If you’re an investor seeking stock market alternatives, consider life settlement investing. Hedge funds, pension funds, and multinational banks routinely purchase life settlements. While these investment vehicles aren’t for everyone, they’re a worthwhile alternative for qualified investors. The market for life settlements is growing rapidly, as many senior citizens discover that they are holding policies they either don’t need or cannot afford. With the recent market volatility and economic uncertainty, life settlements have become increasingly popular with sophisticated investors (and those looking for different ways to plan smarter). Here, we’ll discuss life settlements, explore the pros and cons of investing in them, and talk about who is a good candidate for purchasing these assets.
Just as a property deed or mortgage contract are assets that may be sold, life insurance contracts are also saleable assets. In a life settlement transaction, a life insurance policy owner sells his policy to an investor in exchange for a lump sum payment. The amount paid to the policy owner by the investor is typically less than the death benefit provided by the policy, but more than its cash surrender value. The investor – whether an individual, private equity fund, or an institution – then maintains the policy, covers any further policy costs or premiums, and ultimately collects the death benefit when the insured dies.
The investor must consider the insured’s life expectancy, terms and conditions of the policy, and must verify that the policy meets the conditions of a legal life settlement. This is a must, since policies purchased under false pretenses – or solely for the purpose of reselling to an investor – may be uncollectible.
Why People Sell Their Life Insurance Policy
As an individual’s life circumstances change, so do his insurance needs. Therefore, a policy purchased in the past may no longer be necessary or appropriate. There are numerous reasons why someone may no longer need or want their life insurance policy:
- Funds are needed to cover long-term care or healthcare expenses.
- The insured is divorced, or has no heirs to leave assets to.
- Estate or tax law changes have caused the insured to consider surrendering the policy, or allowing it to lapse.
- The insured prefers to use the money now for a vacation home or travel.
- A spouse has died and other heirs or children are self-sufficient.
- The insured has fallen behind on payments, or wishes to avoid making future premium payments.
- The insured’s needs have changed and he now requires a different type of policy – such as an annuity, health insurance, or long-term care.
Regardless of the reason, the current policy owner decides that he would prefer to have cash rather than the insurance policy – and trades his death benefit for a living benefit he can use today.
Your Right To Sell Your Life Insurance Policy
Life insurance policyholders with policies they no longer wanted or needed once had only two options:
- Surrender the policy back to the insurer for its cash value.
- Allow the policy to lapse, possibly rendering all of your premium payments worthless.
Your legal right to sell your life insurance policy was affirmed by a 1911 Supreme Court ruling in the case of Grigsby vs. Russell. R.L. Russell served as executor of John Burchard’s estate. To pay for an operation, Burchard sold his life insurance policy to Dr. Grigsby. Burchard died about a year later. When the insurance company paid Dr. Grigsby instead of the estate, Russell sued to have the proceeds paid to the estate.
The case eventually reached the Supreme Court, where the court affirmed that Burchard had the legal right to sell his policy, and that Grigsby had the right to purchase it. Justice Oliver Wendell Holmes stated that life insurance policies are ordinary property, and are therefore assets which may be sold or transferred. The practice of buying and selling policies became commonplace during the 1980’s with the rise of the HIV virus. Viatical settlements – as they became known – allowed a terminally ill policy owner to sell his life insurance policy for more than its cash surrender value. Life settlements grew out of this viatical settlement concept, though a life settlement differs in that the insured has a longer life expectancy. With a viatical settlement, life expectancy is 24 months or less. Today, life settlements – or senior settlements – have become popular with both institutional investors and seniors looking to sell their insurance policies.
Investors have the opportunity to diversify their portfolio, since a life settlement is considered a non-correlated asset. They also avoid the wild swings of the stock market, housing market, and interest rates. Returns aren’t dependent on nor affected by a soft economy, stock market volatility, interest rate changes, soaring oil prices, unanticipated global events, or other traditional economic considerations. Life settlements consistently deliver double digit rates of interest with no loss of principal. Upon maturity, they have a known policy maturity value. (This alone can add stability to your retirement portfolio, in ways that traditional investments just can not.)
Life settlements are truly a win-win investment: Many seniors are discovering that life insurance policies they once deemed appropriate are now unaffordable or no longer meet their needs. Consequently, many of them lapse or surrender their policy back to the insurance carrier for the cash value, unaware that a better alternative exists. Seniors who no longer want or need their permanent insurance policy can sell it for more than its cash value, and the investors who purchase the policy will earn a competitive return.
How To Buy Life Settlements
Investors may utilize cash or qualified retirement account funds such as pension plans, profit-sharing plans, or a self-directed IRA to fund the investment. There are three primary ways life settlement investments are purchased:
- Direct purchases of life insurance policies. Buying a policy outright requires a large cash outlay, and the expertise to choose the right policies. For those wishing to invest a million dollars or more, however, this is an option. An outright purchase may be the most efficient way to buy in terms of costs, but life settlements need expert analysis and aren’t for the novice investor.
- Direct fractional life settlements. Rather than selling one large policy, the policy is divided up into smaller portions and sold to individual investors. This can be a viable alternative for an Accredited Investor who is prepared to invest $100,000 or more.
- Life Settlement Private Equity Fund. A life settlement fund pools settled policies to create a diversified portfolio – providing an attractive risk-adjusted return that has low correlation with the returns produced by other types of assets. The investor purchases shares in a fund that is comprised of hundreds of policies. These will likely be issued by different insurance companies, with insureds who have various kinds of health impairments. There can also be diversification by face amount, gender, life expectancy, region, and policy type (for instance, non-guaranteed versus guaranteed universal life). This provides great diversification with more predictable returns than those generated by purchasing one or two policies.
Drawbacks To Life Settlement Investments
The primary disadvantage to life settlement investments is that they are not available to most investors. As of this writing, life settlements are highly regulated and direct or direct fractional policies may only be sold to accredited investors. Accredited investors include individuals, insurance companies, trusts, banks, and employee benefit plans. For an individual to qualify as an accredited investor, he must earn at least $200,000 per year, or have a net worth of at least $1,000,000. The recent JOBS Act could change this, but it will take time to see how the act will be interpreted with respect to alternative investments.
The availability of certain life settlement investments varies from one state to the next. Right now, direct fractional life settlements aren’t available in most states. Furthermore, funds must be committed for the duration of the investment. Another potential disadvantage is that capital will typically be tied up in a life settlement for perhaps 7, 8, or 10 years. Since it involves a lump-sum payout at an unknown time in the future – rather than an interest or income-producing investment – a life settlement is best for diversification, not an individual investor’s entire portfolio.
Life settlement funds aren’t like mutual funds that investors can buy and sell at will. They aren’t liquid, and their current market value may not be known. Private equity funds have a start date and an end date, and it is possible – but not simple or advantageous – to withdraw the investment early.
Life settlements are sophisticated investments which must be selected and managed correctly. They require expert selection, management, and oversight. For example, there must be funds available to maintain the policies or they will be cancelled. The investor must also ensure that the policies were originally purchased and later sold legally, or losses will be incurred.
Learn More About Life Settlement Investments
Life settlements are one way to reduce a portfolio’s exposure to sudden stock and bond market downturns. On a risk-adjusted basis, the returns from life settlement investments are hard to ignore. Everyone will eventually pass away, and these policies are issued by stable life insurance companies. The majority of financial advisors aren’t familiar with true alternative investments. If they work for a brokerage firm, they generally have limited options regarding the types of investments sold – and are uneducated about and not permitted to sell alternative investments. (At David Ortiz Advisors, there is no right or wrong investments, simply the ones that work right for you. Again, a life settlement isn’t for everyone, but that doesn’t it isn’t for you. Contact David Ortiz Advisors today to determine if a life settlement could an investment solution to help you plan smarter and live better.)
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