Rob Levin is the Managing Member of the Oasis Strategy Group, an asset management firm specializing in life settlements.
Life settlements have been viable alternative investments within the U.S. for more than a century, and they can provide diversification and solid returns. Yet awareness of them has only recently started to increase.
The term “life settlements” refers to transactions in which life insurance policy owners sell their policies to third parties for one-time payments that exceed the policies’ cash value. A 1911 U.S. Supreme Court ruling essentially confirmed that owners of insurance policies have the right to sell their policies. In addition, different states regulate the life settlement market to varying degrees.
Why Consider Investing In Life Settlements?
Several attributes of life settlements make them worthwhile for many individuals considering alternative investments. To start, their returns aren’t correlated with the stock and bond markets, nor with the economy.
This is key, given recent movements in traditional investments. In late January, the Buffett Indicator, which is the ratio of the total U.S. stock market valuation to gross domestic product (GDP), stood at about 80% above its historical average, which is considered pricey by many. At the same time, bond yields are quite low. Ten-year treasuries were yielding just over 1%, also as of late January.
Life settlements can offer solid returns while also providing a bond-like quality. Consider an investor who purchases $1 million in treasuries. He or she will receive $1 million at the end of the treasuries’ term.
Similarly, an investor in a life settlement policy who has a $1 million death benefit will receive $1 million when the seller of the life insurance policy passes. With some exceptions, life settlement investors can be confident of the amount they’ll receive when realizing their investments. To be sure, the returns will vary, depending on how long the sellers live and the premiums that must be paid. The aging U.S. population will likely expand the universe of potential insurance policies that could become life settlements. By 2030, Americans age 65-plus will make up 21% of the population, up from about 16% in 2019, according to the U.S. Census.
Finally, the insurance industry is heavily regulated at both the federal and state levels, significantly mitigating the risk that an insurer might not be able to cover a death benefit.
Why Some Policyholders Sell Their Policies
Why would someone sell their insurance policy? Their reasons vary, but often the policyholders no longer need the insurance, are unable or unwilling to cover the premiums or have an immediate need for cash. Rather than allowing a policy to lapse, a policy owner could sell the policy, generating more than the cash value, if any, provides. Over 92% of life insurance policies (by face amount) terminate without paying a death benefit, the Life Insurance Settlement Association (LISA) reports. Life settlements allow policyholders to capture a portion of the benefits they otherwise would forfeit.
Not all life insurance policies or holders are suitable for life settlement investments. Candidates for life settlements typically are 65 or older or have one or more underlying health issues. Most own policies with face amounts exceeding $100,000, also according to LISA.
How It Works
Consider a fifty-year-old woman who buys a million-dollar universal life policy to provide security for her family. Twenty years later, she no longer needs the protection and is facing health challenges. Her options include letting the policy lapse and taking the cash value, if any. Or, if the policy is suitable, she may be able to sell it through a life settlement transaction for significantly more than the cash value.
In this case, the investor purchases the policy and pays any premiums while the policy holder is alive. When the policy holder passes away, the buyer receives the death benefit. The return will be the million-dollar benefit, less the purchase price and premiums paid.
Investing In Life Settlements
Due to their complexity, investors who wish to invest in life settlements usually do so through life settlement funds.
Do life settlements belong in your investment portfolio? To decide, consider the following:
• Life settlements typically are mid- to long-term investments.
• If the fund plans to frequently resell policies, rather than buying and holding them, the investments may be subject to fluctuations in investor demand, among other things.
• Capital is required to purchase the policy and pay the premiums while the policy is in force.
• How the fund calculates sellers’ life expectancies can significantly impact returns. If the life expectancy is underestimated, the returns will be less than expected. Does the fund determine life expectancy based only on sellers’ age and actuarial models, or is it engaging medical professionals to evaluate their health profiles?
• Funds that use leverage to acquire policies and pay premiums and distributions can incur increased risk.
For many interested in alternative investments, life settlements can offer returns that aren’t correlated with the stock or bond markets or the economy. With the right strategy and execution, life settlements can be excellent alternative investments for those seeking diversification and yield.
By Rob Levin
Rob Levin is the Managing Member of the Oasis Strategy Group, an asset management firm specializing in life settlements.
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