A life settlement is the selling of one's life insurance policy to a third party for a one-time cash payment. The purchaser then becomes the beneficiary of the policy and begins paying the premiums. Typically the purchaser is an experienced institutional investor, and policies will have face amounts in excess of $250,000. A life settlement is similar to a "viatical settlement."

Breaking down a Life Settlement

Life settlements are usually only done when the insured person doesn't have a known life-threatening illness. They are often done with "key individual" insurance policies held by companies on executives, who no longer work there. The company has a chance to cash out on a policy that was previously illiquid. Sometimes people outgrow their need for a specific life insurance policy, and a life settlement may offer the chance to gain more than the policy's cash surrender value.

History of the Life Settlement

The existence of life settlements effectively creates a secondary market for life insurance policies. This secondary market has been years in the making. There have been a number of events and judicial rulings that have legitimized the market. One of those is the 1911 U.S. Supreme Court case of Grigsby v. Russell.

Here's a little background on the case. A man by the name of John Burchard wasn't able to keep up the premium payments on his life insurance policy and sold it to his doctor, A. H. Grigsby. When Burchard died, Grigsby tried to collect the death benefit. The executor of Burchard's estate sued Grigsby to get the money and won. The case later ended up in the Supreme Court. In his ruling, Justice Oliver Wendell Holmes likened life insurance to regular property. This means he believed it could be transferred by the owner at will, and had the same legal standing as other types of property like stocks and bonds. In addition, there are rights that come with life insurance as a piece of property:

  • The owner can change the beneficiary unless the insurer has restrictions in place
  • The policy may be used as collateral for a loan
  • Owners can borrow against the insurance policy
  • Policies can be sold to another person or entity

Policy sales became popular during the 1980s, when people living with AIDS had life insurance they didn't need. This led to another part of the industry—the viatical settlement industry. When someone becomes terminally ill and has a very short life span, they may sell their life insurance to someone else. In exchange for a large lump sum of money, the buyer takes on the premium payments, becoming the new owner's policy. After the insured party dies, the new owner receives the death benefit. This part of the industry lost its luster after people with AIDS began living longer.