The purchase of an existing life insurance policy by a third-party institutional investor for a one-time cash settlement from a policyholder is called Life Settlement.
Before the existence of life settlement process, a policyholder had only two options:
- He/she had to surrender the policy and receive the cash value. The cash value of a life insurance policy is the amount of cash offered by the policy provider to the policy owner upon the cancellation of a contract.
- He/she had to allow the insurance policy to lapse. This would forfeit the policy and make it worthless. All the premiums paid towards the policy go waste.
The policyholders may choose the option of a life settlement generally because of the following three reasons:
- Financial assistance is needed to afford medical care and other related expenses.
- The premiums of the policy are not affordable.
- The policy is no longer required as the lifestyle of policyholder might have changed.
Policyholders may wish to use the cash value of the insurance when the above situations arise. A life settlement is just one of the methods to do so.
The insurance cash out option is available in insurance policies which are of permanent life insurance type- whole life insurance, universal life insurance, and variable life insurance. However, a term life insurance policy does not have any cash value. It only pays the death benefit upon the death of the insured.
These permanent life insurance policies give an additional benefit to the policyholders as its cash value can be used for loans and other emergency expenses.
Here are the various ways in which a policyholder may cash out an insurance policy:
- Borrow from the cash value of the policy. These loans taken have low-interest rates and usually, have flexible repayment terms. If these loans aren’t repaid within a stipulated amount of time, then they can lead to a number of consequences such as reduced death benefit and additional taxes.
- Withdraw from the cash value. This method may reduce the death benefit amount. This is an alternative for borrowing money from the cash value. This method may also affect the policy in several ways: reduced death benefit, increase in the value of premiums, and additional tax.
- Surrender the policy. This option must be chosen with caution as it is a drastic measure. If the policyholder has a better alternative or might not need the policy anymore, then he/she can surrender the policy. Sometimes, surrendering a policy may lead to reduced payout, taxes, or the policyholder may also have to give up the death benefit of the policy.
- Life insurance settlement. This option is ideal for higher cash values. Here an institutional investor buys the policy for a one-time cash settlement. The money received in this method is usually more than the cash value of the policy but less than the value of the policy’s death benefit.
Hope that this article helped you to understand life settlements and related things in a better way.
Thanks for reading!