Life settlements

What a life settlement is

A life settlement is the sale of an existing life insurance policy by its owner to a third party for a lump sum that is more than the policy's cash surrender value but less than its death benefit. The buyer becomes the new owner and beneficiary, takes over the premium payments, and collects the death benefit when the insured dies. The buyer's profit is the death benefit minus the purchase price and all the premiums it pays until then, so the shorter the insured's remaining life expectancy, the more the buyer will offer.

Owners usually sell because the coverage is no longer needed or affordable: the children are grown, a business need has ended, or premiums have become a burden late in life. Selling turns an asset the owner might otherwise lapse or surrender into cash now.

When the insured is terminally or chronically ill, the sale has traditionally been called a viatical settlement. For the life settlement law's purposes, a person is terminally ill if death can reasonably be expected within 24 months or less (N.Y. Ins. Law § 7813(j)(3)).

The parties

• Owner: the policyowner who sells. The insured is the person whose life is covered; the two may be different people.
• Life settlement provider: the buyer, the person who enters into the life settlement contract with the owner (§ 7802(m)). Providers must be licensed.
• Life settlement broker: represents only the owner and owes the owner a fiduciary duty, acting on the owner's instructions and in the owner's best interest (§ 7813(l)). A broker shopping a policy to several providers is how the owner gets competitive bids.
• Life settlement intermediary: an online-style marketplace that relays offers between owners, brokers and providers. It must be registered (§ 7804(a)) and may not represent anyone or act as a provider or broker (§ 7814(e)).
• Financing entity: an accredited investor that supplies the money the provider uses to buy policies (§ 7802(e)).

Required disclosures

No later than the date the contract is signed by all parties, the provider or broker must give the owner a separate, signed disclosure document (§ 7811(a)). Among other things it must say that:

• there are alternatives, including accelerated death benefits from the insurer;
• the proceeds may be taxable, may be reachable by creditors, and may affect eligibility for public assistance;
• the owner may rescind the contract until 15 days after receiving the proceeds;
• proceeds will be sent within three business days after the provider receives the insurer's acknowledgement that ownership and beneficiary have been transferred;
• rights such as conversion and waiver of premium may be forfeited;
• the gross offer, the net amount to the owner, and every party's compensation.

The insured gets a separate notice too: the buyer may contact the insured to check health status, but only once every three months, or once a month if life expectancy is one year or less (§ 7811(b)(1)).

Prohibited practices

• No one may, as a condition of the life settlement contract, request or require the insured to take a medical exam at any time after the policy is settled (§ 7814(b)).
• A provider may not pay proceeds in installments; it pays a lump sum (§ 7814(c)).
• No referral or finder's fee may go to the owner's physician, attorney, accountant or insurance producer, other than a life settlement broker representing the owner (§ 7814(a)(8)).
• No compensation may go to anyone acting as a broker unless licensed as a life settlement broker (§ 7814(a)(7)).
• An insurer may not forbid its agents from telling a client that life settlements exist (§ 7814(f)).

Watch out for STOLI

Stranger-originated life insurance (STOLI) is a scheme where a policy is bought from the start with the intent of selling it to investors who have no insurable interest in the insured. A legitimate life settlement sells a policy that was bought for genuine protection; STOLI is designed for resale and is prohibited.