What Is A Life Settlement?
For starters, what is a life settlement? A life settlement generally refers to the sale of a life insurance policy to a third party. The buyer pays the policyholder a single cash payment to become the beneficiary of the policy. Additionally, the new beneficiary takes over paying all future premiums.
"Most life insurance policyholders are unaware a life insurance policy can be sold to a third party for cash. Consequently, most folks will simply stop paying their premiums and allow a policy to lapse. And while this might relieve a policyholder of the monthly payments, this also forfeits all cash value the policy may have accrued over the years." - Ken Kelly, CEO Windsor Life Settlements
A life settlement will typically yield a higher payout when compared to the existing cash surrender value of the policy. When the insured passes away, the new beneficiary collects the death benefit on the life insurance policy.
Ideally, a life settlement transaction benefits both parties involved. Due to a general lack of awareness of this financial option, over $100B worth of life insurance policies lapses every year.
A Brief History Of Life Settlements
How is it that life insurance policies officially became legal “assets”? The life settlement industry has roots that stretch back all the way to a Supreme Court case in the early 1900s. The case in question, Grigsby v. Russell, included a written ruling that stated: “So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of a property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”
In other words, this case, and other judicial rulings over the years made clear that a life insurance policy is a property just like any other. Further, the owner of the policy has a legal right to liquidate that property at their discretion.
However, the life settlement option hasn’t always been on the table for seniors.
Life Insurance Options Before Life Settlements
|Surrender A Policy||Allow A Policy To Lapse|
|Redeem the policy for it's cash value. Policyholders would get a sum of money and be relieved of paying further premiums.||Stop paying premiums and allow the policy to lapse. All the years of making monthly payments are rendered worthless and the value of the policy is forfeited. Unfortunately, the majority of policyholders will simply stop paying their premiums, outright losing a valuable asset in a life insurance policy that could've generated a significant cash payment.|
Life Insurance Companies Vs The Life Settlement Option
Getting back to the original question, “what is a life settlement?”
Well, to life insurance companies, the existence of life settlements ultimately means they will pay more to consumers. So, life insurance companies are known to promote the aforementioned options to policyholders while concealing the life settlement option. However, thanks to increased regulatory pressure on life insurance companies regarding consumer education, there’s a third option. A life settlement allows policyholders to receive a larger sum than the cash surrender value. Additionally, after a life settlement, the original policyholder is relieved of the monthly premiums.
Life settlements gained popularity in the 1980s during the AIDS epidemic. AIDS and cancer led many young terminally ill policyholders to find a way to liquidate their assets to pay for end of life care or final celebrations before their passing.