Understanding the Life Insurance Secondary Market

Most people think of life insurance as a one way transaction. You buy a policy from an insurance company, pay premiums for years or decades, and eventually your beneficiaries collect the death benefit. That is the primary market. But there is an entirely separate marketplace that most people have never heard of, where existing life insurance policies change hands between policyholders and investors. This is the secondary market for life insurance, and understanding how it works could be worth a lot of money if you own a policy you no longer need.

Primary Market vs Secondary Market

Let me start with a quick distinction that trips people up.

The primary market is where life insurance policies are born. You fill out an application with MetLife or Northwestern Mutual or whoever. They underwrite you, issue a policy, and you become a policyholder. The transaction is between you and the insurance company. That is the primary market.

The secondary market is where existing policies get resold. You already own a policy that was issued years ago. Now you want to sell it. The buyer is not the insurance company but an outside investor. The transaction is between you, the policyholder, and a third party buyer. That is the secondary market.

Think of it like the difference between buying a new car from a dealership versus buying a used car from a private seller. Same type of asset, different marketplace entirely.

A Brief History

The secondary market for life insurance is not some newfangled invention. It has legal roots going back over a century.

In 1911, the Supreme Court ruled in Grigsby v Russell that life insurance policies are personal property that can be bought and sold like any other asset. The court specifically rejected the idea that you need an insurable interest to own someone else's policy. This decision established the legal foundation for a secondary market to exist.

But it took decades for an actual market to develop. The modern secondary market emerged in the 1980s during the AIDS epidemic. People who had been diagnosed with AIDS often had life insurance policies but desperately needed cash for medical treatments. They began selling their policies to investors in transactions called viatical settlements. The insureds got money for treatment. The investors acquired policies at a discount and collected the death benefits.

The viatical market had serious problems in those early years. Some investors used predatory tactics to buy policies from desperate people for pennies on the dollar. There were scams and abuses. But over time, states stepped in with regulations, consumer protections were established, and the industry matured.

By the 1990s and 2000s, the market expanded beyond terminally ill people. Investors realized that seniors who were not terminally ill but were older and had health impairments also represented attractive policy acquisition opportunities. This gave rise to what we now call life settlements, which is the sale of a policy by someone who is not terminally ill but is typically 65 or older.

Today the secondary market handles billions of dollars in transactions annually. Industry data shows that the face amount of policies transacted grew from around $200 million in 1993 to over $4 billion by 2020. This is a real market with real money and real participants.

How the Secondary Market Works

The mechanics of the secondary market are fairly straightforward once you understand the players involved.

On one side you have policyholders who want to sell. These are typically seniors who own life insurance they no longer need or can no longer afford. Maybe the policy was purchased to protect young children who are now financially independent adults. Maybe the premiums have become burdensome on a fixed income. Maybe they just need cash for medical bills or long term care. Even people with term life insurance policies can sometimes participate if their coverage has a conversion option.

On the other side you have institutional investors who want to buy. These are hedge funds, pension funds, asset managers, and specialized life settlement investment firms. They view life insurance policies as an alternative asset class with returns that are uncorrelated with stock and bond markets.

In between you have intermediaries who make the market function. Licensed life settlement providers are the entities that actually purchase policies from consumers. Some providers buy for their own portfolios. Others buy on behalf of institutional clients. Life settlement brokers represent policyholders and shop their policies to multiple providers to get competitive bids.

How a Typical Transaction Flows

1. A policyholder decides to explore selling their policy
2. They work with either a broker or go directly to a provider
3. The intermediary collects information about the policy and the policyholder's health
4. This information gets packaged and presented to potential buyers
5. Buyers evaluate the opportunity and submit bids
6. If the policyholder accepts an offer, legal documents are signed, money changes hands, and ownership transfers

After the sale, the investor becomes the new policy owner and beneficiary. They take over premium payments. When the original insured eventually passes away, the investor collects the death benefit from the insurance company.

Why Investors Want These Policies

This is where people sometimes get confused. Why would anyone want to buy someone else's life insurance policy?

The answer comes down to returns. Life insurance policies represent a predictable future payout. If an investor buys a policy with a $1 million death benefit for $300,000 and pays another $100,000 in premiums over the holding period, they collect $1 million when the policy matures. That is $600,000 in profit.

Of course the timing is uncertain. The investor does not know exactly when the death benefit will be paid. But sophisticated investors are not making bets on individual lives. They are building portfolios of hundreds or thousands of policies and using actuarial science to estimate aggregate returns. The law of large numbers smooths out individual variation.

What makes this asset class attractive is that returns are largely uncorrelated with financial markets. Whether the stock market is up or down, whether interest rates are rising or falling, life settlement returns are driven by mortality, which marches to its own drummer. For institutional investors looking to diversify, this is valuable.

Who Participates in the Secondary Market

The secondary market has several categories of participants.

Policyholders (Sellers)

The typical seller is 70 or older, owns a policy worth at least $100,000, and has some health impairment that makes the policy attractive to buyers. Sellers are often motivated by financial need, a desire to stop paying premiums, or simply a recognition that the coverage is no longer necessary.

Life Settlement Providers

Licensed buyers who must be licensed in the states where they operate. Most states have specific regulations governing their conduct. Providers either buy policies for their own portfolios or act as intermediaries connecting policyholders with institutional buyers.

Life Settlement Brokers

Represent policyholders. A broker's job is to shop a policy to multiple providers and negotiate the best possible price. Brokers have a fiduciary duty to the policyholder and are compensated through commissions, which can range from a few percent up to 30% of the transaction value.

Institutional Investors

Provide the capital. These are the ultimate buyers in most cases. They include hedge funds specializing in life settlements, pension funds seeking diversification, family offices, and other sophisticated investors.

Life Expectancy Underwriters

The actuaries who evaluate how long someone is likely to live based on their medical records. Their assessments drive pricing. Major players in this space include Polaris, Fasano, and LSI.

Regulation and Consumer Protection

The secondary market is regulated in 45 out of 50 states. Regulations vary by state but generally include licensing requirements for providers and brokers, disclosure rules, and consumer protections.

Most states require a waiting period before a policy can be sold, typically two to five years from issuance. This is designed to prevent stranger originated life insurance, which is when someone takes out a policy with the intent of immediately selling it to investors. That practice is prohibited.

Sellers typically have a rescission period after completing a transaction, often 15 days, during which they can change their mind and unwind the deal.

Providers must make certain disclosures about the transaction, including any compensation paid to intermediaries and alternatives the policyholder might consider.

The five states without specific life settlement regulations are Alabama, Wyoming, South Carolina, South Dakota, and Missouri. Transactions can still occur in these states, but without the same statutory framework.

The Canadian Comparison

Interestingly, Canada takes a completely different approach. In most Canadian provinces, life settlements are essentially illegal. The Ontario Insurance Act, for example, says a policyholder can only sell their policy back to the insurance company for its cash surrender value. Selling to a third party investor is not permitted.

The only major exception is Quebec, which does allow regulated life settlements.

This difference shows how jurisdictions can take opposite views on the same question. American law views a life insurance policy as property the owner can sell freely. Canadian law treats it more like a service contract with restrictions on transfer. Whether Canadian seniors are protected or disadvantaged by this approach depends on your perspective.

Why the Secondary Market Matters

If you own a life insurance policy, the existence of the secondary market matters because it gives you options.

Without a secondary market, your only choices when you no longer want a policy are to surrender it back to the insurance company for whatever cash value has built up, let it lapse and walk away with nothing, or keep paying premiums for coverage you do not need.

With a secondary market, you have a fourth option. Sell the policy to investors who will pay significantly more than the surrender value because they are valuing the death benefit, not just the accumulated cash. This is what a life insurance buyout is all about. Just keep in mind that the proceeds are generally taxable, so consult a tax professional before finalizing any sale.

Not everyone will qualify for a secondary market sale. You generally need to be older, have some health impairment, and own a policy with meaningful death benefit. But for those who do qualify, the secondary market can put real money in their pockets.

If you are sitting on a policy you no longer need, it costs nothing to find out what the secondary market might pay for it. You might be surprised.

Disclaimer: The information provided in this article is for general informational purposes only and does not constitute legal, financial, or professional advice. Life settlement regulations vary by state, and this content should not be relied upon as a substitute for consultation with a licensed professional. Please consult with a qualified attorney, financial advisor, or licensed life settlement broker before making any decisions regarding the sale of a life insurance policy.