An Introduction to Life Settlements
A life settlement is the purchase of an existing life insurance policy, by a third-party investor, for more than the cash surrender value of the policy. Originally designed for institutional and corporate investors, the life settlement market is now available to qualified individuals.
Life settlements have no correlation to stock or financial markets, oil prices, interest rates, or traditional investment classes. Investing in life settlements can offer outstanding returns while minimizing risk.
Life settlements evolved in the United States during the late 1990s, and experts estimate the market to grow to between $100 and $160 billion over the next two decades. A significant number of policies are expected to come to market, supported by various trends including Baby Boomer population growth, financial uncertainty and favorable legislation.
Cash Surrender Value vs. Secondary Market
Until recently, the only option a policy owner had was to surrender their policy back to the insurance company. With the advent of life settlements, an insured can now sell their policy on the secondary market for an amount much greater than its cash surrender value.
The Wharton School Study
The difference between life policy surrender values and fair market values is simply astounding.
A 2002 study by the Wharton School at the University of Pennsylvania found that while the surrender value for policies in their sample amounted to a total of $93.4 million, the fair market value for these same policies was $336.3 million.¹ This represents a staggering 360% difference between the cash surrender value and fair market value of the policy as a life settlement. This is one reason why this asset class has been so popular with “Smart Money” (institutional) investors.
¹ ( The Benefits of a Secondary Market for Life Insurance Policies by Neil A. Doherty and Hal J. Singer. Direct Link to the Wharton Study. )
The Coveted "Lapse Rate"
According to leading actuarial firm Milliman, Inc., approximately 90% of all life insurance policies are surrendered or lapse without payment of a claim. This is an astonishing rate and something life insurance carriers conceal from the public.
Suppose an individual has been paying annual premiums of $50,000 each year to keep their $2,000,000 life insurance policy in force. They’ve been paying these premiums for the past 5 years for a total of $250,000 paid to the insurance company, and have $75,000 of cash surrender value in the policy. Now suppose that they can no longer afford those premium payments.
What are their options? Most individuals, unaware of the life settlement option, will surrender the policy for $75,000. By exploring the open market, however, this same policy owner could conceivably receive 20% of the policy’s face amount, or $400,000. In this case, a policy owner surrendering their policy back to the insurance company would lose $325,000.
Over the last decade, life settlements have permitted seniors to sell their unneeded or unwanted policies at significantly better market values than they would have received by simply surrendering the policy. In today’s world, where many seniors have lost significant portions of their retirement assets and income, selling their policy for substantially more than its cash value can make a tremendous difference in their lives. As an investor in this asset class, you are in fact helping seniors maintain their quality of life.
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