Posted by Steve | Comments Off
A life settlement is the sale of a life insurance policy by the owner to a third-party, typically for cash in an amount greater than the surrender value (why else would a person sell their life insurance policy?). The buyer assumes ownership and pays the premiums necessary to keep the policy solvent. Upon the death of the insured, the buyer of the policy receives the death benefit.
Generally speaking, life settlements are an option for policy owners of high net worth who are over 65. Independent estimates report that one in five policies in this group has a market value exceeding the cash value offered by the insurance carrier.
The market for life settlements started out on a rational basis. The original business plan for life settlements was to purchase unwanted or unneeded policies as an institutional investment from policyholders over 65 whose health had deteriorated more rapidly than the aging process would indicate. This primary factor established the mortality arbitrage necessary to make the purchase price higher than the policy’s surrender value.
Are life settlements a viable investment?
There are a number of pitfalls policyholders must consider before selling their policies, but if you are in the market to purchase life settlements, it’s important to consider a few details. First, the life settlement market has become quite active, indicating that the industry has convinced itself these life insurance policies are mispriced. As the industry has developed, it’s begun eying the policies of healthy insured individuals and labeling them as attractive targets as well.
Life settlement brokers have begun purchasing policies and repackaging them. These packages are then sold to small institutional and individual investors with the original message: these are unwanted policies from policyholders who are at least 65 years old and in unexpectedly deteriorating health. Unfortunately, all of the packaged policies may not adhere to the investment model.
This is what some in the industry refer to as ‘dumb money’ because the investors don’t know how to analyze the investment potential and they don’t understand that an accurate assessment of life expectancy is critical to this particular investment’s success.
While the life settlement businesses started out as a worthy secondary market for limited situations, the market has gotten out of control. Huge, often hidden, fees and commissions have been assessed to these life settlement package investments. Add that to the misplaced understanding that these policies are all great investments and you have a poor reason to invest. In many cases, the insureds should not be selling their policy until it is about to terminate, and investors shouldn’t become owners of another person’s life insurance policy.
Filed Under: Other Investment Management Topics