Despite the benefits of having life insurance, in some circumstances you may find that it would be better to receive a settlement of your insurance policy during your lifetime rather than leave the proceeds of your insurance to your beneficiaries after your death. You should consider receiving a settlement of your life insurance policy if any of the following apply to you:
In these situations, a life settlement (also known as a "senior settlement"), a viatical settlement, or an accelerated death benefit can be an attractive option.
A life settlement is, in effect, a sale of your life insurance policy before you die, for a fraction of its face value. A life settlement is often referred to as a senior settlement because it is used most often when the insured is over the age of 65 years. He or she typically has a reduced lifespan due to a chronic condition, such as cancer in remission, a heart condition, diabetes, or some other chronic condition which is not immediately life-threatening.
More commonly understood is the viatical settlement. That transaction involves a policy holder who has a terminal illness and a life expectancy of less than 2 or 3 years. This option became well known with the AIDS epidemic.
Another option is for the policyholder to surrender his or her policy to the issuing company, in a tax-free exchange for a different policy, or more commonly, an annuity. This can change a benefit payable only upon the insured's death into a steady stream of income for the insured's remaining life.
The other "early settlement" option is the accelerated death benefit. This would likely be used for an insured who is in the later stages of a terminal illness and whose death is imminent, typically expected within 12 months. This settlement allows the beneficiary to receive funds as an advance against the eventual face amount to be claimed when the insured dies.
In a senior or life settlement or in a viatical settlement, the policy holder, usually also the insured, sells his or her policy to a third party for a fraction of the death benefit of the policy. The proceeds from the sale are paid to the policy holder in a lump sum. The amount of the proceeds depends upon the face value of the policy and the health of the policy holder. The investment company that buys the policy continues to pay the premiums on the policy until the insured dies, and then collects the full death benefit under the policy. From the investment company's perspective, if the insured is healthy, it might be a long time before it can get any return on its investment. Most types of life insurance policies qualify for a life settlement, including convertible term, whole life, universal life, and survivorship policies.
There are many benefits to the life settlement or senior settlement. First of all, it relieves the policy holder of the need to pay any more premiums on the policy. When people reach their 70s, their premiums can increase dramatically. If the policyholder is on a fixed income, freeing up the money that would have gone to pay premiums can make a significant difference. Second, the insured will frequently get significantly more money for the policy than if he or she surrendered the policy to the issuing insurance company for its surrender value. Life settlement companies advertise a cash settlement typically three to four times greater than the surrender cash value. This is because the buyer of the policy will receive the full death benefit, albeit several years down the road. Third, some insurance policies are purchased to pay the estate taxes expected to be due upon the insured's death. If the estate tax is repealed, the policyholder may not feel that the policy is needed anymore.
There are also several characteristics of the life settlement which, while not necessarily disadvantages, should be taken into consideration when considering selling your life insurance policy. Compared to a viatical settlement, the proceeds received for a life settlement are significantly less. A viatical settlement may yield 50 to 80 percent of the face value to the policy holder, whereas, due to the insured's longer life expectancy, a life settlement is likely to yield 20 to 30 percent of the settlement value. However, that is still significantly higher than the cash surrender value of the policy.
Additionally, there are some unscrupulous businesses that will take advantage of an unhealthy or older policyholder. The life settlement industry is fairly new, and thus not heavily regulated. There are two common scams to look out for. The "wet paper" scam is where an investment company induces an older person to purchase a life policy, and then purchases it from the policy holder within a few days or weeks. The "cleansheeting" scam is when a person partners with the investment company to falsify his or her health screening to purchase a life insurance policy he or she couldn't otherwise obtain, for the purpose of selling it to the investment company. Either of these might constitute insurance or investment fraud.
One should also be aware of the tax consequences of selling an insurance policy. Generally, death benefits under a life insurance policy are not considered gross income. However, proceeds on the sale of a life insurance policy are considered income, and subject to capital gain. There are exceptions, so that proceeds from a life or viatical settlement or an accelerated death benefit may not be considered gross income, so long as certain conditions are met.
Under certain situations, the use of a senior settlement or life settlement can be a welcome source of funds. It allows a person to enjoy the benefits of a portion of the value of the insurance policy while he or she is still alive. Unlike the viatical settlement or accelerated death benefit options, the policy holder does not need to be near death to avail himself or herself of this option.
If you think that a life settlement may be a good option for you, please let us know and we'll be happy to explore the possibilities with you.
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.