Insurance Settlement Options – What they are and how they work
Life Insurance Settlement Options
In this article, you will learn everything you need to know about life insurance settlement options for your life or life and health insurance licensing exam. Okay, straight to it then. What’s the good news? You are the named beneficiary on a life insurance policy and you are set to be paid $1M dollars if the insured dies. What’s the bad news? The insured died. So, you are distraught, but you have $1M coming your way.
How do you want to take it? It’s your choice as the beneficiary of the policy. Well, the insurance company, or insurer, is going to give you a few choices of how you can take your money. They are called settlement options. The insurer is settling their debt with the beneficiary (you, in our example).
If you are having a hard time preparing to pass your licensing exam, you are not alone. This stuff is hard! Please check out the sample video below pulled from our course and check out our other free content on our YouTube page.
What are the five life insurance settlement options?
These are the options you as the beneficiary have to choose from when the insured person of the life insurance policy dies. You also have to know these in and out for your state insurance licensing exam. You could have 3-5 questions on these options on your test.
You can remember the five settlement options with the acronym C-I-F-F-A. They are as follows:
1 – Cash settlement option – In our example, the insurer would cut you a check for $1M. That’s it! If you were to select this option, the insurer would send you a check for $1M tax-free. Pretty straightforward right? Usually, they don’t ask about this option on the exam.
2 – Interest settlement option – If you choose this, the insurance company keeps the $1M and makes interest payments to the beneficiary. Under this option, although the underlying death benefit ($1M) is not taxable, the interest payments that are made to the beneficiary are taxable as ordinary income.
Do you think the insurance company likes this option? Uh, yeah! They don’t have to immediately pay out the money! You do need to know if the insurance company does not hear from the beneficiary on which settlement option they want, this is the automatic option.
Why would someone pick this option? Who knows? Who cares? Just make sure you have it down for your test.
3 – Fixed period settlement option – What’s this? This option allows the beneficiary to select a fixed time period during which they would like the insurer to pay out the $1M death benefit. So, for example, you tell the insurer you want them to pay you monthly for 20 years. At the end of the 20 years, the entire $1M will be gone.
Keep in mind that with this option, while the insurer is holding the $1M death benefit they will also be paying the beneficiary interest, which is taxable.
4 – Fixed amount settlement option – Alright, so fixed period and fixed amount always get confused. The fixed period settlement is for a set fixed period of time. The fixed amount settlement option is a fixed dollar amount. So, using the fixed amount life insurance settlement option, you tell the insurer to send you a check for $10,000 a month. They will do so until the money is gone.
5 – Annuity settlement option – As the beneficiary, you can use the death benefit to purchase a single premium immediate annuity. Now, annuities have their own pay-out options which we plan to cover in another article. However, at this point, you need to know this death benefit is the only one where the beneficiary has the potential to be paid out more than the $1M and interest over their life since it is a lifetime payout! This is a huge benefit of an annuity.
So, there is a brief explanation of the five life insurance settlement options. Now let’s look at some questions to see if you truly understand them for your state exam.
Which settlement option pays a stated amount to a beneficiary?
Fixed amount! The fixed amount settlement option pays a fixed amount monthly to a beneficiary.
A beneficiary receives only the death benefit earnings in which settlement option?
Interest! The interest settlement option allows the insurer to keep the death benefit and pay only interest to the beneficiary.
Which settlement option provides a single beneficiary with income for the rest of his/her life?
This would be the annuity settlement option. The annuity payout option is for the life of the annuitant.
Which of the following is not a life insurance settlement option?
Well, if you have the five life insurance settlement options memorized with the acronym CIFFA, you will know the odd answer out is the correct answer to this question.
Let’s check out some actual sample life insurance licensing exam practice questions taken from our exam prep course on settlement options to really bring this home for you.
Which of the following settlement options might provide payments that exceed the proceeds of the policy and the interest earned?
A. Life annuity
B. Fixed Period
C. Fixed amount
D. Interest-only
Answer: A
Explanation: There are five settlement options from which a beneficiary may select upon death of the insured: 1) cash; 2) fixed period (proceeds, plus interest, are all paid out over a fixed period of time, the client chooses the time period); 3) fixed amount (the beneficiary elects to receive a specific dollar amount monthly, for as long as the money lasts); 4) interest (the proceeds are left with the company to accumulate additional interest), and 5) life annuity (paid as long as the beneficiary/annuitant lives).
Which of the following settlement options provides for payments to be made in regular installments of a specified amount until the principal and interest are exhausted?
A. Fixed amount
B. Fixed period
C. Interest
D. Life income
Answer: A
Explanation: When the insured dies, the beneficiary may select any one of five settlement options. They are: cash; fixed amount (for example, the beneficiary elects to receive $1,000 a month for as long as the money lasts); fixed period (the beneficiary chooses to be paid out over a 20-year period); interest (the beneficiary leaves all the proceeds with the company to accumulate additional interest), and life income (the beneficiary takes the policy proceeds as cash and buys a straight life or pure life annuity).
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