The Value of Senior Life Settlements

From the ASR Blog

The Senior Life Settlement market is experiencing an abundance of suitable investment grade policies being offered for sell, as limited capital flow is available for purchase.  This is creating an atmosphere that is producing additional value and exceptional returns for investors.

Arguably the most important metric, from an investment standpoint, is the rate of return offered by Senior Life Settlements.  The 2009 Life Policy Dynamics Market Analysis, an annual report completed by Life Policy Dynamics, LLC, provides detailed analyses of the Senior Life Settlement industry.  The 2009 report collected IRR values for policies that closed during that calendar year.  It must be noted that any analysis of market IRRs is complex, since the data is coming from a multitude of sources, each with different calculation methods.  Variation may be a result of factors such as different approaches to cost of insurance projections, intended future premium payments or, perhaps most significantly, the use of different life expectancy providers.  Further, the use of proprietary valuation models can change IRR calculation methods.  Despite these factors, the numbers for 2009 were in line with the word-of-mouth understanding of the market.  The average IRR for Senior Life Settlements was 15.38%, and a median of 13.93%.  Three quarters of all life settlements were calculated with a purchasing IRR of between 12% – 16%.

A Maturing Asset Class

The asset class, as it passes its 10th anniversary, is becoming more mature.  Oversight and a lack of regulation have long been the source of scrutiny in the industry, but more and more states are now regulating providers.  Within the industry, practices focused on greater due diligence and disclosure are continually improving the quality of companies in the industry.  Companies that have been unable to adhere to the new standards have been forced out as the Life Insurance Settlement Association and the Institutional Life Markets Association.  The industry now has a better understanding of mortality risk which affects the timing of returns on investment.  On a combined basis the largest and most respected life expectancy providers have completed nearly one million individual life expectancy projections during the last decade.  Based upon their considerable data and experience, mortality tables have been updated, processes have been improved and methodologies have been enhanced.  Today’s life expectancies benefit investors with what we believe to be more reliable mortality predictions.

Better Legislation and Regulation

Almost 90% of the U.S. population now lives in a state that regulates life settlements and the remaining states will be enacting their own legislation.  It should be noted that most states have adopted legislation based on the consumer-friendly NCOIL model which is supported by the settlement industry.  This gives both buyers and sellers additional layers of comfort and protection throughout the life settlement process.

NCOIL Disclosure Means Better Informed Consumers

More states will enact the NCOIL model disclosure law requiring insurers to inform elderly consumers who are about to lapse or surrender a policy that the option of a life settlement exists.  Agents of companies that prohibit them from doing life settlements will increasingly be caught in an unenviable position between their company’s restrictions and the best interests of their clients.  At some point, the insurance companies and broker-dealers that prohibit their producers from participating in a life settlement will have to recognize the responsibility that producers have to their clients.

Additional evidence of the increased interest of investors in the settlement market is the recent report that a subsidiary of the private equity firm, Kohlberg & Co., is entering the market through the purchase of a major life settlement provider.  This steady uptick in investor interest in life settlements will continue and accelerate in 2012 and beyond, as the economy continues to improve.

Broker Consolidation Will Continue

The number of life settlement brokerages declined substantially in 2009 and 2010.  This trend will continue as smaller and marginal players drop out.  The increased cost and complexity of doing business in a more heavily regulated environment make many smaller life settlement brokers no longer viable.  The good news for consumers and producers in all of this is that what will be left are a smaller number of larger, compliance intensive life settlement brokers.

Demographic Shift Gives Life Settlements a Boost

The abundance of Senior Life Settlement options is driven by the demographic shift in the US with a rapidly growing affluent senior population.  An expanding supply of Senior Life Settlement opportunities is also a result of the growth in the awareness of consumers, their life agents and financial advisors regarding the benefits of the life settlement option.  These combined and complimentary forces have resulted in an increased supply of policies available for settlement within the market place.  Recent figures from both Conning and Cantor Fitzgerald suggest that $60 billion of Life Settlements have been transacted in the past decade.  Based upon assumptions from the Life Policy Dynamics Settlement Market Analysis, we believe that nearly 24,000 individual senior insurance consumers were served by the life settlement market in the past 10 years.

Frequently asked Questions about Senior Life Settlements

Q – What is a Life Settlement?

A – A Life Settlement is simply the sale of an existing life insurance policy that is no longer needed, wanted or affordable, by an elderly person to another party.  The owner sells their ownership and beneficiary rights of the policy for a lump sum payment.  An investor buys the policy at a discount to the face value and holds it until maturity, at which point they receive the face value from the issuing insurance company (or under certain circumstances, the investor may, for a variety of reasons, elect to re-sell the policy in the secondary market).  Generally speaking, life settlements represent insured’s who are 78 to 80+, medically impaired, and with a life expectancy of 2 to 6 years.

Q – Why is a Life Settlement a good investment?

A – Buy Low and Sell High

The old adage of “buy low and sell high” is timeless advice.  Unfortunately, it is virtually impossible to know with the lows and the highs are in some financial instruments.  With the life settlement asset class, individuals can purchase an asset at the lowest price it will ever be offered, and when it reaches the highest price it will ever be worth, investors are forced out with their gains – automatically!  There is absolutely no guesswork involved, as you will always buy low and sell at the top!

No other asset class offers an investor such a unique investing alternative.

Q – Why is the investment into a life insurance policy considered safe?

A – Due to the legal reserve act, no Legal Reserve Life Company has ever failed to pay a legitimate life insurance claim.  Investors like Warren Buffet and Wells Fargo, have invested heavily in Life Settlements because of the returns and the safety of the principal.  The return is not connected to stocks, bonds, interest rates, commodity markets, or to social, political or economic concerns.

Q – Why haven’t I heard of Life Settlements from my financial advisor?

A – A financial advisor’s duty is to represent investments available through his or her firm’s inventory.  Representing any other investment would be considered “selling away” and cause for dismissal.  There are no on-going management fees, which affects the broker’s profits.

Q – Small and Average investors have been conditioned to believe that a high single digit return is a good, and that anything higher, are associated with risky investments.  Is this true?

A-A 6% to 9% return is certainly considered a very reasonable rate of return by small and average investors.  Expecting a higher rate of return on any investment certainly comes with sizable risks, if the investment is tied to the stock market.  However banks, corporate, institutional and larger investors have received consistently high returns through the use of Senior Life Settlements.  They are not tied to the market and are absolutely not affected by any outside influences, such as war, terrorism, oil prices, an economic recession or depression, and world events.

Q – What does ROI mean?

A – ROI stands for Return on Investment.  ROI is stated in percentages over an annual period of time.

Q – What’s the history of the Life Settlement market?

A – Although the secondary market for life insurance is relatively new, the market is more than 100 years in the making.  The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.

Q – The Policy as Transferable Property

A – The United States Supreme Court case of Grigsby v. Russell (1911) established the policy owner’s fundamental right to transfer an insurance policy.  Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner could transfer without limitation.  Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.”  This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds.  As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policy owner.

This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:

• Name the policy beneficiary

• Change the beneficiary designation (unless subject to restrictions)

• Assign the policy as collateral for a loan

• Borrow against the policy from the carrier

• Sell the policy to another party

A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Settlements Model Act defining guidelines for avoiding fraud and ensuring sound business practices.  Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital.  The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policy owners who no longer needed a given policy.  Strong demand for life settlements policies is driving a rapid market expansion that continues today.

Q – What are Life Settlement Investors/Funders?

A – Life settlement investors are known as financing entities because they are providing the capital or financing for life settlement transactions (the purchase of a life insurance policy).  Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures.  The life settlement provider is the entity that enters into the transaction with the policy owner and pays the policy owner when the life settlement transaction closes.  In most cases, the life settlement provider has a written agreement with the life settlement investor that requires the investor to provide the life settlement provider with the funds needed to acquire the policy.  In this scenario, the life settlement investor is effectively the ultimate funder of the secondary market transaction.  However, in some life settlement transactions, the life settlement provider is also the investor; the provider uses its own capital to purchase the policy for its own portfolio.

Q – What are the benefits for the seller’s of such life insurance policies?

A – The settlement of one’s life insurance policy allows them to use the proceeds as they wish including:

• Enjoy a higher quality of life or maintain current lifestyle

• Purchase “replacement” life insurance that is more applicable to current circumstances and use proceeds to reduce or eliminate future premiums

• Eliminate debt

• Retire or take the vacation of their dreams

• Free up cash flow, i.e. end future premium payments

• Purchase long-term care insurance to secure well-being

• Contribute to a charity

• Purchase an annuity for a lifetime income stream

Q – What does the Life Settlement Company offer investors?

A – The Life Settlement Company’s services allow suitable investors the opportunity to purchase fractionalized beneficial interests in death benefits payable under life insurance policies as an investment at substantial discounts to their face value.  Funding of the Life Settlement Company’s policy transactions are managed through an independent escrow company.  By having a chartered escrow company operate in this capacity, it offers both a higher degree of credibility and an additional layer of protection for our investors.

Q – What is the role of the Life Settlement Company?

A – The Life Settlement Company’s role is similar to that of a real estate broker.  In a typical real estate transaction the buyer specifies certain criteria to the broker regarding the type of real estate that he or she wants to purchase.  The broker then identifies a property which matches the buyers expected criteria.  We do essentially the same thing with life settlement policies, by matching policies to the buyer’s criteria.  Once the buyer agrees to purchase the policy we can either change the ownership directly into their name or they may utilize a third party trustee to hold and manage the policy on their behalf.   As in a real estate transaction the buyer never writes a check to the seller, in this case the Life Settlement Company, but instead all funds will be handled by an independent escrow company.

Q – What is the minimum investment?  Can I use my IRA or 401k or any type of qualified vehicle to fund a life settlement investment?

A – The minimum investment accepted is $25,000.  You have many choices for funding a life settlement investment with the Life Settlement Company.  These range from cash to retirement accounts such as IRA (Traditional, SEP, Roth) and 401k, 403B, etc.  A chartered trust company will operate as a third party administrator, acting as custodian for our IRA accounts.  Upon opening an IRA, you would transfer/rollover funds from your existing retirement account into the new IRA.  Once funds are received, the investment is then placed with your retirement account, which then owns the investment.

Q – Is this also referred to as a viatical settlement?

A – No, and we DO NOT offer viatical settlements.  A “traditional” viatical settlement, as that term was originally used in the life settlement industry, applies only to policies of people who have a terminal illness.  Such people could be of any age.

The insured’s longevity and life expectancy for the policies, which we invest, are based on a number of factors including the insured’s age, individual health factors, medications, family history when available, and whether or not the individual smokes.  The insured does not have a chronic condition or suffer from a terminal or life threatening illness.  We focus on these “Senior” Life Settlements because we don’t want to expose our investors to risk due to the subjectivity of catastrophic or life threatening health diagnosis.  With a traditional viatical settlement, an unexpected cure, a new drug, or a new treatment could result in the insured living for years or even decades beyond the expectation.  Although it ispossible that an insured out lives their anticipated life expectancy, since we buy policies from seniors, the time frame is much narrower, as there is no cure for old age.

Q – What is the average annual Rate of Return for Life Settlements?

A – The annual ROI historical average is over 10% since 2001.  Past performance does not guarantee future results, and your return may vary from the historic average.  You don’t receive annual payments, so there is no annual rate of return as such.  Your hypothetical annual rate of return is determined by the duration between purchase of the investment and when the investment matures.  We offer fractionalized death benefits payable under policies that are estimated to mature in three to six years, but, as you know, determining one’s life expectancy is not an exact science.  However, you know the amount you’ll receive when the policy matures.

Q – What kind of policies does your company seek out for this investment in the death benefits?

A – We purchase only Whole Life or Universal Life, also known as Flexible Premium Adjustable Life, policies.  Additionally, we only offer non-contestable policies for purchase, i.e., policies that have been outstanding for at least two years.

Q – Can I put this investment in my company’s name, living trust name, etc.?

A – Yes you may.  Virtually any entity with a tax I.D. number or social security number may invest in senior life settlements.

Q – What information do I get about the policy?

A – Per state and federal laws, strict disclosures exist as to the information you must receive before any investment can be made and money distributed from escrow.  You’ll receive this information in the Purchase and Sale Agreement that you sign, as well as the Policy Election Notice which designates the policy(s) in which your money is invested.  For instance you’ll receive the name of the Life Insurance Company, face value amount of the policy, annual premiums based on current minimum cost of insurance, life insurance Company rating, age of the insured, the insured’s estimated life expectancy, a summary of the insured’s medical history, a list of all prescription medications the individual is taking and whether or not they are a smoker.

Q – If I pass before the investment pays out, what happens?

A – The investment would transfer to your heirs per your will or living trust.  Your heirs would be required to contact both the Escrow Company and Life Settlement Company, to re-register the asset to the new assignee.

Q – Who acts as the Escrow Company?

A -A Chartered Trust Company is empowered to act as the independent Escrow agent by holding funds on behalf of transactions by and between the Life Settlement Company and investors.

Q – Who do I make my check payable to?

A -All qualified funds are made payable via check or transfer/rollover to the IRA Custodian. Once all the appropriate custodial forms have been submitted, funds are then transferred to the Escrow Company for placement.

Q – What role does an Escrow Company play?

A -The Escrow Company acts as an independent escrow agent on behalf of transactions by and between the Life Settlement Company and investors. All funds are held in an escrow account until all necessary documents have been completed. Upon completion of such documents, escrow is broken and funds are released in order to fund the Purchaser’s respective (%) percentage of beneficial interest in the death benefit payable under said Life Settlement policies. Additionally funds are released in order to pay for fees associated with the transactions.  However, please understand that a percentage of the purchaser’s funds will remain in escrow with the Bank in order to pay future policy premiums and servicing costs.

Q – What happens when a policy matures?

A -Investors are notified upon the maturity of such policy that he or she holds a % interest in the death benefit payable under the policy.  Once the death benefit has been collected from the respective insurance company and deposited in escrow; investors are paid out according to their percentage of interest held in that death benefit.

Q – What if the insured outlives their life expectancy, plus the two and a half to three years worth of premiums escrowed?

A -The Life Settlement Company shall deliver promptly to the Purchaser a Required Additional Funding Notice setting forth the Purchaser’s Percentage Ownership of (a) the amount of life insurance premiums due under such Life Settlement Policy to keep such Life Settlement Policy in-force for an additional year after the Coverage End Date or any Additional Coverage End Date, as applicable, and (b) the cost of the Policy Services for such Life Settlement Policy for an additional year after the Coverage End Date or any Additional Coverage End Date, as applicable, within ten (10) Business Days after delivery of a Required Additional Funding Notice to the Purchaser, the Purchaser must remit or cause to be remitted to the Life Settlement Company, in immediately available funds, the Required Additional Amount. Failure of the investor to satisfy the required additional funding requirement will result in the loss of the investor’s entire investment in the life settlement interest; i.e. the portion of the death benefit payable under the policy at maturity.

Q – What happens if a Purchaser does not remit funds in the event they receive an Additional Funding Notice?

A -If the Purchaser does not remit or cause to be remitted to the Life Settlement Company or the Escrow Agent, in immediately available funds, the required additional amount within ten (10) business days after delivery of a required Additional Funding Notice to the Purchaser, the Purchaser shall immediately be divested of the Purchaser’s percentage (%) ownership in the death benefit payable under such life settlement policy.

Q – Once my funds are placed, what should I expect to receive as closing documents?

A -You will be provided with a packet including copies of all documents, agreements and certificates.

Q – Will I be taxed on the death benefit I receive?

A – It depends if the life settlement is in a 401k, IRA, Roth IRA, etc.  You should consult your CPA, tax accountant or tax advisers in this regard.

Q – Why would someone sell their life insurance policy?

A – Below are various reasons why policy holders choose to sell their policy.

• As part of a change in estate planning or investment objectives.

• To pay for healthcare costs for themselves or someone in their family.

• To fund a more cost effective life insurance policy.  One out of every three settlements results in the insured creating a new life insurance policy.

• Premium payments are no longer affordable.

• An alternative to surrendering the policy.

• To provide a cash gift to family members, or to a charity.

• Dissolution of a business.

Q – Who is Investing?

A – The life settlement industry is dominated by institutional investment firms and the number of participants continues to grow every year including large investors like Warren Buffett and institutional investors such as Credit Suisse and Deutsche Bank.  Likewise, as this market continues to mature, more and more suitable retail investors are participating in this growing sector.  There are numerous reasons as to why such firms and individual investors are attracted to and participate in life settlements.  For one, life settlements are inexpensive in relation to their intrinsic value.  Furthermore, they represent an asset class which does not directly correlate to the stock, bond, or real-estate markets.

Q – Isn’t this kind of morbid?

A – Some suggest that purchasing a life settlement contract is “betting on death”.  The question is not whether a life settlement is betting on death, as death is inevitable.  The question is; what is in the best interest of the owner of the policy?  An insurance policy is an asset that someone owns, much like real estate or stocks.  When someone has some unwanted or unnecessary real estate, or an undesirable portfolio, they can sell that asset.  An insurance policy is no different.

Historically, when a policy owner no longer wanted or needed their life insurance policy, they only had two choices:

• Return the policy to the insurance company for its cash surrender value

• Let the policy lapse for nonpayment of premium

Today the policy owner enjoys a third option: selling the policy on the open market and receiving fair market value; usually 3 to 6 times the cash value an insurance company will pay.
Life Settlements Bring Value

On July, 2010, a long awaited study on the life settlement industry was published by the U.S. Government Accountability Office (GAO).  Two major points jump out from the report.

First, the life settlement industry brings significant value to consumers.  The report contained a government survey which showed that consumers doing a life settlement received, on average, almost 8 times the surrender value.  A settlement sure beats lapsing or surrendering a policy!

Second, inconsistent and poor legislation hurts everybody.  Life settlement regulation runs the gamut with some states having no legislation regulating life settlements at all, while others have legislation so draconian that it effectively shuts down the industry.  An absence of legislation leaves consumers and everyone else in the life settlement industry unprotected from unscrupulous operators.  On the other hand, unworkable legislation leaves consumers with no option other than surrendering their policy to the insurance company.

Fortunately, most of the states enacting new statutes have adopted legislation based on the NCOIL (National Conference of Insurance Legislators) Model Act which properly regulates life settlements as opposed to the unusable NAIC (National Association of Insurance Commissioners) model pushed by insurance industry groups intent on wiping out life settlements to the detriment of consumers.

Life settlement industry spokesmen point to the GAO report as confirming the value of life settlements and how important proper legislation is to the industry and the consumer.
Life Settlement and Viatical Life Expectancy Providers (Actuaries)

The life settlement industry is big business, both for providers who typically purchase life insurance policies from their original owners, and investors who buy the instruments as investments.

Reuters valued the life insurance market at over $26 trillion in 2006, and a large chunk of these policies are owned by retiring baby boomers.

The life settlement business consists of the resale of life insurance policies, surrendered by their original purchasers, for an immediate cash payout.  The policies are then resold to investors.

With respected investors like Warren Buffett and institutional investors such as Credit Suisse and Deutsche Bank entering the market, Reuters reports the market has gained respectability as an investment vehicle.  For example: Warren Buffet made his initial purchase of 207 million in 2004 in this asset class. (Wall Street Journal-May 2005)

One crucial player in this market is life expectancy providers (LEP’s).  These are usually independent companies, and serve the vital role of estimating a life insurance policyholder’s life expectancy.  They issue life expectancy reports that detail this information to both selling and buying parties.  Some of the leading life expectancy providers include www.21stServices.com, www.FasanoAssociates.com, www.AVSllc.com and www.EMSInet.com.

Life expectancies are extremely important in the purchase of these secondary market investments.  It’s one of the most important factors involved in pricing a life settlement policy, in addition to other factors, such as the underlying insured’s age and health condition.

The reports don’t predict the life expectancy of an insured.  Instead, the life expectancy providers use actuarial data to arrive at an average survival time for a particular risk group.  Group characteristics may include age, gender, smoking, and other health and morbidity items of the group in question.

By creating this risk group data, the life expectancy providers make it easier and more transparent for all parties to a transaction – the insured selling the policy, the life settlement company buying/brokering it, and the purchasing investor.

Much like an insurance underwriting group, life expectancy providers employ medical underwriters and actuaries.   In addition to referencing data supplied by the Society of Actuaries, they rely on proprietary data they have collected and analyzed over time.