What Is a Life Settlement and How Does It Work?

A life settlement is a way to get cash for a life insurance policy you no longer need or can no longer afford. For older adults struggling to pay health care costs or who need long-term care in retirement, or for those who are younger but have terminal illnesses, it can be a lifeline.

Many people don’t know that this option exists. But how does the process work? Do your loved ones qualify for it? And is selling the policy the right move?

In a life settlement, the holder of a life insurance policy names a third party as the policy’s benefactor in exchange for immediate cash. The seller typically gets more than the cash surrender value but less than the death benefit. The third party continues to pay the policy’s premiums and then collects the death benefit when the insured individual dies.

Another term for "life settlement" is "viatical settlement," although the two are not technically synonymous. The American Life Fund, which brokers such arrangements, says, "Viatical settlements are reserved for people who have a serious medical diagnosis. Examples of this include someone diagnosed with cancer, ALS or Alzheimer’s. In contrast, with a life settlement, you don’t necessarily need to be ill, but you typically need to be over the age of 70."

Century-Old Ruling
A 1911 U.S. Supreme Court ruling established the precedent that life insurance is private property, but it was the AIDS epidemic in the 1980s that opened up the market for ownership transfers. It was a morbid business; a viatical settlement was a bet on another’s demise. The sooner the death, the sooner the payoff. An ad at the time marketed the settlements as “an immediate cure for one of the most damaging side effects of AIDS — financial devastation.”

In the viatical industry’s first years, it was often individual investors who purchased stakes in these policies. Fraud was a problem as people would apply for life insurance policies after testing positive for HIV, then turn around and sell their policies. But now the industry is heavily regulated. Most states require a two-year waiting period from the time the policy is issued to when it can be sold, according to the Life Insurance Settlement Association. Ten states have a five-year waiting period. Most states provide substantial consumer protections and require life settlement providers and brokers to be licensed. Typically, you must be 65 years or older to qualify. The average age of people who sell policies through life settlements is 75. You can be younger, but you must have a serious health issue.

If people know they will have costly medical bills that need to be taken care of upon their death, they may invest in a viatical settlement to keep their family from the financial burden of paying off their bills.

This is just a summary of a complex set of rules, and you should consult a qualified professional before making a decision about buying or selling a policy.