Have you ever thought it would be nice to enjoy the benefits of a life insurance policy before the insured’s death? Sometimes, these insurance policies are no longer needed. Perhaps you bought a whole life policy twenty years ago to protect your family if you died, but that need is no longer there. Maybe you purchased life insurance to keep a loan officer happy during the term of a loan, but the loan has been paid off. Regardless of the situation, things change - and so does your need for insurance - but does it make sense to cash in the policy? What if there is another way to get value without settling for the cash value of your policy? Well, there is - and it’s called a “life settlement”.

A life settlement is essentially the sale of an insurance policy for its fair market value, typically an amount greater than the cash surrender value, but less than the face amount. Once the sale is effectuated, the new owner takes responsibility for the payment of future premiums. A wide range of policies can qualify for a life settlement, including term policies in some cases, and the cash received can be used for any lawful purpose.

Unlike a viatical settlement or a living benefit rider, you do not have to be terminally ill in order to qualify for a life settlement. A viatical settlement is one where an owner sells an in-force policy on the life of a terminally or chronically ill person.and should typically result in a cash offer of 50% to 80% of the face amount of a policy. The life settlement generally produces somewhere in the range of 25% to 30%. Though the settlement is less, the life expectancy of the insured can be anywhere from 25 months to144 months. The insured does not need to be in poor health either.

Here’s how a typical life settlement works. The owner of a policy that is no longer needed or too expensive contacts a broker. If the owner is not the insured (person whose life is covered under the policy) the owner must first obtain the consent of the insured.

The broker is responsible for obtaining preliminary information to determine the possibility of a successful sale. If the broker decides to go ahead, he or she prepares a request for a proposal to be sent to multiple providers. The providers, which are generally institutionally funded, submit an offer to the broker, who evaluates the proposals, confirms acceptance of the most advantageous offer, prepares a cost/benefit analysis for the seller, then prepares and executes the closing documents. The provider represents the purchaser of the insurance policy and obtains the necessary life expectancy calculations, performs a policy review, and calculates the fair market value of the policy.

Properly structured, a life settlement can be a win-win situation for all parties. Of course, the brokers and providers earn fees on the sale, but the purchaser obtains an investment that will eventually pay off and the seller obtains liquidity of an asset they would not have had otherwise.

One major drawback to a life settlement is that the tax effects are unfavorable. In truth, there is no specific guidance on the taxability of life settlement proceeds. The consensus among most experts, however, is that the excess of the settlement proceeds over the premiums paid is ordinary taxable income. Compared to life insurance proceeds upon death being nontaxable, this can be a significant drawback to the estate. However, the broker is required to include this as a consideration in the cost/benefit analysis.

Utilizing a life settlement can be a significant source of funds for some policy owners, though great care must be taken in selecting the parties to the transaction. A good place to start would be your state’s department of insurance. If you have an interest in pursuing this, let us know if we can help locate a suitable broker.

Enjoy your June.