You may have reached a point in life where you no longer need your life insurance policy. You are nearing retirement age or already retired, your children are grown and independent, you have sufficient retirement funds, and you have concluded that the potential benefits are no longer worth the payments. You can cancel the policy… or you can sell it.
“Life settlements” refers to the process of selling your life insurance policy to a third party for some cash amount between the much lower cash surrender value and the higher death benefit. For those with short expected life spans and terminal diseases, these are known as viatical settlements.
Policies are not always easy to sell, and your policy may not have significant value, but it is something to consider as a means of getting extra cash.
It is certainly not for everyone. Unlike the regular insurance arrangement, where the insurance company is hoping you will outlive your premiums, you will be selling your death benefits to a third party — who is essentially betting that you will die sooner so that they can receive the death benefits with minimal investment in premiums.
It is unpleasant to think of your life on a cost-benefit basis, but that is the essence of insurance.
Finding a buyer for your life insurance policy and working out terms by yourself is extremely difficult; most sellers use a broker. Start by checking out the Life Insurance Settlement Association (LISA) website. You can search for brokers that are licensed in your state, along with links with company details and webpages.
Once you have found possible brokers, what else do you need to consider?
- Verify the Rules – Insurance is state-regulated, and different states have different laws regarding resale of life insurance policies. It is important to verify acceptability and options with your state insurance commission.
- Check Financial Ramifications – Your payout may be subject to income or capital gains taxes, and it could affect eligibility for government programs. Contact your accountant or financial advisor before making a final decision. In addition, consider any debts you have, as creditors may have a claim on your proceeds.
- Research the Value – This is significantly more difficult to do than with most assets, because there are no standard guidelines. Insurance policies vary, and the risks involved have to be handled case-by-case. However, you can use a 2010 Government Accountability Office (GAO) report as a guideline. They reported a typical offer range of 13-21% of the policy value (compared to around 5% for cash surrender value).
The younger and healthier you are, the less desirable your policy is to third parties. Be prepared with all your medical records to verify your health (or lack thereof).
- Consider Fees – According to the GAO, brokers’ fees in 2009 were around 9%. Keep that in mind as you do your cost-benefit analysis.
- Get Multiple Offers – Offers may vary significantly, so you need to get quotes from multiple vendors — just as you did when you bought your policy in the first place. You do not have to accept the first offer that is made.
Who loses in this scenario? Clearly, it is the former beneficiary of your policy. Once you sell the policy, they are completely cut out. If you had your children named as your beneficiary, you have made the decision that you need the money during your life more than they will after you are gone.
Treat a life insurance settlement as you would any investment: do a proper cost-benefit analysis, and you will come to the right conclusion for your situation.