Don’t let it lapse! How to determine when a life settlement makes sense

If you’re on this page, you’re likely interested in learning more about how you can help your clients join the thousands of American seniors who’ve sold their life insurance policies for cash to third party investors – a transaction commonly known as a life settlement.

And if you’re not familiar with life settlements, you’re not alone. Most agents do not know that they can sell the same policy not just once, but twice! Agents are leaving over 1.1 million policies worth roughly $112 billion per year on the table by not selling off their clients’ lapsing life insurance policies, largely because they’re unaware they can do so.

Life settlements do provide an immediate payday – and make a lot of sense for certain individuals – however there are also downsides to consider, so it’s important to assess your client’s individual situation to determine if a life settlement is appropriate.

Below we’ve outlined some of the most important factors to consider when deciding whether to sell your clients’ life insurance.

What does it mean for your client to sell their policy?

By selling their life insurance policy your client is agreeing to sign over his or her benefit payout to a third party investor, known as a life settlement provider, in exchange for them taking on the remaining payments of his or her policy. The client receives an immediate cash payment, and the investor receives the full amount of the client’s policy upon his or her passing.

Life settlement cash payouts by definition will be less than the policy size, but can offer up to 26 times more than the cash surrender value offered by the original insurance provider.

What value can your client expect from a life settlement?

There are several factors determining the value of a life settlement – most notably your clients’ age, health condition, policy size, and the size of premiums. An average life settlement usually fetches a selling price equal to 20-25% of policy size, and some can even go as high as 50%. For example, a qualified $1 million face value policy sells on average for $220,000. The value will always differ based on the policyholder and the purchasing entity, and are often negotiable.

What commissions can you expect from a life settlement?

Agent commissions on life settlement transactions are usually in the 5-20% range of selling price. For example, if a $1 million policy is sold for $250,000 to a provider, the agent can expect, depending on the case, somewhere between $12,500 and $50,000 in commissions for having sourced a successful transaction.

Is your client eligible to sell the policy?

Candidates for life settlements need to be at least 65 (many companies prefer ages 70 and up), have a policy of at least $50k, and have either universal, whole, or convertible term life insurance (however, over 90% of policies sold as life settlements today are UL policies). Exceptions to the age guideline exist for people who are terminally ill, typically with a life expectancy of less than 2 years. These are known as viatical settlements.

Does a life settlement make sense for your client?

There are various specifics your client should consider when selling his or her life insurance, but the main question to ask is if the premium payment is still worth the perceived benefit of the life insurance payout. If your client is feeling financially stable, is in good health and nothing has changed from when he or she purchased the policy, then it probably makes sense to keep it. Here are some of the most common reasons why your client may want to sell his or her life insurance policy:

1. Your client’s life insurance policy is about to lapse

This one’s a no brainer. If your client’s life insurance is about to lapse due to non-payments, you and your client are simply leaving money on the table by not selling it. Life insurance is legally recognized as an asset, and should be thought of similarly to a mortgage. With thousands of dollars invested over decades into the life insurance, you should absolutely consider advising your client to sell it for its max value, rather than let your client lose all the money they put into it. Otherwise your client is just giving an asset worth thousands or even hundreds of thousands of dollars back to the insurance company – for free.

2. Your client’s intended beneficiaries are no longer in need

As you know, most policyholders purchase life insurance as financial security for their children. However many now find their children are grown (often with children of their own), and financially independent. If the adult children no longer need the life insurance proceeds, it may be worth having a conversation with them about a life settlement. Similarly, if your client is divorced and the ex-spouse was the intended beneficiary, his or her needs have likely changed.

3. Your client’s payments are a burden on his or her retirement funds

If your client already retired and is living off a fixed income – or feels they haven’t properly saved enough for retirement – a sizable life insurance premium can really eat away at a budget. In this case it can make sense to liquidate the client’s life insurance policy in order to bolster a 401k or other investment options, and strengthen the client’s retirement position.

4. Your client is facing a large upfront medical expense

If your client has a large medical expense to deal with and can’t afford it, it can make sense for your client to sell a policy. How much sense would it make to pay for the future if your client can’t look out for him or herself today? A morbid truth to the matter is a serious illness can often increase the value of your client’s policy as insurers may project a lower life expectancy.

However, as always it’s also important to note that in the case of a terminal illness, accelerated death benefits should be weighed against selling the policy, since the former might be the better option for your client.

What to watch out for when advising your client about a life settlement

First, if your client sells their current life insurance policy, it can make it difficult and sometimes impossible for the client to purchase another policy. That said, if your client is selling a life insurance policy, the client probably won’t want additional coverage down the line.

Additionally, with most settlement contracts your client is signing away their rights to his or her health privacy, and are often obligated to provide health updates to the purchasing company for the remainder of their life.

Next, there are usually tax consequences for the money received from a life settlement. Without getting overly technical, the proceeds from the life settlement are treated as a mix of income and capital gains tax (see our blog post on life settlement taxation for more details.)

Finally, there can be broker or affiliate fees incurred during the selling process. It’s crucial to pay attention to who you work with when you help your client sell a policy, as a broker can charge 10-20% of the payout. These commissions don’t have to be the cost of doing business with several direct-to-agent or consumer companies emerging. Make sure you ask about the fees associated with your client’s transaction. And remember: these fees are almost always negotiable.

If you want to learn more about life settlements, check out our guide, or get an idea for how much a client’s policy is worth with this free and instant estimate tool.

Felix Steinmeyer is a licensed life settlement provider (buyer of policies) based in San Francisco. He and his co-founder Charles run Mason Finance, a company founded on the idea that access to the right information and excellent financial services has no retirement date.