With economic instability, life settlements are attracting more public interest. A life settlement is a financial transaction between the policyholder and a third party, where the policyholder sells their life insurance policy to a third party. The offer is attractive because the policyholder gets more than the cash (surrender) value offered by the life insurance company. In return, the third party pays all premiums, and becomes the beneficiary of the life insurance policy. When the policyholder dies, the third-party beneficiary receives the full amount of death benefits. Both the policy holder and the third party (who makes a profit) benefit from this type of transaction. This secondary life insurance industry began in the 1990s, and was worth about $12 to $15 billion in 2007. Because it is of its lucrative proposition, it is predicted to grow in the next decade to more than $150 billion.
There are several reasons why a policyholder would allow his/her policy to lapse or surrender for its cash value. The beneficiary may no longer need the death benefits or there may be pressing financial circumstances that would lead the policyholder to trade off death benefits to a stranger (who becomes the beneficiary) for immediate cash.
How does the secondary life insurance market affect the life insurance industry?If there were no secondary life insurance market, the policyholder would have no other option than to let a policy lapse or surrender the policy. When this happens, the inherent economic value of the policy goes to the life insurance company. This would mean that a life insurance company is no longer obligated to pay death benefits on this policy. Its more beneficial for any life insurance company for a policy to lapse because they receive premiums, but do not have to pay out death benefits. Potentially, this would allow the life insurance company to offer insurance at lower premiums to their customers. Some industry analysts suggest that if policy lapses are high enough, they can increase the profitability of a company.
If everybody were to start selling off their life insurance policy to third parties, there would be no policy lapses. Theoretically, life insurance companies would lose their profit margins and begin raising
life insurance rates in order to make up the difference. This would eventually lead to less competition in the industry and lower sales.
Some argue that life insurance companies need not be afraid of the secondary life insurance market. Even if life insurance rates are raised, people will still continue to buy life insurance knowing that it can be sold at a good enough price later on to fund their retirement. The actuaries of life insurance companies, while calculating premiums, make sure they consider payouts to a certain percentage of insurers, thus covering their costs.
Who actually loses in a life settlement?Before you sell your policy to a third party, consider who actually loses in a life settlement. The policyholder gets a good deal since they get more than the surrender value of the life insurance policy, but is it really such a good deal? If your children were designated to be the beneficiaries, why sell your policy to a third party just because you can no longer afford to pay the premiums? Your children may be able to help you with premium payments without you having to sell your life insurance.
Another aspect to consider when selling your life insurance to a third party is that the policyholder never knows who his beneficiary may be. It may wind up being owned by large financial institutions and hedge funds, or a questionable third party you dont even know may be waiting for you to die. This might be a disturbing issue to some people who may not be able to sleep so peacefully at nights.
If it is a term life insurance policy, the third party is taking a risk because the policyholder must die within the stipulated term period. Usually, life-threatening circumstances cause people to sell their term
life insurance policies to meet urgent cash needs. If it is a whole life policy, the third party may have to wait out the duration period between the time the policyholder purchased the policy to the time they actually receives the death benefits.
ConclusionA life settlement should not be used as a means to get free money as there are certain risks involved. Remember, if you are using your life insurance in the planning of estate taxes, a life settlement will dissolve your purpose. Life insurance settlements could be considered at times when liquid assets are urgently required and when all other options are closed.
