Life Settlements: The term that you need to know

Life Settlements: The term that you need to know

If an existing life insurance policy is brought by a third party such as an institutional investor from a policyholder for a lump sum settlement, then this process is called a life settlement.

The policyholder may sell the insurance policy at his/her own will for various numbers of reasons. The most common reasons behind choosing a life settlement are:

  1. Financial assistance is needed to afford medical care and other related expenses.
  2. The premiums of the policy are not affordable.
  3. The policy is no longer required as the lifestyle of policyholder might have changed.

They are similar to viatical settlements but are not the same.

A viatical settlement involves a terminally or chronically ill person (with less than two years life expectancy) who sells his or her existing life insurance policy to a third party for a one-time money settlement.  The third party becomes the new owner of the policy, pays the premiums and receives the full death benefit when the insured dies.

It all began in 1911 when the United States Supreme Court gave a revolutionary decision in the case of Grigsby vs. Russell.  The court recognized the right of the policy owner to assign his/her life insurance policy. The Justice of this case- Justice Oliver Wendell Holmes declared that a life insurance policy is similar to any other property. Hence, it can be transferred by its owner without any limitation.

The life settlement market grew in the 1980’s during the AIDS epidemic.

Due to lack of money, the terminally ill policyholders decided to transfer their insurance policies as they no longer needed it. Thus the “Life settlement” industry bloomed.

A policy holder may choose to cash out life insurance policy in various ways-

  • Borrow money from the life insurance policy’s cash value. The policyholder may choose to take a loan from the policy’s cash value. These loans do come with a few strings attached. One has to pay interest for these loans and by repaying the loan within the deadline.
  • Surrender the insurance policy. This decision must be taken with caution as it terminates the policy entirely. The insurance provider gives the policyholder the cash value of the policy in exchange for the death benefit payout.
  • Life insurance settlements. In this process, a third-party buyer such as institutional investor buys the existing insurance policy for a lump sum settlement from the policyholder. Here the policy is treated just like any other asset.
  • Withdraw from the cash value of the policy. This is an alternative to borrowing money from the policy’s cash value. This may reduce the death benefit amount of the policy. It may also have tax implications. An increased premium value may also be one of the implications of withdrawing money from the cash value of the policy. The policy holder should be well aware of life insurance, its settlement process and the various terms and conditions involved.

Life settlements are gaining gradually gaining wide popularity widely, and we hope that this article has helped you to learn more about it.

Happy saving!

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