Life insurance has been a core part of the U.S. financial fabric since its early development in the 1800s. A life insurance policy is a valuable asset. It provides financial benefits to loved ones, businesses or other beneficiaries who might otherwise experience financial hardships from the early or untimely death of the insured person, and it often provides resources that last well beyond the policy holder’s lifetime.
However, benefits can be also be unlocked from a life insurance policy during the policy holder’s lifetime because -- like any asset that is personal property -- life insurance can be sold. This simple premise was the foundation for the life settlements industry in the U.S.
Legal Foundation for Life Settlements
The legal basis for life settlements as a legitimate option for life insurance owners may be found in the Grigsby v. Russell decision from the U.S. Supreme Court in 1911.
The litigation was touched off because Dr. A.H. Grigsby treated a patient named John C. Burchard. Mr. Burchard, being in need of a particular surgical operation, offered to sell Dr. Grigsby his life insurance policy in return for $100 and for agreeing to pay the remaining premiums. Dr. Grigsby agreed and the transaction was completed. When Mr. Burchard passed away a year later, Dr. Grigsby tried to collect the benefits – but an executor of Burchard’s estate (R.L. Russell) challenged him in court and won. The case eventually reached the U.S. Supreme Court, where Justice Oliver Wendell Holmes Jr. delivered the opinion of the court.
The crux of Justice Holmes’ opinion was this: “So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property. To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”
Justice Holmes’ decision set forth the fundamental principle upon which the life settlement industry would eventually be based: a life insurance policy is private property, which can be assigned at the will of the owner. This legal precedent has been reinforced in the decades since the Grigsby decision, most recently in the passage of the Health Insurance Portability and Accountability Act (HIPAA) in 1996. Signed into law by President Clinton, HIPAA allowed the owner and/or beneficiary of a life insurance policy to transfer the ownership and/or beneficial interest in that policy to a third party.
Birth of an Industry
The life settlements industry itself may be traced back to the 1980s and the onset of the AIDS epidemic in the U.S. In the 1980s, AIDS victims faced an extremely short life expectancy. Often, these individuals owned life insurance policies they no longer needed. It was under these circumstances that the first “viatical” settlements were created.
A viatical settlement occurs when a terminally or chronically ill individual (less than two years life expectancy) sells his/her life insurance policy to a third party for a lump sum. The third party becomes the new owner of the policy, pays the monthly premiums, and receives the full benefit when the individual expires.
As medical advancements made progress in the lives of those living with AIDS and other life-threatening illnesses, viatical settlements became less common. But out of this period of time, the life settlement industry emerged. In a life settlement transaction, the policy owner is usually at least 65 and not terminally or chronically ill. The individual sells the policy to a third party for a lump sum.
A Mature, Regulated Industry
Today, the life insurance settlements and viatical settlement marketplace is heavily regulated. As of 2014, 42 states and the territory of Puerto Rico regulate life settlements, affording approximately 90% of the United States population protection under comprehensive life settlement laws and regulations. Of this group, 31 states have a statutorily mandated two-year waiting period before one can sell their life insurance policy from the time of issue, while 10 states have five-year waiting periods and one state (Minnesota) has a four-year waiting period. Most states have provisions within their life settlement acts where one can sell their policy before the waiting period if they meet certain criteria (i.e. owner/insured is terminally or chronically ill, divorce, retirement, physical or mental disability, etc.).
Interestingly, there have been only two closed consumer complaints nationwide involving life settlements since 2012, according to the National Association of Insurance Commissioners (NAIC). This is in stark contrast to the more than 8,000 complaints against life insurance carriers in 2014 alone for delays in paying claims.