Each year, it is estimated that 250,000 life insurance policies with a combined face value of $57 billion are lapsed or surrendered. Add term policies to the equation, and that figure jumps to $110 billion.

That’s only part of the story. According to the American Council of Life Insurers, 88 percent of universal life policies are ultimately lapsed or surrendered, and 98 percent of term policies lapse without paying a death benefit.

At American Business, we educate trusted partners and their clients on life insurance matters that can better inform their decision-making when it comes to life, long-term care and disability insurance protection. It’s a role we cherish playing, so given these remarkable numbers, we feel very strongly about helping you and your clients understand life settlements—specifically, how life settlements can potentially offer significant benefits for insured individuals and their loved ones.

What is a Life Settlement?

A life settlement is the sale of an unwanted life insurance policy to a licensed institutional investor. The qualified policyholder receives a lump sum payout that can be significantly greater than its cash surrender value. The purchaser assumes responsibility for payment of the premiums and becomes the policy's beneficiary, while the seller is relieved of the burden of paying future premiums.

Life settlements evolved from the viatical settlements market of the early 1990s, where terminally ill policyholders (primarily afflicted with AIDS or cancer) had a life expectancy of 2-5 years. Private investors were the primary source of capital, and oftentimes, the policy was sold to a party or parties who knew the insured.

Since then, an institutional market has developed, and today, policy sellers generally are individuals who have had a change of need rather than a dramatic change of health.

Who Qualifies for a Life Settlement?

The insured policyholder generally is age 70 or older; has experienced a change in health since the policy was originally issued; and has a life expectancy of less than 15 years.

As for the policy type, typically it’s classified as universal life, variable universal life, indexed universal life or survivorship universal life. Whole life policies do not apply due to the inflexibility in the premium structure. Additionally, term policies with a conversion option apply, and the policy amount typically is between $500,000 and $5 million.

What a Life Settlement is NOT…

• An investment opportunity
   
• Stranger Owned Life Insurance (STOLI), aka, an arrangement to initiate or facilitate the issuance of a new policy for the benefit of an investor who has no insurable interest in the life of the insured.
   
• Premium finance or non-recourse premium financing

When is a Life Settlement Appropriate or Advantageous?

A life settlement may be appropriate under a number of different scenarios. Consider some common examples:

• Estate planning requirements change
   
• Insurance premiums become a financial burden
   
• A mortgage is paid off
   
• Children become financially independent
   
• A business is sold

The common denominator is that the existing policy no longer fits the needs of the policyholder. At the time, buying the policy may have made good sense. But a lot can change in life, and what once was a good idea may now represent an undue burden. Generally, good candidates for a life settlement are policyholders over age 70 whose health has changed since their policy was in effect and whose policies have a face value greater than $250,000. However, the owner of the policy can be an individual, trust, company or nonprofit.

The types of life insurance that qualify for a life settlement are broad and include:

• Universal Life
   
• Variable Life
   
• Some forms of Term Life
   
• Survivorship
   
• Whole Life

Can a Business or Charity Benefit From a Life Settlement?

In many cases, yes. A life settlement can be an appropriate option for life insurance-funded businesses whose owner has sold the business or retired. Businesses can also benefit from a life settlement when an employee, for whom key person insurance or a deferred compensation plan was purchased, has left the company. Charities and nonprofits can use a life settlement strategy to monetize what may appear to be illiquid assets.

What Factors Determine the Size of a Life Settlement Payout?

The most critical factors affecting the amount of a life settlement include the insured’s age, health and the future required premiums. The type of policy, insurance company rating, face value, outstanding loans and cash values are also important. The payout amount is also affected by the market offer secured for your client, which can vary greatly.

What is the Tax Treatment on a Life Settlement?

Each client should consult their tax advisor on their own tax situation. Generally, the proceeds from a life settlement are tax-free up to the cost basis of the policy. The difference between the policy’s stated cash surrender value and the original cost basis is taxed as ordinary income, and anything above the cash surrender value is taxed as capital gains.

What is the Process of Pursuing a Life Settlement?

American Business specializes in helping clients navigate the life settlement marketplace from inception through completion, ensuring the client receives the highest offer for their policy.  

Trusted Insurance Partners Are Best Suited to Help CPA Clients Navigate Life Settlements

A life settlement can be an ideal vehicle to help a policyholder sell an unwanted policy at an attractive rate; receive a lump sum payout in the process that may be significantly greater than its cash surrender value; and avoid paying future premiums. At American Business, we believe the path toward obtaining life settlements is one best traveled alongside an experienced and trusted advisor. We hope this article helped you understand the basics behind life settlements, and how they can potentially help your clients in numerous ways. We appreciate the opportunity to highlight this topic and help you and those close to you navigate the complex and evolving life, long-term care and disability insurance landscape.