The time may come when life insurance policy owners want to rid themselves of the policies they own. Some desire to do away with their policies on account of simply no longer wanting to pay the premium. Others find themselves in a position where they need to access cash due to a major - and often unexpected - expense. Still others just don't believe they have a need for the protection afforded by the life insurance companies. Whatever the reason, policy owners need be aware of all of the options they have at their disposal when deciding what action to take when shedding an unwanted policy. (To learn more about life insurance, see How Much Life Insurance Should You Carry? and Buying Life Insurance: Term Versus Permanent.)

Tutorial: Introduction to Insurance

Historically, policy owners elected to use one of six methods to dispose of an unwanted policy. The six methods are lapse, surrender for cash value, reduced paid-up, extended term, 1035 exchange for an annuity and 1035 exchange for a different life insurance policy. (Find out more on these options in Life Insurance Distribution And Benefits and Fifteen Insurance Policies You Don't Need.)

An additional option has recently been introduced to policy owners. This option is referred to as a life settlement.

Life Settlement Features
According to the Financial Industry Regulatory Authority, a life settlement occurs when a life insurance policy is sold to an individual or entity other than the company that issued the policy for an amount that exceeds the policy's cash surrender value but is less than the net death benefit. In addition to the lump sum payment the individual receives from the buyer, the individual is no longer responsible for any premium payments on the insurance policy; these will be paid by the buyer. Life settlements are distinct from the six aforementioned disposal options in that ownership of the policy is transferred to another person or entity. This concept may sound familiar to some readers because it is related to what the life insurance industry refers to as viatical settlements. Viatical settlements are exchanges that also involve the sale of a life insurance policy to a third party; however, they differ from life settlements in that the insured has a terminal illness.

To the Winner … Goes the Payments
Most policy owners solicit the assistance of a life settlement broker when attempting to sell their policies. Life settlement brokers contact life settlement companies to let them know that a policy is available for purchase. The broker then waits for the life settlement companies to bid on the policy. Upon receiving all of the bids, the broker lets the policy owner know which company offered the most money for the policy. Like an auction, the policy owner typically sells his or her policy to the company that is willing to pay the most money.

Waiting For You to Die?
You may be asking yourself why a company would want to purchase someone else's life insurance policy. The short answer is that when the policy is sold, the new owner purchases the right to receive the death benefit at the insured's death. For example, if you agree to sell your life insurance policy to a life settlement company, the company is effectively purchasing the right to receive the death benefit that will pay out at your passing. This is an attractive investment for the company if it believes factors ranging from your health status to the specifics of the life insurance policy are favorable.

Many policy owners who consider selling their policies through life settlement transactions are uneasy about the idea of a life settlement company essentially waiting for them to die. The notion of a company counting down the weeks, months or years until death is not very comforting. Some may even go as far to think that a company will resort to criminal activity in order to get access to the death benefit sooner rather than later. However, keep in mind that life settlement companies are in the business of making money. The companies would eventually put themselves out of business if they engaged in any type of criminal behavior.

Another item worth mentioning is that some entities that purchase life insurance contracts from others couldn't care less about when the insured dies. These entities purchase life insurance policies so they can use them for collateral to obtain loans from banks. The loan may be taken out so the company has additional cash to pursue attractive investments. Whether the insured dies in two years or 20 years means little to the company - the company simply wants to own the policy so it can qualify for a loan today.

The Bottom Line
Life settlements offer an additional option for life insurance policy owners to consider when deciding what to do with a policy they no longer want to own. From a monetary perspective, this alternative may be more attractive than the six traditional options. That is reason enough for policy owners to discuss the option with one of their trusted advisors (i.e., financial advisor, accountant, broker, lawyer, etc.).

There will probably always be concerns that companies buying these policies could participate in criminal behavior, but with proper due diligence performed on the life settlement broker, the life settlement company and any other entity involved in the transaction, an individual should be able to allay all of these fears. Also, the fact that the industry is being actively monitored by the New York attorney general may soothe the concerns of some. Moreover, the presence of billionaire Warren Buffett's company, Berkshire Hathaway, as an investor in these unwanted policies may calm the fears of others. It is difficult to believe that the "Oracle of Omaha", a man widely revered for his integrity, would participate in a corrupt industry.

To read more about Buffett's investing techniques, see Warren Buffett: How He Does It, Financial Wisdom From Three Wise Men and What Is Warren Buffett's Investing Style?

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