What is 'Life Settlement'

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 '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. Although the secondary market for life insurance is relatively new, it was 100 years in the making, thanks to a number of events, judicial rulings and key individuals.

The U.S. Supreme Court case of Grigsby v. Russell, 222 U.S. 149 (1911) established a life insurance policy as private property, which may be assigned at the will of the owner. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner may transfer without limitation. His opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property, such as stocks and bonds. As with these property, a life insurance policy is transferrable to another person at the discretion of the policy owner.

The Holmes decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:

  • Name or change the beneficiary of the policy (unless subject to restrictions)
  • Assign the policy as collateral for a loan
  • Borrow against the policy
  • Sell the policy to another party

During the 1980s, AIDS victims faced short life expectancies, and they often owned life insurance policies they no longer needed. As a result, the viatical settlement industry emerged. 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 lump sum. The third party becomes the new owner of the policy, pays the premiums, and receives the full death benefit when the insured dies. Because of medical advancements, people with AIDS started living longer and therefore viatical settlements became less profitable. As a result, the life settlement industry arose.

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