The purchase of an existing life insurance policy by a third-party institutional investor for a one-time cash settlement from a policyholder is called Life Settlement.
Before the existence of life settlement process, a policyholder had only two options:
- He/she had to surrender the policy and receive the cash value. The cash value of a life insurance policy is the amount of cash offered by the policy provider to the policy owner upon the cancellation of a contract.
- He/she had to allow the insurance policy to lapse. This would forfeit the policy and make it worthless. All the premiums paid towards the policy go waste.
- The policyholders may choose the option of a life settlement generally because of the following three reasons:
- Financial assistance is needed to afford medical care and other related expenses.
- The premiums of the policy are not affordable.
- The policy is no longer required as the lifestyle of policyholder might have changed.
A policy holder may select many different paths to a life settlement:
- Agents- The agents are often a part of the client’s insurance company. They act on behalf of the policyholder.
- Brokers- They are well-trained professionals who do all the work related to the settlement. These brokers keep a certain part of the settlement amount.
- Insurance providers- These companies directly buy the life insurance policy from the policyholder. There are no middlemen or brokers involved.
- A life settlement yields a higher cash payment when compared to the cash surrender value of the policy. The cash surrender value of the policy is the amount offered by the insurance provider to the policy owner upon cancellation of the insurance contract.
The history of Life settlements began in the early 1900’s. The United States Supreme Court gave a groundbreaking decision in Grigsby vs. Russell case. The court stated that a life insurance policy is a property just like any other. The policy owner has the right to liquidate the property according to his wishes.
Life settlements became common in the 1980’s as the AIDS and Cancer epidemics drove many young terminally ill policyholders to sell their insurance policies before their death.
A policyholder needs to be well aware of the life insurance policy cash out process.
He/she needs to know when to cash out the life insurance policy. A life insurance policy has two different portions: The death benefit, which is the amount provided by the policy provider upon the death of the insured. The second portion is the cash value of the insurance policy.
Here are the various ways in which a policyholder can cash out his/her insurance policy:
- Borrow from the cash value of the policy. These loans taken have low-interest rates and usually, have flexible repayment terms.
- Withdraw from the cash value. This method may reduce the death benefit amount.
- Surrender the policy. This option must be chosen with caution. If the policyholder has a better alternative or might not need the policy anymore, then he/she can surrender the policy.
- Life insurance settlement. This option is ideal for higher cash values. Here an institutional investor buys the policy for a one-time cash settlement.
Hope that this article helps you understand more about life settlements and the various processes involved in it.