Life Settlements: How the Secondary Market for Life Insurance Works

$4.4 Billion in Face Value Sold in 2022—and Most Sellers Still Don't Know This Market Exists

The U.S. life settlement market processed approximately $4.4 billion in life insurance face value in 2022, according to the Life Settlement Report published annually by the Life Insurance Settlement Association (LISA). Providers paid out roughly $860 million in cash to sellers—a figure that represents significant liquidity created for policyholders who would otherwise have lapsed or surrendered their policies for far less. Despite this volume, surveys consistently show that the majority of Americans over 65 do not know that selling a life insurance policy to a third party is a legal and sometimes financially superior alternative to surrendering it to the issuing insurer.

A life settlement is the sale of an existing life insurance policy to a third-party investor for an immediate cash payment greater than the policy's cash surrender value but less than its face value. The buyer assumes ownership, pays future premiums, and collects the death benefit upon the insured's death. Life settlements differ from viatical settlements primarily in the health status of the insured: life settlements typically involve seniors (generally 65 or older) with reduced but not necessarily terminal life expectancy, while viatical settlements involve the terminally ill with projected life expectancy under 24 months.

The Life Settlement Transaction Structure

The life settlement process involves several parties and typically takes 60–120 days from initial contact to receipt of funds.

After closing, the provider files a change-of-ownership form with the insurance company. Premium bills are redirected to the new owner. The original insured maintains no further obligation or benefit under the policy.

What Policies Are Eligible

Not every life insurance policy is marketable in the secondary market. Providers seek specific characteristics that make the policy economics viable.

• Policy type: Universal life, whole life, and convertible term policies with remaining conversion rights are all marketable. Pure term policies with limited remaining term (fewer years than projected life expectancy) are generally not viable.
• Face value: Providers generally require minimum face values of $100,000; the most actively traded policies are $500,000 and above. Small policies generate insufficient profit margin to justify transaction costs.
• Insured age and health: Typically 65 or older with some health impairment that reduces life expectancy below actuarial norms for the insured's age. Healthy 65-year-olds receive poor offers or no offers; an 80-year-old with cardiac conditions generates much better pricing.
• Premium affordability: Policies with very high ongoing premiums relative to face value reduce the buyer's potential return and either reduce offers or make the policy unmarketable.
• Issuer strength: Providers prefer policies from highly-rated insurers with strong claims-paying ability.

How Life Settlement Offers Are Calculated

Providers model the transaction as an investment with an internal rate of return target, typically 8%–20% depending on competitive conditions, policy type, and life expectancy certainty.

The calculation considers: (1) the settlement price paid to the seller; (2) all future premium payments required to keep the policy in force; (3) the expected time until death; and (4) the eventual death benefit collected. The provider's profit is the death benefit minus all costs and the time value of money. Life expectancy assessment is the single most consequential variable—a 2-year error in life expectancy projection can transform a profitable investment into a loss for the buyer.

Tax Treatment of Life Settlement Proceeds

Life settlement proceeds are taxed in three layers, depending on the policy's cost basis and the settlement amount received.

• Return of basis: The amount received up to the policy's cost basis (total premiums paid minus any dividends or other tax-free distributions received) is returned tax-free.
• Ordinary income: Proceeds above cost basis but below the policy's cash surrender value at the time of sale are taxed as ordinary income—the same character as if the policy had been surrendered directly to the insurer.
• Capital gain: Proceeds above the cash surrender value are treated as long-term capital gain (assuming the policy was held for more than one year), taxed at preferential capital gains rates (0%, 15%, or 20% depending on income).

This three-tier treatment was clarified by IRS Revenue Ruling 2009-13. For large universal life policies with minimal cash value (common in the life settlement market), a significant portion of proceeds may be ordinary income rather than capital gain.

Regulatory Landscape

Life settlements are regulated by state insurance departments in 42 states plus the District of Columbia, covering roughly 90% of the U.S. population. The remaining states either have no specific life settlement statute or have adopted only partial regulation. NAIC model regulations require provider and broker licensing, mandatory disclosure of alternatives, and rescission rights (typically 15–30 days).

Consumer Protections Worth Knowing

• Licensed brokers are legally required to disclose all offers received and their own compensation.
• Rescission rights allow cancellation of the transaction within the statutory period without penalty—critically important if circumstances change.
• Providers must maintain premium escrow accounts to ensure policy continuity during transfer.
• Privacy protections regulate how the insured's medical information is shared during the underwriting process and afterward.

The primary consumer risk is selling too cheaply—either by not shopping the policy to multiple providers, or by working with an unlicensed buyer in an unregulated state. Competitive bidding through a licensed broker consistently produces higher prices than direct provider contact. For policies with significant face value, having an independent attorney review the transaction before closing is money well spent.

This article is for informational purposes only and does not constitute financial advice.