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Ask Bob: How Do I Start the Process of Investigating a Life Settlement?

A reader wants to know about the process of getting a life insurance settlement.
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How, exactly, do I start the process of investigating a life insurance settlement? I have a $430,000 whole life policy with a life insurance company, with a cash value of about $125,000.


Before exploring a life insurance settlement, the first thing to do is to identify the problem you're trying to solve, says Paul Wilson, CFP, a financial adviser with Schwarz, Dygos, Wheeler Investment Advisors.

Is it a cash flow issue? Have you had a recent health event causing you to reconsider your life expectancy? Is there a large one-time expense you need funds for? "Only when the problem is fully understood can you assess the pros and cons of a life insurance settlement and determine if it is an appropriate option for you," he advises.

Wilson provides a primer on what a life insurance settlement is and how it works:

With any life insurance policy, there is an owner, an insured, and a beneficiary. In a typical scenario, Person A is the owner and the insured. When Person A dies, the death benefit is paid to the beneficiary of Person A's choosing. However, in a life insurance settlement, Person A sells the ownership of the policy to Company XYZ for a lump sum. As the new owner of the policy, Company XYZ is now responsible for premiums to be paid and can make itself, or any other person/entity, the beneficiary when Person A passes away.

Why would Company XYZ want to own Person A's life insurance policy? In a word: profit.

Company XYZ has a team of number-crunchers who figure out just how much they're willing to pay you for your insurance policy based on a variety of factors, among them: 1) your life expectancy, 2) the cash value and 3) the death benefit of the policy.

Think of the cash value as the "current value" of the policy and the death benefit as the "future value" of the policy. If the actuaries at Company XYZ believe you will live for many years, their offer will likely be closer to the "current value" of the policy because the risk they bear (you living a long time) is too great. However, as life expectancy shortens, Company XYZ's risk is lowered and therefore it is more willing to pay you closer to the "future value" of the policy. Therefore, the lump sum an insured will receive from life insurance settlements is nearly always somewhere between the cash value and the death benefit of the policy. From an actuarial standpoint, what Company XYZ is trying to do is guarantee itself a profit (an acceptable time-weighted profit given life expectancy probabilities) upon your death.

How do you know what your policy is worth to someone else? If a life insurance settlement broker has approached you, chances are they will be motivated by hefty commissions and may have their interests, not yours, in mind. The best way to find the best offer is to shop around and do much of the legwork yourself.

Start with two or three different life insurance settlement companies. If the initial companies are all offering similar lump-sum payments, chances are you've found fair quotes. However, if you've received a wide range of offers, seek an additional two or three quotes from other companies. Have your advisers review the offers and provide feedback to you on implications to your financial plan, your tax situation, and your estate plan.

Before diving head-first into a life insurance settlement, consider all of your options first, cautions Wilson. "While the transaction seems very straightforward, it can be an extremely expensive endeavor, one that minimizes what you receive and maximizes the acquiring company's profit margin and commissions paid to the brokers involved," he says.

Here are a few other possibilities to look at:

Borrow against your $125,000 cash value, or surrender the policy outright and receive the surrender value of your cash value.

1035-exchange the cash value into a fixed annuity (if eliminating premium payments and increasing cash flow is the desired outcome)

1035-exchange the cash value into a low-cost variable annuity (if eliminating premium payments and having access to funds as-needed is the desired outcome)

Convert your policy into a paid-up contract (if eliminating premium payments while maximizing what your beneficiaries will receive is the desired outcome)

Wilson also recommends contacting your insurance carrier to discuss all of the options available to you with your existing policy. "The insurance company may work with you to find appropriate and creative solutions to your financial circumstances, he says.

"Make sure that you are aware of the tax implications of a life insurance settlement," Wilson warns. "Premiums paid over the life of the policy, growth of the cash value, and the lump sum paid to you are all factors that impact the taxes you will pay in the year in which you receive the lump sum payment. Unintentionally adding a couple hundred thousand dollars or more to your taxable income may effectively cut your actual net after-tax payout by a third or more."

Lastly, life insurance settlements are often aggressively marketed to seniors because of high commissions and profits involved in these transactions, Wilson notes. "To ensure that a life insurance settlement is in your best interest, seek the counsel of your accountant, financial advisor, and attorney," he recommends.


How, exactly, do I start the process of investigating a life insurance settlement? I have a $430,000 whole life policy with a life insurance company, with a cash value of about $125,000.

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