneficiary of a life insurance policy to transfer the ownership and/or beneficial interest in that policy to a third party.

Viatical settlements

The modern life settlement industry can be traced back to the 1980s onset of the AIDS epidemic in the United States. AIDS patients were given short life expectancies and many individuals owned life insurance policies. The viatical settlement was created for individuals who were diagnosed as terminally or chronically ill (less than two years life expectancy). The individual could sell their life insurance policy to a third party who, in exchange for a lump sum payment today, would become the owner of the policy, pay the monthly premiums, and receive the full benefit when the insured individual expired. The lump sum payment is generally classified as an acceleration of the policy’s death benefit, so it is not taxable.

Since 2007, the National Association of Insurance Commissioners' Viatical Settlements Model Act and the National Conference of Insurance Legislators' Life Settlements Model Act have provided state-by-state regulation of the industry. The industry is now thriving as it has evolved and narrowed to select policy types and client criteria.

When is a life settlement a good alternative?

Following are some guidelines to determine if you are a good candidate for a life settlement:

  • Minimum 65-70 years of age
  • Life expectancy is 13 years or less
  • A negative change in your health since the original policy was issued
  • The policy is a universal life policy (fixed, indexed, or variable) or is a term life policy that is still convertible
  • The premiums required to maintain the policy are no more than 5 percent of the death benefit
  • The cash value is less than 25 percent of the death benefit (varies based on policy type and situation)

How we can help

Before you decide to surrender your life insurance policy, find out if a life settlement is a good fit for your situation. Carefully read the entire sales agreement, consult financial, tax, and legal advisors, and consider all available options before completing any transaction.

Disclosure: In a life settlement arrangement, the current policy owner transfers the ownership and beneficiary designation to a third party, who will receive the death proceeds upon the death of the insured. As a result, this buyer has a financial interest in the seller’s death. When an individual decides to sell their policy, he or she must provide complete access to his or her medical history, and other personal information, that may affect his or her life expectancy. This information is requested during the initial application for a life settlement. After the completion of the sale, there may be an ongoing obligation to disclose similar and additional information at a later date. A life settlement may affect the seller’s eligibility for certain public assistance programs, such as Medicaid, and there may be tax consequences. Individuals should discuss the taxation of the proceeds received with their tax advisor. Individuals considering life settlements should carefully read the entire sales agreement, consult their advisors, and consider all available options before selling their policies. ValMark Securities and its registered representatives act as brokers in the life settlement transaction and may receive a fee from the purchaser. A life settlement transaction may require an extended period of time to complete. Due to complexity of the transaction, fees and costs incurred with the life settlement transaction may be substantially higher than other securities. Neither ValMark Securities nor its registered representatives provide tax advice. ValMark Securities supervises a life settlement like a security transaction.

  • Frank Zawlocki
  • Insurance Services Director
  • CLA Madison Middleton
  • CliftonLarsonAllen Wealth Advisors, LLC
  • 608-662-9149