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."