Life Settlement

What it is

A life settlement is the sale of an existing life insurance policy to a third party for a one-time cash payment. The payment is typically greater than the policy’s cash surrender value but less than the death benefit. After the sale, the buyer becomes the policy owner and beneficiary and assumes responsibility for future premium payments; when the insured dies, the buyer receives the death benefit.

How it works

• The policy owner sells the policy to an investor (often an institutional investor).
• The seller receives a lump-sum cash payment—generally higher than surrender value, lower than the death benefit.
• The buyer takes ownership, pays ongoing premiums, and collects the death benefit when the insured dies.
• For many sellers the cash is largely tax-advantaged, but tax treatment can vary and should be confirmed with a tax advisor.
• Because the transfer is made by the policy owner, legitimate life settlements are not the same as illegal stranger-owned life insurance (STOLI).

Why people choose a life settlement

Life settlements are most commonly used by older policyholders who need liquidity. Typical reasons include:
* Supplementing retirement income.
* Avoiding lapsing the policy when premiums become unaffordable; a settlement often pays more than surrendering the policy.
* The policy is no longer needed (dependents no longer require coverage).
* Covering unexpected expenses or emergencies.
* Cashing out corporate key-person or executive policies that are otherwise illiquid.

Life settlements vs. viatical settlements

• Life settlement: sale of a policy by a policyowner who is generally not terminally ill; buyer expects a return over an uncertain time horizon.
• Viatical settlement: sale of a policy by someone with a terminal illness or severely reduced life expectancy. Buyers are effectively betting on a much shorter time to payout.
• Viatical settlements are generally riskier for investors because if the insured lives longer than expected, premium costs rise and returns decline.

Market and legal background

Life settlements create a secondary market for life insurance. Courts have long treated life insurance as transferable property. A notable legal precedent established that a policy owner may transfer rights in a policy much like other property, enabling:
* Changing beneficiaries unless restricted by the insurer.
* Using the policy as collateral.
* Borrowing against a policy.
* Selling a policy to another person or entity.

Role of brokers and representation

A life settlement broker represents the policy owner and typically seeks to obtain the best offer. Brokers may owe fiduciary duties depending on jurisdiction and contract terms; sellers should confirm the broker’s obligations and fee structure up front.

Settlement structures and options

• Lump-sum settlement: single immediate payment for transfer of the policy.
• Structured settlement/annuity: periodic guaranteed payments for a set term or until death.
• Single-life settlement: payments stop at the death of the annuitant.
• Joint-life settlement: payments continue until the last covered beneficiary dies (if structured that way).

Key takeaways

• A life settlement converts a life insurance policy into cash by selling it to a third party who becomes the beneficiary and pays future premiums.
• Sellers typically receive more than surrender value but less than the death benefit.
• Common motivations are retirement funding, unaffordable premiums, or changing needs.
• Viatical settlements involve terminally ill sellers and present different risk profiles.
• Sellers should evaluate tax consequences, fee arrangements, and legal protections before proceeding.