Many life insurance policyholders borrow against their policies to access cash for retirement, unexpected expenses, or other financial needs.
But what happens when a client has an outstanding policy loan and no longer needs the coverage?
Some policyholders may assume that having an outstanding loan prevents them from selling their life insurance policy. However, a policy with an existing loan may still qualify for a life settlement.
At Abacus Life Solutions, we believe understanding how policy loans affect settlement eligibility and potential value can help advisors identify opportunities that might otherwise be overlooked.
How Do Life Insurance Policy Loans Work?
Certain permanent life insurance policies allow policyholders to borrow against their accumulated cash value.
These loans generally do not require a traditional credit check, and repayment terms may be flexible depending on the policy.
However, outstanding policy loans can affect the coverage over time.
- Interest charges: Unpaid loans accrue interest, increasing the outstanding balance.
- Reduced death benefit: The loan balance generally reduces the amount beneficiaries would receive.
- Policy lapse risk: Growing loan balances can put a policy at risk of lapsing if the policy is not properly maintained.
For clients who no longer need their coverage, these factors may make it worth exploring alternatives.
Can a Policy With an Outstanding Loan Qualify for a Life Settlement?
Yes. An outstanding policy loan does not automatically disqualify a life insurance policy from a life settlement.
A life settlement allows an eligible policyholder to sell an existing policy to a third party in exchange for a lump-sum payment.
The buyer assumes responsibility for future premiums and receives the death benefit when the insured passes away.
When a policy has an outstanding loan, the loan balance and its impact on the policy are considered during the valuation process.
Eligibility depends on several factors, including the insured’s age and health, policy type, death benefit, premium requirements, and outstanding loan balance.
How Do Outstanding Loans Affect Life Settlement Offers?
A policy loan can influence the amount a buyer is willing to offer.
Because the outstanding balance generally reduces the net death benefit payable, it can affect the policy’s potential secondary-market value.
Other factors that may influence an offer include:
- The size of the outstanding loan
- Accrued interest and loan terms
- The policy’s remaining cash value
- Future premium obligations
- The insured’s age and health
In some cases, the loan may need to be repaid or otherwise addressed as part of the settlement transaction.
This means the amount ultimately received by the policyholder may differ from the policy’s gross valuation.
Why Advisors Should Consider a Valuation Before Surrendering
When a client has a heavily loaned policy, surrendering the coverage or allowing it to lapse may seem like the simplest option.
However, that decision could overlook potential value in the secondary market.
A life settlement valuation can help advisors determine whether an eligible policy may provide proceeds beyond what the client would receive by surrendering it.
It can also help clients better understand their options before making a decision that permanently ends their coverage.
Importantly, policy loans can create tax consequences when coverage is surrendered, lapses, or is sold. Advisors should coordinate with qualified tax professionals when evaluating these options.
Don’t Overlook Policies With Existing Loans
An outstanding policy loan does not necessarily mean a life insurance policy has no remaining value.
For clients who no longer need their coverage, a life settlement may offer an alternative worth considering, even when a loan balance exists.
The key is understanding how the loan affects the policy and evaluating all available options before surrendering or lapsing coverage.
A policy with an outstanding loan may still have value worth exploring.
Find Out What Your Client’s Policy Could Be Worth
If your client has a life insurance policy with an outstanding loan, a policy valuation can help determine whether a life settlement may be an option.
