How a life settlement sale works from appraisal to closing

Selling a life insurance policy is a slower, more paper-heavy transaction than most sellers expect. It usually takes weeks, it involves strangers reading your medical records, and it ends with a buyer owning the death benefit that your family had counted on. This post follows one hypothetical seller through every stage, from the first phone call to the day the money arrives, and marks the points where a careful seller checks something before moving on.

The people and numbers are invented to show the sequence. The rules for life settlements are set by states, and they differ, so treat the steps as a general map and use your state insurance department for the specifics.

Meet the seller (a hypothetical)

Say Helen is 79 and owns a universal life policy with a $500,000 death benefit. She bought it in her fifties to protect a business that she sold long ago. Her children are financially secure, the monthly cost of keeping the policy has risen as she has aged, and she has started to wonder whether the premiums are worth paying. A friend mentioned that policies like hers are sometimes sold.

Helen's invented numbers: she has paid $60,000 in premiums over the years, the policy's cash surrender value is $75,000, and the premium needed to keep it in force is about $18,000 a year. She is in fair health, with managed heart disease and a history of one cancer that has been in remission for years.

Step 1: Decide whether selling is even the right question

A life settlement is the sale of an existing policy to a third party for more than its cash surrender value but less than its death benefit. It is one of several exits, and a sensible first step is to compare them. The life settlements: selling your life insurance policy guide and the surrendering a life insurance policy: what you get and what it costs guide set out the options in detail. In short:

• Keep it. Right if the death benefit still serves a real purpose, such as paying an estate tax bill, supporting a dependent or funding a business agreement, and the premium is affordable.
• Reduce it. Some policies allow a lower face amount, which can lower the cost.
• Surrender it. The owner receives the cash surrender value, and any amount above the cost basis is taxed as ordinary income.
• Use living benefits. A seriously ill owner may have an accelerated death benefit rider that costs nothing to use.
• Sell it. A third party pays an amount between the surrender value and the death benefit.

Helen runs the keep, surrender or sell your policy? with her figures to see how a sale might compare. She also asks her insurer for an in-force illustration, a document that shows how the policy is projected to perform if premiums continue, because buyers will want one and because it tells her whether the premium will keep rising. Nothing in this step commits her to anything.

Step 2: Gather the documents

A seller who is organized gets better service and shorter delays. Helen collects:

1. The policy contract and any riders.
2. The latest annual statement and a current in-force illustration.
3. A statement of any loans against the policy. Helen has none.
4. Her premium payment history, which also gives her an estimate of her cost basis.
5. Contact details for her insurer and the names of the owner, insured and beneficiary on file. Here the owner and the insured are both Helen.
6. A list of her physicians and her authorization to release her records.

If a trust or another person owns the policy, that owner must be part of the process. Any irrevocable beneficiary or assignee, such as a lender, may also need to consent to the transfer.

Step 3: Choose who represents you

Two kinds of businesses operate here. A provider buys policies, often on behalf of institutional investors. A broker represents the seller and solicits offers from several providers. Both are licensed by the state, and the rules differ, so ask for a license number from anyone who approaches you and check it with your state insurance department.

Under the NAIC's model act, a settlement broker is deemed to represent only the seller, with a duty to the seller, no matter how the broker is paid. A provider has no such duty: it is the other side of the transaction. Helen decides to use a broker so that several providers compete for her policy. Before she signs a brokerage agreement she asks:

• How are you paid, and what is the amount or percentage? Is it paid by me, by the buyer, or by both?
• How many providers do you send my file to, and will you show me every offer?
• Will you tell me which providers you decline to work with, and why?
• How is my medical information protected, and who sees it?
• What happens if I decide not to sell?

Compensation disclosure is a requirement in states that follow the model act, but Helen asks anyway and keeps the answers.

Step 4: Authorize medical records and the life expectancy review

The central input to any offer is a life expectancy estimate. The broker needs Helen to sign a HIPAA authorization so that her physicians' records can be released. The providers then obtain life expectancy estimates from independent underwriting firms, which read the records and estimate how long a person with her health history is expected to live.

This step has a cost in privacy that deserves plain attention. Helen's medical history will be read by people at the broker, the providers, the underwriters and possibly the investors' agents. State laws and the model act require confidentiality protections. After a sale, the provider may contact the insured to confirm her health status, but only at limited intervals under the model act: no more than once every three months if life expectancy is longer than a year. Helen asks the broker to put the confidentiality terms in writing.

The records review usually takes several weeks, because doctors' offices respond slowly. Helen contacts her physicians' offices to ask for prompt release, which can shorten the process.

Step 5: Receive and compare offers

Weeks later the broker returns with bids from several providers. The price each provider offers depends mainly on the insured's life expectancy, the death benefit and the cost of keeping the policy in force. The post on how a life settlement offer is priced and why offers differ explains why offers can differ widely. Here they are, invented:

Helen does not simply choose the highest number. She asks the broker to explain every condition. Provider 3's offer sounds attractive until she finds that $28,000 of the amount is deferred and not guaranteed. Provider 2 is the strongest, but the offer depends on the insurer confirming the policy details, and the price could change if the in-force illustration differs. She asks how long each offer remains valid.

She also compares each offer with the surrender alternative:

1. Surrender: $75,000 received.
2. Best sale offer: $132,000 received before any broker compensation is deducted.
3. Difference: $132,000 - $75,000 = $57,000 more from a sale than from a surrender, subject to taxes and fees.

That difference is the reason people sell. It is not a guarantee: many policies on younger or healthier insureds receive no offer above surrender value.

Step 6: Read the contract and the disclosures

Once Helen picks Provider 2, it sends a settlement contract and a set of disclosures. Under the model act, a seller must receive a signed, separate disclosure document. It must state, among other things, that alternatives exist, including accelerated death benefits and policy loans; that some or all of the proceeds may be taxable; that the proceeds could be subject to creditors' claims; and that receiving the proceeds could affect Medicaid or other government benefits.

Helen reads the contract with a pen. She looks for:

• The price and how it is paid. A single lump sum into escrow, or part now and part later?
• Any deductions. Broker compensation, escrow fees, other charges.
• The conditions. What must happen for the sale to close, and what happens if the insurer will not approve the transfer?
• The rescission rights. How long she can undo the sale and what she must repay.
• Confidentiality and contact terms. How often the provider may contact her about her health.
• Her own warranties. Statements that the policy is in force, that she is the owner, and that she has no undisclosed loans or liens.

Because the sale is final once the rescission period ends, this is the time to have a lawyer review the contract. A tax professional should look at the tax effect before she signs. The cost of those two hours is small relative to the amount involved.

Step 7: Escrow and change of ownership

After signing, the paperwork moves to the insurer. The provider submits a change of ownership and a change of beneficiary form. The insurer verifies the request, confirms the policy is in force and records the new owner. Helen's role in this step is to sign and return anything the insurer sends and to answer calls promptly.

The model act contemplates the buyer depositing the purchase price with an independent escrow agent before the insurer changes ownership. The escrow agent releases the funds to the seller when the insurer confirms the change. Helen asks the broker for the escrow agent's name and confirms the escrow instructions in writing. She never sends the transfer paperwork to the provider unless the funds are in escrow.

If the insurer's records differ from what the provider expected, the closing can slip, or the provider may offer a lower price. She keeps a copy of everything she signs.

Step 8: Closing, payment and the rescission window

On closing, the escrow agent pays Helen. In this example the payment is $132,000 less any agreed fees. She asks for a written closing statement showing every deduction.

The sale is not necessarily final the day the money arrives. Under the NAIC model act, a seller may rescind before the earlier of 60 calendar days after all parties sign the contract or 30 days after the proceeds are paid, by giving notice and repaying the proceeds. If the insured dies within that window, the contract is deemed rescinded. States set their own periods, and some are shorter, so Helen reads her contract and her state's rule. During the window, she keeps the money in a safe, accessible account and does not spend it.

Step 9: What happens after the sale

Several consequences follow, and a seller should know them in advance.

• The death benefit belongs to the buyer. Helen's children will receive nothing from this policy. The buyer pays the premiums from now on.
• Taxes. The treatment turns on the seller's basis and the policy's cash value. In general terms, basis is the premiums paid, and the gain is the sale price minus basis. Helen's gain is $132,000 - $60,000 = $72,000. Under the IRS framework in Revenue Ruling 2009-13 as updated by Revenue Ruling 2020-5, the part of the gain up to the amount by which cash surrender value exceeds basis, here $75,000 - $60,000 = $15,000, is generally ordinary income. The rest, $72,000 - $15,000 = $57,000, may be long-term capital gain. These figures are an illustration and a tax professional should model her case, including any prior withdrawals or loans.
• Reporting. Since the 2017 tax law, life settlement transactions are subject to information reporting (section 6050Y), so the IRS will receive a record of the sale.
• Benefits and creditors. The proceeds could affect eligibility for need-based programs, so Helen looks at medicaid eligibility and life insurance cash value before she spends them.
• Contact about her health. The provider may be in touch on the schedule agreed in the contract.

The buyer faces its own issues under the the transfer-for-value rule, which can make part of the death benefit taxable to the buyer. That is the buyer's concern, but it explains why providers are careful about documents. The post on how the tax on a life settlement sale works in principle covers the seller's side in more depth.

What can slow or stop a sale

Not every sale closes. Knowing the usual snags helps a seller stay patient and avoid panic decisions.

• Medical records arrive late. Doctors' offices are the most common bottleneck, and the providers cannot price until the life expectancy reports come back.
• The insurer takes its time. Insurers must verify ownership, review the transfer forms and sometimes confirm that the policy is in force at the date stated. Delays of a few weeks are not unusual.
• The numbers change. A new in-force illustration can show higher future premiums or a lower cash value than the provider assumed, and the offer may be revised.
• A required signature is missing. A spouse with an ownership interest, a lender with an assignment or a trustee who must approve can all hold up closing.
• The offer is withdrawn. Offers expire. If a seller waits months, a change in health, in the policy's costs or in the buyer's appetite can alter the price.

If a provider asks you to sign something before escrow is in place, to keep the sale secret from your family or to act quickly because the offer will vanish, treat it as a warning sign and call your state insurance department. A legitimate buyer expects the seller to take time to compare, consult advisers and read the contract.

A checklist for the seller

1. Confirm that the death benefit is no longer needed by your family.
2. Compare keeping, reducing, surrendering and an accelerated benefit.
3. Check the license of every broker and provider with the state.
4. Ask how everyone is paid, and get it in writing.
5. Compare offers on guaranteed money, not headline numbers.
6. Read the separate disclosure document.
7. Use an escrow agent and confirm the instructions in writing.
8. Know your rescission rights and the dates.
9. Ask a tax professional about the sale before you sign.
10. Keep every document for tax filing.

Key takeaways

• A life settlement sells the policy to a third party, usually for more than its surrender value but less than the death benefit, and the buyer collects the death benefit.
• The process runs in stages: gather documents, choose a licensed broker or provider, authorize medical records, compare offers, read the disclosures and contract, use escrow, transfer ownership and respect the rescission window.
• Offers vary, so compare guaranteed cash rather than headline numbers, and ask how every party is paid.
• The seller's family loses the death benefit, medical privacy is partly given up, and taxes depend on basis and cash value.
• Confirm state licenses, rescission periods and tax treatment with your state insurance department and a tax professional before you sign.