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What the Heck are Life Settlements?
Life Settlements are an interesting new asset class that has low risk, attractive returns and maybe best of all, no correlation with other asset
classes like real estate or the stock market. This relatively new asset class is about 10 years old and until recently the play ground of the
Big Boys. A life settlement is described as the purchase of an unwanted life insurance policy at a discount to its settlement value. The buyer
is then responsible for maintaining the premium payments and in exchange they receive the proceeds from the policy when the insured person dies.
Sounds simple enough, buy the insurance from an elderly person and collect when they die in a few years. Most of the life insurance that is
purchased is large policies, about $1 million or larger. Even though the purchase price is a significant discount to the face amount it can
still cost about $250,000 to $400,000 depending upon a number of factors. The purchaser/investor in this policy will want to know what type of
insurance policy it is and the length of time it has been in force since this can limit the payout. The purchaser of the policy will be
responsible for making premium payments for the rest of the insured person's life. It is not unusual for these payments to be $30,000 a year or
more! While it would seem to be a safe bet that if you purchase a policy on a person that is 81 years old you will collect in a short period of
time we all know of someone that has just had there 100th birthday party. The Big Boys purchase numerous policies on elderly people and like the
insurance companies they pool them together to in a portfolio to reduce their risk. Should someone live beyond the expected period it doesn't
seriously affect the return. With life settlements it's not a matter of if they will collect but rather when they will collect. As you can
quickly see if you purchase a policy cheaply enough ($250,000) and even if you had to make 10 years of $30,000 on a million dollar policy you
could still make $450,000! Not bad but the Big Boys stack the odds in their favour even more. Rather than just depending on buying policies from
elderly people or depending on the actuarial tables they ask for the medical records. These records are reviewed by specially trained professionals
that can further refine the life expectancy. In this manner the Big Boys can get a more accurate idea of their rate of return on a purchased policy.
These actuarial firms' claim to have an accuracy level of 87% to 96% predicting life expectancy!
Isn't this morbid?
People sometimes worry that this is exploitive or morbid. Actually an insured person may no longer need or want a policy and the first response is
to let it lapse and stop the payments. About $1.6 trillion of life insurance policies lapsed last year. A person with a million dollar policy could
easily be making payments of $35,000 a year on a policy that is unneeded. This is a pretty heavy financial burden. Sometimes the insured person
checks to see if there is any value (cash surrender value). A simple request of the agent or insurer should come up with this amount. It is not
unusual that the cash surrender value is quite low or non-existent. A rule of thumb is that you might get up to 10% of the face value or $100,000
in our $1 million example. A new and potentially more beneficial option for the insured is to explore the Life Settlement market. By signing forms
releasing medical information so that a "life assessment" can be made, the insured can get a bid on their policy. There are a number of factors that
go into calculating the value or bid price but usually the bid is greater than the cash surrender value. The Life Settlement option could see the
insured getting 2-3 times, or more, than the cash surrender value. This seems like an attractive option for the insured that wasn't available previously.
Where life insurance is still needed, Life Settlements are not an attractive option and discussions should be had with their agents to see what avenues
are open to recognizing value of this asset.
From an investor's standpoint, this is an attractive investment due to its high quality, low risk, and competitive returns that are not affected by any
other investments.
As the saying goes "Nothing is certain except death and taxes", now we can have some of that certainty in our investments.
