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Life Settlements: Selling Your Policy

People sell their life insurance for many different reasons, a transaction known in the insurance world as a life settlement. Most of those reasons relate to the policyholder needing money during life more than their beneficiary needs money after they are gone. It is a decision that should be weighed carefully, and if you are unsure whether a life settlement is right for you, contact your trusted financial advisor to discuss your options.
  • A life settlement is the sale of a life insurance policy to an investor for cash. The amount received is greater than the policy's cash surrender value but less than the death benefit. People often seek life settlements when they need money to pay for retirement, long-term care, or other expenses.
  • In a life settlement transaction, a seller transfers ownership of their policy to a buyer.
  • All aspects of ownership transfer, including premium payments and the death benefit, meaning the original policyholder's beneficiaries no longer receive anything when the previously insured person dies.
  • In exchange, the original policyholder receives a cash payment that is largely tax-free.

Eligibility for Life Settlements

Although every situation is different, certain factors increase the possibility of selling your life insurance. These are the most basic life settlement eligibility requirements:
  • Age/Health: Most people who sell their life insurance are over 65 or have a serious medical condition.
  • Policy type: Eligible types include universal life, whole life, and convertible term policies.
  • Policy size: Most policies have a face amount of $100,000 or more.

Life Settlements vs. Viatical Settlements

Policy sales became popular during the 1980s, when people living with AIDS had life insurance they did not need. This led to another part of the industry: viatical settlements, in which people with terminal illnesses sell their policies for cash. This part of the industry lost momentum after people with AIDS began living longer. When someone has a terminal illness and a very short life expectancy, they may sell their life insurance to another person. In exchange for a large lump sum, the buyer takes over premium payments and becomes the new policy owner. After the insured person dies, the new owner receives the death benefit. Viatical settlements are generally riskier because the investor is essentially speculating on the insured person's death. Even though the original policyholder may be ill, there is no way to know when they will actually die. If the insured person lives longer, the policy becomes cheaper, but the actual return declines after accounting for premium payments over time.

1911 Supreme Court Decision in Grigsby v. Russell

Life settlements effectively create a secondary market for life insurance policies that has developed over many years. A series of court rulings have legitimized the market, one of the most notable being the U.S. Supreme Court's 1911 decision in Grigsby v. Russell.

John Burchard, an insured individual, had purchased a policy but could not keep up payments after the second premium and sold it to his physician, A. H. Grigsby, for $100 and a commitment to continue paying premiums. When Burchard died, Grigsby tried to collect the death benefit. The executor of Burchard's estate—the insurance company—sued Grigsby for the money and won. But the case went to the Supreme Court.

The argument was that Dr. Grigsby had no insurable interest because there was no family or financial connection between Burchard and Grigsby, making the death benefit invalid. However, the Supreme Court held that the assignment was valid because Dr. Grigsby had provided consideration through surgery for the policy's death benefit. This landmark case marked the beginning of life and viatical settlements. Essentially, Grigsby v. Russell made it legal to assign a death benefit without an insurable interest. Outside investors can now comfortably buy policies without needing a family or financial connection to the insured person.

In his opinion, Supreme Court Justice Oliver Wendell Holmes compared life insurance to ordinary property, allowing—and setting a precedent for—a policy to be transferred by its owner at will and have the same legal value as other types of property, such as stocks and bonds. Additionally, treating life insurance as property provides other rights:

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

Sources / References

  1. U.S. Supreme Court 1911 decision in Grigsby v. Russell https://tile.loc.gov/storage-services/service/ll/usrep/usrep222/usrep222149/usrep222149.pdf