Life Settlement is the sale of an existing life insurance policy to a third party for more than its cash surrender value. It provides liquidity for policyholders and investment opportunities for buyers.
Life Settlement refers to the financial transaction where a life insurance policyholder sells their existing policy to a third party for a sum that exceeds the policy's cash surrender value but is less than its net death benefit. The buyer then assumes responsibility for paying future premiums and ultimately receives the death benefit when the insured individual passes away. This transaction offers an alternative to surrendering the policy back to the insurer or letting it lapse, thereby unlocking immediate cash value for the seller. In finance and wealth management, life settlements are considered alternative investments. Investors purchase these policies for the life expectancy-based returns driven by actuarial calculations and the discounted death benefit payment in the future. Policies involved are typically from seniors who no longer need or can afford them. Life settlements can diversify portfolios, providing uncorrelated returns compared to traditional asset classes.
Life settlements impact investment strategies by offering an alternative asset class with potentially higher returns and diversification benefits due to their low correlation with stock and bond markets. This can be valuable in family office portfolios aiming for risk mitigation and income diversification. Furthermore, life settlements introduce unique governance considerations around due diligence, ethical investing, and compliance given the sensitivity of underlying life insurance contracts. From a tax and reporting standpoint, proceeds from a life settlement are treated differently than typical insurance payouts or policy surrenders. Understanding the tax implications and proper accounting treatment is essential when integrating life settlements into wealth management strategies. They can provide liquidity options that support cash flow needs without forcing asset sales or triggering unfavorable tax events.
Suppose a 75-year-old policyholder owns a life insurance policy with a $1 million death benefit and a cash surrender value of $50,000. The policyholder decides to sell this policy via a life settlement and receives an offer of $200,000 from an investor. The investor pays $200,000 upfront and assumes premium payments of $10,000 annually. If the insured person's life expectancy is 10 years, the investor may calculate an expected internal rate of return based on premium outflows and $1 million payoff upon death, adjusted for mortality risk.
Life Settlement vs Life Insurance
Life Insurance is a contract providing a death benefit to beneficiaries upon the insured's death, often used for wealth transfer and protection. Life Settlement involves selling such an insurance policy to a third party for immediate cash, transferring ownership and beneficiary rights. While life insurance is a protective financial product, life settlements convert that product into a financial investment opportunity for buyers and liquidity for sellers.
Who typically benefits from a life settlement?
Seniors or policyholders who no longer need or can afford their life insurance policies benefit, gaining access to more cash than the surrender value. Investors also benefit by acquiring policies at a discount for potential returns.
Is a life settlement considered a taxable event?
Yes, proceeds from a life settlement may be taxable. The amount received above the cash surrender value can be subject to income tax, and careful tax planning is advised to manage potential liabilities.
How is life expectancy determined in life settlements?
Life expectancy is typically estimated by actuaries or medical underwriters who assess the insured's health, medical history, age, and lifestyle to predict the probable duration until death, which impacts valuation.
