What Are Life Insurance Settlements?

It is quite possible that you’ve never heard of life insurance settlements. What is the purpose of a settlement when you can easily surrender your policy? Settlements can actually be beneficial to some policy owners.

Life insurance settlements:

A settlement is a way to turn one’s existing insurance policy into cash, in particular a permanent life insurance policy. This may boggle the mind, being that this product already has a cash value life insurance component with the ability to be surrendered. Surrender refers to terminating your policy, but leaving with its cash value. However, a settlement also allows you to handover your policy and leave with cash… but in a different way. A settlement will liquidate your policy and pays no mind to the amount of cash value your policy has accumulated; in fact, many policy owners can make more from a settlement than they would be surrendering their policy.

Instead of surrendering a policy, and just giving it up, the owner of the permanent life insurance sells his or her policy to anyone, most often financial companies. Once someone purchases the policy, the new owner must take over premiums payments; however, the coverage is still based on the lifespan of the original policy owner. Because of this, those who purchase settlement policies only target policies on people who are at risk, either aged or terminally ill, because such policies will payout a death benefit sooner than later.  The buyer of a settlement policy will generally pay a high percentage of the policy’s death benefit (around 75%), which will typically be much larger than the policy’s cash value. Other types of life insurance products, such as term life insurance, will not work for settlement purposes because there is a chance a benefit will never payout (the original owner can outlive the policy), whereas a permanent policy does not have a term date. A permanent policy is guaranteed to payout.

When cash value matters:

Universal life insurance, although a form of permanent insurance, is a different story. The cash value from a universal policy is used to pay for the cost of the policy. Because of this, the amount of money in the policy's cash value account will affect the value of the policy and thus the cost of the settlement, because the buyer can use what is in the cash value account in order to pay for future insurance charges. This could result in the seller demanding a higher price for his or her policy.

Settlements vs. surrender:

It is clear that not all life insurance products can be settled. So which ones can be settled and which ones can be surrendered? Permanent life insurance policies can be settled, while most cash value policies can be surrendered (only permanent policies can be surrendered, not all cash value accounts are).  While it is true that nearly all permanent life insurance policies are also cash value, there are exceptions. Products such as no-lapse guarantee is a permanent policy, which does not have a cash value account, and universal term life insurance is a term policy with cash value (it does expire). Some permanent policies even come with a death benefit and cash value, but only coverage for a certain amount of years. So as simple as it sounds, there are exceptions to the rules.