Executive Summary

Life settlements offer policyowners an alternative to lapsing or surrendering unwanted life insurance policies by selling them to institutional investors or large financial entities. This white paper provides:

1. A historical overview of the life settlement industry’s evolution.
2. A detailed transaction process for life settlements.
3. Key criteria policyowners should evaluate when deciding to sell.
4. Basic parameters defining a qualifying policy.

This document serves as a technical resource for insureds, policyowners, financial professionals, and institutional investors seeking to understand and engage in life settlement transactions.

Table of Contents

• 1. Introduction
• 2. Historical Evolution of Life Settlements
  • 2.1 Grigsby v. Russell (1911)
  • 2.2 Rise of Viatical Settlements in the 1980s
  • 2.3 Emergence of the Modern Life Settlement Industry
  • 2.4 Key Regulatory Milestones
• 3. Life Settlement Transaction Process
  • 3.1 Origination
  • 3.2 Underwriting & Valuation
  • 3.3 Bidding & Pricing
  • 3.4 Sale & Transfer
  • 3.5 Servicing & Maturity
• 4. Key Criteria for Policyowners
  • 4.1 Insured’s Characteristics
  • 4.2 Policy Parameters
  • 4.3 Financial Considerations & Market Dynamics
  • 4.4 Impact on Beneficiaries & Estate Planning
• 5. Parameters of a Qualifying Policy
• 6. Regulatory Framework & Consumer Protections
• 7. Tax Implications
• 8. Fees, Commissions & Costs
• 9. Alternative Options
• 10. Case Studies & Examples
• 11. Conclusion

1. Introduction

A life settlement (also known as a senior settlement) is the sale of an existing life insurance policy to a third party—typically an institutional investor or large financial entity—for a lump-sum payment. The policyowner receives an amount greater than the cash surrender value but less than the death benefit, while the buyer assumes premium payments and collects the death benefit upon the insured’s death.

This transaction provides immediate liquidity for policyowners who no longer need, want, or can afford their policies. For investors, life settlements offer attractive risk-adjusted returns, with stable, uncorrelated cash flows driven by actuarial projections of life expectancy, rather than market performance.

2. Historical Evolution of Life Settlements

2.1 Grigsby v. Russell (1911)

The 1911 U.S. Supreme Court case, Grigsby v. Russell, established that a life insurance policy is private property that can be sold or transferred like any other asset. Justice Oliver Wendell Holmes Jr. ruled that restricting sales only to those with an insurable interest would diminish the owner’s rights and the policy’s value.

2.2 Rise of Viatical Settlements in the 1980s

During the AIDS epidemic, terminally ill patients (rather than seniors) began selling their life insurance policies to pay for medical and end-of-life care—known as viatical settlements. This nascent market highlighted the need for liquidity among insureds with high medical costs and limited life expectancies.

2.3 Emergence of the Modern Life Settlement Industry

By the 1990s, as HIV treatments improved, viatical settlements gave way to a broader life settlement market. Seniors over age 65 with policies they could no longer afford or no longer needed began selling to institutional investors. By 2017, annual face value sold reached approximately $3 billion, underscoring the asset class’s growth potential.

2.4 Key Regulatory Milestones

• 1993: Formation of the National Viatical Association to increase professionalism in viatical settlements.
• 2001: IRS clarifies tax treatment of life settlements, providing guidelines on proceeds taxation.
• 2009: NAIC introduces the Life Settlement Model Act, standardizing licensing, disclosures, and consumer protections across states.
• 2010–Present: Continued growth in consumer awareness and technological innovation, leading to estimated annual face value sold of $4.6 billion by 2020.

3. Life Settlement Transaction Process

Life settlements follow a structured, multi-step process involving policyowners, brokers/providers, underwriters, and institutional buyers.

3.1 Origination

Policyowners initiate the process by contacting a broker or life settlement provider. Eligibility typically requires:

• Insured age ≥ 65 or qualifying health condition
• Face value ≥ $100,000
• Policy in force > 2 years (incontestability period)

3.2 Underwriting & Valuation

Medical records and policy details are collected and submitted to an independent underwriter for a Life Expectancy (LE) assessment. This actuarial estimate of the insured’s lifespan (in months or years) is crucial for determining the policy’s present value.

• LE calculations may use proprietary actuarial tables, adjusted for health status and lifestyle.
• Machine learning and AI are increasingly used to enhance LE accuracy.

3.3 Bidding & Pricing

Brokers may solicit competitive offers from multiple providers or funds. Purchase price is influenced by:

1. LE estimate
2. Premium schedule (annual or monthly premiums remaining)
3. Face value (death benefit)
4. Discount rate targeting an IRR of 8%–12%
5. Market demand and investor risk appetite.

3.4 Sale & Transfer

Upon agreement, ownership is legally transferred to the buyer. Policyowner and beneficiary designations are updated. The escrow agent holds settlement proceeds until the insurance carrier confirms the change of ownership.

3.5 Servicing & Maturity

• The buyer pays ongoing premiums, monitors the insured’s health status, and manages the policy.
• At the insured’s passing, the buyer collects the death benefit.
• Returns are realized as the difference between the death benefit and the sum of the purchase price plus premiums paid.

4. Key Criteria for Policyowners

4.1 Insured’s Characteristics

• Age: ≥ 65 (some buyers accept younger with serious health conditions).
• Health Status: Lower LE → higher offer; insurers rely on accurate LE underwriting to assess risk.
• Life Expectancy: Typically < 14–20 years for optimal offers.

4.2 Policy Parameters

• Policy Type: Whole life, universal life, convertible term, survivorship, and variable policies qualify; term policies without cash value generally do not unless convertible to permanent coverage.
• Face Amount: ≥ $100,000 for most buyers; some providers accept ≥ $50,000.
• Incontestability Period: Typically the policy must be in force for ≥ 2 years (some states require up to 5 years).

4.3 Financial Considerations & Market Dynamics

• Premium Affordability: Buyers prefer policies with premiums ≤ 5% of face amount; high premiums reduce net offers.
• Surrender Value Comparison: Life Settlement offers typically 3–7× the cash surrender value.
• Market Conditions: Tariff wars, inflation, and interest rate fluctuations can influence discount rates and investor appetite.

4.4 Impact on Beneficiaries & Estate Planning

• Loss of death benefit for original beneficiaries.
• Potential disruption to estate plans, inheritance, and asset protection from creditors.
• Opportunity to leave alternative financial legacy with life settlement proceeds.

5. Parameters of a Qualifying Policy

Parameter                                                             Requirement

Insured Age                                                                  ≥ 65 (health exemption possible)

Face Amount                                                                ≥ $100,000 (commonly)

Policy Type                                                                    Whole life, universal life, VUL, convertible term

In Force Duration                                                         ≥ 2 years (contestability period)                                                      

Premium Status                                                           Premiums remaining ≤ 5% of face amount 

Cash Value                                                                    Not required, but may affect surrender comparison

Ownership                                                                    Individual, trust, business entity

6. Regulatory Framework & Consumer Protections

Life settlements are regulated at the state level by insurance departments and at the federal level when involving variable life products, which are deemed securities under SEC and FINRA rules.

Key regulatory provisions include:

• Licensing requirements for providers and brokers.
• Disclosure of offers, fees, alternatives, and tax implications.
• Waiting periods (2–5 years) to deter stranger-originated life insurance (STOLI) speculation.
• Rescission rights allowing policyowners to cancel within 10–15 days post-closing.
• Anti-fraud plans and privacy safeguards for medical and personal data.

7. Tax Implications

Under the Tax Cuts and Jobs Act (TCJA, 2017) and IRS Revenue Rulings 2009-13 and 2020-05, life settlement proceeds are taxed as follows:

1. Return of Basis: Up to total premiums paid is non-taxable.
2. Ordinary Income: Next portion up to cash surrender value minus basis is taxed as ordinary income.
3. Capital Gain: Excess over cash surrender value is taxed as long-term capital gain.

Example: Policyowner sold a $58,000 settlement on a policy with $42,000 premiums paid and $50,000 cash surrender value. Under TCJA:

• Basis = $42,000; gain = $16,000.
• Ordinary income taxed on $8,000; capital gains on $8,000.
• Total tax ≈ $2,640 vs. $4,080 under pre-TCJA rules.

State tax treatment varies; some states impose capital gains taxes as regular income, while others have preferential rates.

8. Fees, Commissions & Costs

• Broker Commissions: Typically 8–30% of gross settlement. Negotiable based on policy size and complexity.
• Provider Fees: May include underwriting, administration, and custodial costs.
• Escrow & Closing Costs: Legal, notary, and paperwork fees.
• Investor Due Diligence: May require fees for LE assessments and medical record retrieval.

Transparency of all fees and commissions is critical. Policyowners should request full disclosure from providers and brokers up front.

9. Alternative Options

Alternative                                                   Description

Cash Surrender                                                 Policy returned to insurer for cash surrender value (20–30% of face amount).

Policy Loan                                                        Borrow against cash value; loan interest accrues; policy stays in force.

1035 Exchange                                                  Transfer cash value to new policy or annuity with tax deferral.

Accelerated Death Benefit                                Rider allows early payment of a portion of death benefit for terminal illness.

Partial Surrender                                              Withdraw a portion of cash value; policy remains active with reduced death benefit.

Reduction of Death Benefit                              Decrease face amount to lower premiums; policy remains in force. 

10. Case Studies & Examples

• Improved Retirement & Care: A 91-year-old sold a $500,000 UL policy for $132,100, using proceeds for long-term care.
• Estate Planning: A 95-year-old sold a $1M term policy for $2.65M, exceeding expectations and funding family living expenses.
• Business Sale: A 60-year-old sold $750,000 of term coverage for $202,500, retaining partial coverage and funding business operations.

(See detailed case studies illustrating life settlement outcomes.)

11. Conclusion

Life settlements transform an often-overlooked asset—life insurance—into immediate liquidity for policyowners and an alternative asset class with predictable cash flows for institutional investors. Understanding the history, transaction process, qualifying criteria, and regulatory environment is vital for all participants. While life settlements incur taxes, fees, and risks, they frequently yield 3–7× the cash surrender value and unlock billions in financial potential for seniors and investors alike.

By prioritizing transparency, due diligence, and best practices, policyowners and financial professionals can confidently leverage life settlements to meet changing financial needs. Institutional investors with long-term horizons can enhance portfolio diversification and pursue attractive, uncorrelated returns. The life settlement industry stands at the intersection of financial innovation and consumer empowerment, poised for continued growth as awareness and technology advance.

References

www.viatical.org

The history of the viatical settlement. Grigsby vs. Russell

en.wikipedia.org

Life settlement - Wikipedia

www.harborlifesettlements.com

Life Settlement Taxation Guide

www.windsorlifesettlements.com

Why Economic Uncertainty Has Institutional Investors Eyeing Life ...

www.welcomefunds.com

Life Settlements Eligibility Requirements - Welcome Funds

www.forensisgroup.com

Life Expectancy Calculation: Underwriting and Settlement Methods