I’ll tell you right out of the gate – this might be the creepiest financial topic I’ve ever researched. But, just like any financial option that you have available to you, I feel like it’s my job to shed some light on the subject. Life Settlements, formally known as Viatical Settlements, elicit a great deal of emotion. “Selling your life insurance policy so that someone else can collect on it when you die?” – The thought of it is just uncomfortable.
Here’s how Life Settlements work: This is a financial product where a group or company will buy a seller’s life insurance policy while that person is still alive for less than the value of the full death benefit. Then, once the original owner of the policy passes away, the company that purchased the policy is able to collect the full amount of the death benefit (as opposed to the original owner’s beneficiaries).
It’s a little creepy, right? But I wanted to figure out if there was any upside to these “life settlements” for me and you. The life settlement industry actually began about 20 years ago as a way for crucially ill patients who needed to pay for medical attention to receive a lump sum of cash in return for someone else to ultimately collect on what was originally their death benefit. Now it’s an option for not only those facing health issues, but also people having financial difficulties in retirement that would prefer (or need) cash today rather than leaving behind a life insurance death benefit.
Generally speaking, big institutional investors engage in life settlements via large pools of policies as a means of generating excess returns. Think of life settlements as a way for pension funds, endowments and hedge funds to diversify their investment portfolios. By and large, though, these investments are not suitable for individuals… so don’t get excited about buying them.
However, your life insurance policy could be up for sale as a means of last resort.
The first step to knowing if a Life Settlement is a good idea for you is to look at your own financial fingerprint. Run your current finances while also thinking about the ultimate unknown – your own longevity. AARP is now saying that the number of people living until the age of 100 will increase 900 percent by 2050.
So, is it a good deal for you to sell your policy?
Growing long-term care costs and increasing longevity are the two main drivers for the life settlement industry. Extended life expectancy means that life insurance premiums may eventually reach a point where they become too high to maintain. So if you have paid a great deal into a life insurance policy and are in need of liquidity, a life settlement may provide an outlet for you. Also, if you need that money for healthcare or any other reason, and you no longer have a need for the death benefit upon your passing, a life settlement may be an option for you.
Let’s look at an example for what this might look like. In trying to find some approximate numbers on what a policy might sell for, I talked with Stephen Terrell a Senior VP at Lifeline Capital Management – an Atlanta based company that specializes in life settlements. Here are a few thoughts and examples directly from the company:
“Life settlements depend on many factors including the size of premiums after conversion (from term insurance to universal insurance) and the health status of the client.”
A 79-year-old woman of above average health with a $2 million policy may receive $125,000 for her policy.
A 73-year-old male with a $500,000 policy in excellent health is not likely to receive an offer at all. This is due to life expectancy and the amount of premiums that would be required to keep the policy in force.
Look at a similar situation: A $500,000 policy for 73-year-old male in average health could qualify for a Life Settlement of approximately $50,000. Someone with average health might have diabetes and a manageable heart condition, or other conditions with similar lifespan-affecting consequences.
A 73-year-old male with poorer health would probably receive a larger offer, depending on the severity of the health conditions.
*Please note that there are many other factors of the policy not mentioned here that could affect the offer.
As you can see, today’s offer for cash is far less than the value of what the death benefit would be. There would be no reason to even entertain such an idea (selling your policy) unless you absolutely did not need (or want) the death benefit for your heirs – or you can no longer afford to continue making premium payments to keep the policy in force.
Another reason to keep your current life insurance is because once a life insurance policy is sold in a life settlement, the coverage remains in force and it may affect your future insurability. If your want to replace your coverage – either in the short or long term – then you have to work with insurance companies that are willing to write future policies, knowing the original coverage will still be in force. That can be a tricky proposition.
In full disclosure, I have never in my entire career as an Investment Advisor seen a client use one of these things. However, I thought it would be worth exploring here as you should know about every possible financial planning tool available to you.
Bottom Line: Life Settlements are only an option when you have an insurance policy that you just plain can’t afford anymore or don’t want anymore, and you are positive that you are going to let it lapse – meaning the death benefit coverage is going to go away.
Have you or anyone you know participated in a life settlement? What are your thoughts about them?
Wes Moss, the Chief Investment Strategist for Wela, writes a weekly blog for the AJC.com. You can find his original article here.