Transferable Insurance Policies: How TIPS Work and Their Benefits

Transferable Insurance Policies (TIPS) are life insurance policies that allow the beneficiary to be transferred. The owner can sell their transferable policy to an investor at a discount to the policy's face value. The purchaser, who becomes the beneficiary of the policy, will pay all subsequent premiums and receive the settlement value when the insured person becomes deceased. It's also known as a viatical settlement.

Key Features and Risks of Transferable Insurance Policies (TIPS)

Transferable insurance policies have a guaranteed principal, similar to a bond, but an uncertain maturity. Since they are sold at deep discounts, TIPS often have high yields. While TIPS contain no external risks, such as interest rate fluctuations, they do have the risk of an extended maturity. The longer an insured person lives, the less return for the investor.

The two primary types of TIPS include viaticals and life settlements. Both types function in similar ways; however, they have different expected maturities. Viaticals are policies on people with terminal illnesses who have a life expectancy of two years. Life settlement TIPS cover senior citizens as insured individuals, who usually have a life expectancy of 2 to 15 years.

Legal Background: Supreme Court Rulings on TIPS

The U.S. Supreme Court ruled in 1911 in Grigsby v. Russell that people had the right to sell their policies in this way. "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," the court ruled.

Transferability of life insurance policies gained momentum in the 1980s when people suffering from AIDS sold their policies, sometimes to obtain money for their care. 

At least 43 states have set up rules on viatical settlements after complaints that syndicates were buying policies for speculative purposes. "Thirty of the regulated states have a statutorily mandated two-year waiting period before one can sell their life insurance policy, while 11 states have five-year waiting periods and one state, in Minnesota, has a four-year waiting period. Most states have provisions within their life settlement acts whereby 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.)," according to the Life Insurance Settlement Association.

Michigan and New Mexico regulate viatical settlements only, while Alabama, Missouri, South Carolina, South Dakota, Wyoming, and Washington, D.C. do not regulate viatical or life settlements. Most unregulated states and states that regulate viaticals only, with the exception of Missouri, which has a one-year contestability period, have a two-year contestability period under their general insurance code, according to LISA.