About Life Settlements
A life settlement is a transaction where, the owner (who may or may not be the insured) of a life insurance policy is paid a discounted value in cash in exchange for transferring ownership and all beneficiary rights of the policy to a new owner/investor. That new owner/investor assumes the future premium payments. A life settlement policy typically covers insurance policies of insured’s over the age of 65.
Life settlement investments provide portfolio diversification through an emerging asset class uniquely poised to remain uncorrelated to the economic instability often found in traditional capital markets. Family and Institutional investors, pension plans, endowment funds, individual accredited investors, insurance companies and banks have long recognized the value of this alternative investment class called senior life settlements.
We often hear the constant mantra of “diversification” from financial professionals and the business press. Most investors, however, (as well as their advisors) consider diversification within their portfolio to be a variety of holdings in different traditional financial instruments whose returns and risks are still in some way tied to the financial markets and the overall health of the domestic or global economy. Whether invested in stocks, bonds, variable annuities, or real estate, most investors have taken huge hits to their portfolios at some time or the other – even if they thought they were adequately diversified. Many investors have found that, in one way or another, all of their investments were linked to the condition of the economy through interest rates, the stock market, or even through the health and viability of well known Wall Street investment banks.
In these uncertain times, many investors have simply turned to holding cash or other classic “safe” investments such as CD’s, money market accounts, or U.S. Government securities. While these investment options also aren’t truly diversified from market conditions, they do at least offer a modicum of safety. Of course, the downside is that they usually offer paltry rates of return. While these types of safe investments are occasionally advertised with rates as high as 3% or 4%, this is all too often an introductory rate that will eventually decrease once the initial honeymoon period is over. It is more common to find rates in the 1% to 2% range, or even lower for U.S. Treasuries. Thus, the price of “playing it safe” is a low rate of return that may not even keep pace with inflation.
So where does this leave the investor that wants true diversification while still retaining the potential for a reasonable rate of return? Life Settlements as an investment option has the characteristics that a growing number of investors are taking advantage of. A life settlement is simply the purchase of an existing life insurance policy insuring the life of an elderly person at a discount to its face value. The purchaser obtains legal and beneficial ownership of the policy, including the premium obligation to keep the policy in force, and holds it until its maturity. Upon the policy’s maturity, the purchaser receives the payout of the benefits of the policy as their return on investment.
Rate of Return
The primary factors affecting the rate of return in a life settlement transaction are the discount at which the policy is purchased, the premium payments necessary to keep the policy in force, and the time until maturity. Since the maturity of a life insurance policy depends upon the passing of the insured, this is the factor with the most uncertainty in a life settlement transaction. The sooner the policy matures, the higher the purchasers’ annualized rate of return. Conversely, the later the policy matures, the lower the purchasers’ annualized rate of return, both because of the time value of money and the need to pay premiums to keep the policy in force. While there is certainly the potential for a higher or lower rate of return, historically investors can expect to receive double digit returns by investing in a number of life settlements policies. Investing in a Private Placement Memorandum(PPM) which would typically hold a portfolio of policies would be the best way for an investor to maximize their diversification and return potential.
What are the Risks?
Of course, just as with any investment, life settlements have their own set of risks. Life settlements are considered an illiquid investment. They are a growth instrument, not an income producing investment and should only be purchased with funds with which you do not need access. Policies may be purchased with life expectancy estimates from 48 months and up to 75 months. Since the life expectancy for the insured cannot be determined with certainty, life settlements do not have a known holding period or date of maturity. Generally, if the insured exceeds their life expectancy or the number of years that premiums may be escrowed for, the investor is responsible for paying the annual premiums in order to keep the policy in force.
The risk of premium obligations can be greatly alleviated by investing in life settlements through the vehicle of a Private Placement Memorandum(PPM), which typically maintains adequate cash reserves in escrow to to keep all policy premiums paid through to the maturity date. Purchasing life insurance policies that are all issued by investment rated, legal reserve life insurance companies, mitigates the risk an investor never being paid the death benefit when the insured dies.
While these and other risks do exist, these risks are not directly tied to market or economic conditions making life settlements a great way to truly diversify your investment portfolio.