Life Settlements: The Best Investment You Probably Have Never Heard Of
Most financial advisors aren't very savvy when it comes to alternative investments. If they work for a brokerage firm, or if they are associated with an insurance company or a bank, they typically have limited options as far as the types of investments they sell. Most advisors and brokers are not educated about, nor even allowed to sell outside of what their brokerage firm offers.
However, large, successful institutional investors like Warren Buffett, hedge fund managers like Blackstone, endowments and national pension funds are VERY knowledgeable and savvy when it comes to alternative investments and have, in fact, in recent years put billions of dollars into a unique alternative known as life settlements.
These big, smart investors appreciate the strong performance potential of this type of investment and they especially like the non-correlation to other types of investments they hold. They also like the fact that the payouts from life settlements are essentially a matter of when, and not if, and that those payouts are coming as a result of a contractual obligation from some of the world’s largest and strongest companies: namely well-rated U.S. life insurance companies
So What Is a Life Settlement?
A life settlement (or more specifically, a senior life settlement, as they are known) is the term given to describe when an individual (usually someone in their 70’s or 80’s) sells an existing life insurance policy they own to a third party -- a person or an entity other than the company that issued the policy -- for more than the policy's cash surrender value, but less than the death benefit amount.
Most people who own a life insurance policy that they no longer want, need, or no longer can afford, generally think they only have 2 options: they can either surrender the policy for its cash surrender value (CSV), or allow the policy to lapse.
A life settlement presents a third, often more profitable choice to these insureds: They can sell their policy (and the associated right to receive the death benefit upon their passing) to an investor. The process of conducting such a sale is referred to as a life settlement, and the resulting investment that the buyer holds is also referred to a life settlement investment.
How Life Settlements Work
When an insured party no longer needs their insurance policy, they can sell it for a certain amount of cash to an investor, historically and usually an institutional investor. The insured person essentially transfers ownership of the policy to the investor. The insured party receives a cash payment in exchange for the policy -- more than the surrender value, but less than the policy's prescribed payout at death.
By selling it, the insured person transfers all aspects of the policy to the new owner. This means the investor who takes over the policy inherits and becomes responsible for everything related to the policy including premium payments along with having the right to the death benefit payout when the insured eventually passes away.
There are many reasons why people choose to sell their life insurance policies, and this is usually only done when the insured person doesn't have a known life-threatening illness.
The majority of people who sell their policies for a life settlement tend to be older people who need money in retirement but haven't been able to save up enough for it (this is why life settlements are sometimes also called senior life settlements). By receiving a cash payout, the insured party can supplement their retirement income.
It is important to note that they only do this when the need for money now outweighs the desire to pass money to someone else upon their death. And often the person or people they originally were planning to leave the death benefit to are no longer in their lives, either due to divorce, or perhaps due to their beneficiary predeceasing them.
Other reasons for a senior choosing to sell their policy include the inability for the insured to afford the premiums, emergency situations, cases involving key individual insurance policies held by companies on executives and changes to the estate tax laws and limits.
Advantages of Investing in Life Settlements
So we see the benefit to the older insured who sold their policy, but what about the buyer? What is in it for them (or you if you are considering this investment)? A life settlement investment can deliver strong returns at a moderate (and different) risk for investors, all while satisfying liquidity needs of the selling policyholder.
1. Potential for a competitive rate of return
Research indicates that life settlement investments can yield double-digit returns for investors. A study published in 2013 by the London Business School, for example, found that the average expected return among institutional life settlement investors was greater than 12% annually. Even if an investment yielded half of that estimation, it would still be very much worth a look when you consider the returns for life settlement investments don’t have stock market risk, real estate market risk, geopolitical risk, or really any other risk that all the rest of one’s investments have.
2. Compelling risk/reward profile
Life settlement investments don't fluctuate in value based on market trends or interest rates. The primary risk the investor faces is longevity risk. This is due to the fact that the insured's life expectancy is uncertain at the time the transaction closes. That life expectancy dictates when the death benefit will be paid and how much investors will have to fund in premium payments to keep the policy in force until maturity of the policy. Investors can address longevity risk by utilizing third-party, professional underwriting laboratories to help determine the approximate time horizon of the investment. And just as insureds can live longer than expected, they also can pass away much sooner than anticipated, too. In those cases, the investor receives the return and gain on their investment much sooner, resulting in much higher than projected annual rates of return.
3. Win-win scenario for both parties – a Socially Responsible Investment
According to a study done by the Wharton School of Business, policyholders who sold their policies in life settlement transactions collectively received more than three and half times the amount they would have enjoyed by surrendering those policies. Life settlement investors can benefit from owning life settlement policies, but they also allow seniors to get maximum value for their insurance asset at a time in their life when that extra money could be quite meaningful.