A growing number of Americans are selling their life-insurance policies to get cash for retirement expenses and long-term care. These transactions are commonly called "life settlements," "senior settlements," or—if the person is terminally ill—"viatical settlements." While selling a policy may make sense in some circumstances, consumers should be cautious.
How Life Settlements Work
Life settlements involve selling a policy to a company other than the original insurance provider. As the policy owner, you typically receive more money than you would get if you cancelled or surrendered the policy, but less than the policy's death benefit. You can either shop your policy around through a life-settlement broker or contact life-settlement providers directly.
The first step is to provide copies of your insurance policy and medical records. A settlement provider then makes you an offer based on your age and health, the type of insurance, the premiums, and the death benefit.
Candidates for life settlements are typically 65 or older and own a policy with a face value of at least $100,000. "Simply put, the lower the premium and life expectancy, the more a policy is worth," says Doug Head, executive director of the Life Insurance Settlement Association.
If you choose to accept the offer, the life-settlement provider pays the amount agreed upon and takes ownership of the policy. The provider then becomes responsible for the premiums and eventually will receive the death benefit when you die.
"There are definitely instances where a life settlement makes sense," says Wendy Goldband, an independent insurance agent in Baltimore. "Your life circumstances may have changed so that you no longer need the coverage. Perhaps you've just divorced. Or you may have been hit so hard by the economy that you can't afford to keep paying premiums."
What to Watch Out For
While life settlements may sound appealing, there are several potential drawbacks. "People often don't realize that there may be tax consequences to selling a policy," cautions Bonnie Burns, a policy specialist with California Health Advocates. "And money from a life settlement can affect a person's ability to qualify for public assistance like Medicaid."
You should also be aware that your personal health information could be shared widely during the application process. And once you accept a settlement, providers can frequently check up on your health. "You're basically signing away your privacy," Burns adds.
Another issue to consider is that it may not be possible for you to get another life insurance policy. Each person's life has a maximum amount for which it can be insured. And even if you can get more insurance, you may end up paying higher premiums because you've grown older and your health may have changed.
When it comes to life settlements, one of the hardest aspects for consumers to determine is whether they're getting a fair price for their policies. The Financial Industry Regulatory Authority warns that the life-settlement industry can be prone to aggressive sales tactics and abuse. Commissions paid to brokers and other financial professionals can be as high as 30 percent. Along with the reduction of the policy's value, the amount of money the seller receives can be substantially eroded.
Consider These Alternatives
Before pursuing a life settlement, financial experts recommend exploring other options. "If you have a cash-value policy and have been paying premiums for years, you should be able to borrow money from it," says David W. Bennett, a certified financial planner from Newport Beach, Calif. "It's typically tax free, plus you'll be keeping the policy in force so your loved ones still get money later on."
People who are terminally ill have another avenue for getting needed cash. Most life insurance policies—term and cash value—now include a rider called "accelerated death benefits." This option allows you to tap into your death benefit early and use the money tax-free. Ultimately, the death benefit is reduced by the amount borrowed, plus some additional fees.
You can request accelerated death benefits by contacting your insurance company. Typically, the company will ask you to provide documentation of your health condition. Exact requirements vary, but generally you must have a life expectancy of less than two years.
When evaluating options, Bennett recommends involving adult children in the discussion. "A son or daughter may offer to help with expenses in order to keep a life-insurance policy in force, thereby preserving the value of the policy," he says. "Often, that makes the most sense for everyone financially, since the life insurance money may ultimately be needed for future parental expenses or estate-planning purposes."
Do Your Homework
If you do decide to proceed with a life settlement, do thorough research. "Call your state insurance department, and make sure everyone you're dealing with is licensed," says Thomas R. Sullivan, commissioner for the state of Connecticut Insurance Department. "Find out whether there have been any consumer complaints."
It's also important for you to understand the rules governing life settlements in your state. Many states have adopted model standards from the National Association of Insurance Commissioners or the National Conference of Insurance Legislators. Policy owners sometimes have the option of returning their life settlement and reinstating their life-insurance policy within 30 to 60 days.
Sullivan also urges you to consult with a financial or tax adviser: "Life settlements are a big decision," he says. "You need to understand all the implications for you and your heirs before moving forward."