What is a Life Insurance Settlement?

Written By: Robert D. Cavanaugh, CLU on September 8, 2009 No Comment

Don’t feel bad if you don’t know what a life insurance settlement is all about. Most people have never heard of the practice. Here is a simple explanation. If you are aged 65 or older you can sell an insurance policy you no longer need for more than the cash value of the policy through a sale called a life insurance settlement.

The life insurance settlement transaction has been available since 1995. The purchase of the policy will probably be made through an insurance settlement company for pension or institutional fund buyers.

Although people choose a life insurance settlement for many reasons, here are the three main reasons people choose the life insurance settlement option.

1. The policy is no longer needed.

If you are like most people (78%), you, as the primary wage earner, bought a life insurance policy to provide for your family’s needs if you met an untimely death.

However, later in life these needs may have disappeared. A life insurance settlement can turn a policy that is no longer needed into more cash than simply cashing it in.

2. You have borrowed heavily against the policy.

You have borrowed the maximum amount against the policy at some point in time but not repaid the loan.

Unless you pay the interest on the loan each year, the interest is added to the amount you actually borrowed.

Over time, the loan and the unpaid interest can consume the entire cash value. That’s when you get the letter from the insurance company telling you that to keep the policy in force, you need to come up with some astronomical amount of money. But that’s not the worst of it. If the policy lapses there will likely be a gain that the insurance company is required to report to the IRS. Worse yet is the fact that there is no money in the policy to pay the tax.

A life insurance settlement can resolve everything. Once you sell the policy, the loan becomes the buyer’s problem. They will then pay off the loan and keep the policy in effect.

The only downside is that not all policies with loans are candidates for a life insurance settlement. Settlement companies may not be willing to make an offer on a policy with too large a loan or may make an unacceptable offer.

3. Interest rates have declined on your Universal Life policy

One of the factors that is used to determine the premium you pay on a universal life policy’s face value is the assumed interest rate at the time you purchased the policy. If, as has happened recently, interest rates decrease, your original premium amount might not be adequate to keep the policy in effect.

If this happens, you get a call one day to tell you that if you want to keep the policy you have to pay the difference in the premium amount. This will be some outrageous amount of money.

This problem can also be handled with a life insurance settlement.

Here are a few real examples.

A woman purchased a $1 million universal life policy many years ago. She is now 82 years old. The premium she has been paying for decades has not been enough to pay the required premium for some time. The difference has been deducted from the cash value of the policy, bringing it down to $17,800. Unless the woman can pay much higher premiums, the policy will lapse in two years.

Her estate plan demands that she keep some insurance in effect, but a much lower amount. She solves the problem by taking a life insurance settlement of $192,000. With it she buys a single-premium paid-up policy.

A mans wife died several years ago. As a result he no longer needs the $300,000 policy he has carried on his own life. He could cash it in for its cash value of $518. After investigating a life insurance settlement, he discovered he could sell his policy for $53,000. He sold it, paid off all of his bills, bought a new car, and took a fabulous vacation.

Finally, let’s look at a 65-year-old man who has a 10 year term policy that he bought when he was 55. In a couple months, it will expire. Even though term insurance has no cash value, he was able to sell it for $8,400.

This final example is a reminder that even though a term life policy has not cash value it can still be sold in a life insurance settlement.

So, if you are age 65 or older and you have any kind of life insurance policy that is no longer appropriate and fits one of the scenarios I have presented, keep in mind that you might do very well to carefully consider a life insurance settlement.

Robert D. Cavanaugh, CLU is a 39-year veteran of the life insurance, financial and estate planning industry. He publishes The Smart Giver, a planned giving educational program which teaches strategies to increase income and reduce taxes while simultaneously helping churches and non-profits. More information about how a life insurance settlement can apply to fundraising can be found on his blog.