Life settlements: To sell or not to sell?

For seniors with declining health and limited finances, a lump sum of cash can be a godsend. Life settlements may be the answer, but there are a number of factors to consider before you sell your life insurance policy.

A life settlement or "senior settlement" is where you sell your unwanted or unneeded life insurance policy to a third party, which in most cases is an investment company.

A life settlement allows you to receive a large sum of cash in exchange for your insurance policy while you are still alive, it eliminates premium payments, and it accommodates the changing financial needs of your dependents who may no longer rely on you for financial support. The settlement buyer ultimately receives the death benefit when you die.

Life settlements have raised many questions in the insurance industry, including concerns about possible insurance and investment fraud. Several insurance companies and trade groups warn policyholders about the consequences of selling their policies to third parties.

Unlike viatical settlements, which are sales of policies by those who are terminally ill, life settlements are sales of policies by folks who have impaired health.

Before you enter into a life settlement, it's important to determine whether selling your life insurance policy is your best option.

Questions to ask before you sell

• Do I still need life insurance?

• If I sell my policy, how does the buyer figure out how much cash I receive?

• If I sell my policy, who is the legal owner?

• Should I consult a tax or estate-planning advisor before I sell?

• What are the fees and commissions?

• Who will have information about me, my health and my family if I sell? How can I protect my privacy? What are the confidentiality policies of the parties involved?

• After I sell my policy, can the buyer resell it?

• If I change my mind, what happens next? How many days do I have before the transaction closes?

•What are the transaction cost?

• What are the tax consequences?

• If I decide I need life insurance after my settlement, will I be able to buy a new policy at my age and health?

• If I have a complaint about my settlement, who can I contact?

Source: The Financial Industry Regulatory Authority (FINRA)

A life settlement investment company buys life insurance policies by paying a percentage of the face value to the sellers.

From the investment company's perspective, the shorter your life expectancy, the greater the potential profit — and the higher the percentage of your death benefit you should receive as a life settlement. You generally must be 65 or older to receive a life settlement and your life expectancy must be two to 18 years; some life settlement buyers will purchase policies only from sellers age 70 and over.

Here are some main reasons policyholders consider selling:

  • The policy is simply no longer needed.
  • Beneficiaries don't need the death benefit.
  • The insurance premiums have become unaffordable.

Make sure to check out a potential buyer as much as possible. A good place to start would be your state's department of insurance.

How it works

A potential buyer must calculate the possible life expectancy of the seller in order to make an appropriate offer. You'll be asked to sign an authorization to release your medical and other personal information; this is good time to understand the life settlement company's privacy practices and how it shares information with others.

Among the factors that are used to calculate the buying price are: the death benefit amount (generally no less than $100,000 and usually higher than $300,000); the age and health of the insured person; the type of policy (whole, universal or term); the rating of the insurer that issued the policy; and the premiums needed to keep the policy in force.

When the investor buys the policy, it becomes the new policy owner, pays all future premiums and collects the entire death benefit when the seller dies. The settlement company will likely set aside the estimated future premium payments in an escrow account.

The buyer takes on a certain financial risk: They don't know exactly when you are going to die and they are paying the premiums until you do. Life settlement transactions are typically handled by investment firms and sometimes bundled into securities.

Reputable life settlement brokers will keep your personal information as a confidential portfolio asset.

Life settlement companies use various methods to determine when an insured dies so that they can submit the claim. Some firms periodically send a postcard asking you to send it back. If the postcard is not returned, the company investigates further. Others designate a third party (a lawyer, for example) to stay in touch with you.

Look before you sign

Be ready for fees

Make sure to find out what commissions and fees will be charged in your life settlement. According to a study by Deloitte Consulting and the University of Connecticut, these are typical fees:

Broker's commission of 4 to 8 percent of the face amount of the policy

Selling commission of 5 to 10 percent of gross proceeds

Life settlement company's origination fees of about 5 percent of gross proceeds

Manager's and servicer's fees of about 5 percent of gross proceeds.

While life settlements are a good option for some, the insurance industry warns policyholders to be careful. The American Council of Life Insurers (ACLI), a Washington D.C.-based trade group, points out beneficiaries will lose valuable insurance benefits if the policies are sold to an investor. Also, if someone sells his life insurance policy and his health is less than optimal, future insurance coverage might not be attainable.

Insurance companies generally urge customers to examine all options available with their current policies before they decide to sell. (See Alternatives to life settlements.) In addition, anyone considering selling a policy should consult a financial planner or attorney before signing a contract, plus their state insurance department to find out applicable laws.

Beware of schemes

The life settlement business is commonly regulated by the state's insurance department or the securities commissioner, but it is still good practice to ask the company if it's licensed. If you're not using a broker to shop around your policy, negotiate with several provider firms to determine the market value of your policy.

Avoid these well-known schemes if you are considering selling your life policy:

"Cleansheeting." This is when someone partners with an investment firm to "doctor" their medical report to improve their health on paper and then buys a life insurance policy they otherwise would not have been able to get, for the purpose of selling it to an investor.

The "stranger-owned life insurance" (STOLI) scheme. In this arrangement, a speculator convinces a senior citizen to buy a life insurance policy for the sole purpose of transferring the policy to the speculator shortly after the sale. Seniors may get a sales pitch about "free life insurance" or other financial incentives. In response, The National Association of Insurance Commissioners (NAIC), developed model legislation that calls for a five-year moratorium on the sale of a life policy after it has been purchased. Many states such as Arizona prohibit the sale of STOLI policies, according to LISA.

Jack Dolan, spokesperson for the ACLI, says there is an important distinction between legitimate life settlements and STOLI: "We understand that people who purchased life insurance to protect their families may want to investigate the possibility of a life settlement after their coverage needs cease. The real problem is with manufactured sales, where elders in particular are induced to secure coverage so that third parties can greatly profit from their demise."

"Flipping." Although not a scam per se, the flipping of life insurance policies has been receiving attention. "Flipping" is when a person — often someone with substantial financial resources — buys a large face value policy for the purpose of quickly selling it for profit. TV host Larry King sued an insurance brokerage over his life settlements after experiencing major flipper's remorse. (See The Larry King case: How not to do a life settlement.)

What to do before you sell

The NAIC offers these tips if you're considering selling your life insurance policy:

  • Comparison shop by getting quotes from several companies.
  • Find out how much tax you'll pay on the proceeds from selling your policy.
  • Find out if any of your creditors could claim your policy benefit.
  • Read the privacy notice outlining who will receive your personal information when the buyer wants to periodically check on your health.
  • Make sure all life settlement application forms are completed accurately, especially your medical history.
  • Make certain you have the right to change your mind after you receive the proceeds. Ask how many days you're allowed to reconsider.

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