Savvy financial pioneers are discovering a unique investment avenue that offers both mortality-linked returns and portfolio diversification: the $50 billion secondary market for life insurance policies. This intriguing market, known as life settlement investing, has been quietly gaining traction among investors seeking alternative ways to grow their wealth. But what exactly are life settlements, and why are they becoming increasingly popular?
Life settlements involve the sale of existing life insurance policies to third-party investors. The concept is simple: policyholders who no longer need or want their life insurance can sell their policies for more than the cash surrender value offered by the insurance company. Investors then continue paying the premiums and receive the death benefit when the insured person passes away.
The history of life settlements dates back to the 1980s, with the AIDS crisis sparking the creation of viatical settlements. These arrangements allowed terminally ill patients to sell their life insurance policies to pay for medical treatments. Over time, the market evolved to include elderly policyholders who simply outlived their need for life insurance, giving birth to the modern life settlement industry.
The Mechanics of Life Settlement Investing: A Deep Dive
To truly understand life settlement investing, we need to explore the intricate process of acquiring life insurance policies. It’s not as simple as buying stocks or bonds; there’s a whole ecosystem involved.
First, life settlement providers identify potential policies for sale. They work with insurance agents, financial advisors, and even directly with policyholders to find suitable candidates. Once a policy is identified, a thorough evaluation process begins.
The valuation of a life insurance policy depends on several factors. The most crucial is the insured person’s life expectancy. This is where things get interesting – and a bit morbid. Professional life expectancy underwriters assess the insured’s medical records, lifestyle factors, and family history to estimate how long they’re likely to live.
Other important factors include the policy’s face value, the ongoing premium payments required, and the financial strength of the insurance company that issued the policy. It’s a delicate balance of risk and reward, much like other forms of insurance investing liabilities.
Once a policy is acquired, the investor takes on the responsibility of paying the premiums. This continues until the insured person passes away, at which point the investor receives the death benefit. It’s a waiting game, but one that can potentially yield significant returns.
The Allure of Life Settlement Investing: Potential Benefits
So, why are investors flocking to this unconventional market? The potential benefits are compelling, to say the least.
First and foremost, life settlements offer the potential for high returns. While returns can vary widely depending on the specific policy and how long the insured person lives, some investors have reported annual returns in the double digits. This potential for outsized returns has caught the attention of both individual and institutional investors.
But it’s not just about the potential returns. Life settlements also provide a unique form of diversification. The performance of life settlement investments is largely uncorrelated with traditional financial markets. When stocks are plummeting and bonds are yielding next to nothing, life settlements continue to march to the beat of their own drum – or rather, to the rhythm of human mortality.
This low correlation makes life settlements an attractive option for investors looking to diversify their portfolios beyond traditional assets. It’s a strategy that aligns well with the principles of life stage investing, allowing investors to adjust their portfolio mix as they move through different phases of life.
Another advantage of life settlements is the potential for steady cash flow. Once a policy pays out, it provides a lump sum that can be reinvested or used to fund other financial goals. For retirees or those approaching retirement, this can be an attractive feature, complementing other strategies like investing in life insurance for retirement.
Navigating the Risks: Challenges in Life Settlement Investing
While the potential benefits of life settlement investing are enticing, it’s crucial to understand the risks and challenges involved. This is not a get-rich-quick scheme, and like any investment, it comes with its own set of pitfalls.
The most significant risk in life settlement investing is longevity risk. Simply put, if the insured person lives longer than expected, the investor will have to continue paying premiums for a longer period, potentially eroding returns. It’s a delicate balance – while we all hope for long, healthy lives, in the context of life settlement investing, longevity can be a double-edged sword.
Regulatory and legal considerations also pose challenges. The life settlement market is regulated at the state level, and rules can vary significantly from one jurisdiction to another. Investors need to be well-versed in the regulatory landscape or work with experienced professionals who can navigate these complexities.
Ethical concerns and public perception are another hurdle. Some people find the concept of profiting from someone else’s death distasteful. While life settlements can provide a valuable service to policyholders who no longer need their insurance, the industry still grapples with image issues.
Liquidity is another consideration. Unlike stocks or bonds, life settlement investments are not easily traded on public markets. Investors need to be prepared for a long-term commitment, potentially tying up their capital for years or even decades. This long-term horizon aligns with the principles of lifecycle investing, but it may not be suitable for investors who need quick access to their funds.
Crafting a Life Settlement Investment Strategy
For those intrigued by the potential of life settlements, there are several ways to approach investing in this market.
Direct investment in individual policies is one option, but it requires significant capital and expertise. Most individual investors find it more practical to invest through life settlement funds or other pooled investment vehicles. These funds provide diversification across multiple policies, spreading out the longevity risk.
Fractional ownership is another emerging trend, allowing investors to buy partial interests in life settlement policies. This approach lowers the barrier to entry and provides greater diversification, even for smaller investors.
Institutional investors, including pension funds and endowments, have been increasing their allocations to life settlements in recent years. They’re attracted by the potential for uncorrelated returns and the ability to match long-term liabilities with long-duration assets.
When constructing a portfolio that includes life settlements, careful risk management is crucial. Diversification across multiple policies, insurers, and age groups can help mitigate some of the inherent risks. It’s also important to consider how life settlements fit into your overall investment strategy and risk tolerance.
Due diligence is paramount in life settlement investing. This includes thoroughly vetting the policies, the insured individuals, and the life expectancy estimates. It also means scrutinizing the track record and practices of any funds or investment managers you’re considering.
The Future of Life Settlement Investing: Trends and Opportunities
As we look to the future, the life settlement market appears poised for growth. The aging baby boomer population is expected to drive an increase in the supply of policies available for settlement. At the same time, persistent low interest rates have investors searching for yield, potentially increasing demand for alternative investments like life settlements.
Technological advancements are also shaping the future of the industry. Big data and artificial intelligence are improving the accuracy of life expectancy calculations, potentially reducing longevity risk. Blockchain technology could streamline policy transactions and increase transparency in the market.
Regulatory changes could also impact the future of life settlements. As the market grows, it’s likely to attract more regulatory scrutiny. This could lead to more standardized practices and potentially greater investor protections, but it could also introduce new compliance challenges.
Emerging trends in the life settlement market include the growth of “retained death benefit” transactions, where policyholders sell only a portion of their policy’s death benefit. This allows them to maintain some coverage while still accessing the value in their policy.
There’s also growing interest in combining life settlements with other alternative investments. For example, some investors are exploring strategies that pair life settlements with investing in structured settlements, creating a diversified portfolio of mortality and longevity-linked assets.
Wrapping Up: Life Settlements in Your Investment Playbook
As we’ve explored, life settlement investing offers a unique opportunity to diversify your portfolio and potentially achieve attractive returns. However, it’s not without its challenges and risks. The complexity of the market, the long-term nature of the investments, and the ethical considerations all need to be carefully weighed.
For those considering adding life settlements to their investment mix, thorough research and professional guidance are essential. It’s crucial to understand not just the potential returns, but also the risks and operational aspects of these investments.
When approached thoughtfully, life settlements can play a valuable role in a diversified portfolio. They offer a source of returns that’s largely uncorrelated with traditional financial markets, potentially providing a buffer against market volatility.
However, life settlements should be viewed as just one piece of a broader investment strategy. They can complement other alternative investments like secondaries investing or life sciences investing, as well as more traditional assets.
Ultimately, the decision to invest in life settlements should be based on your individual financial goals, risk tolerance, and investment horizon. Like any investment, it’s not suitable for everyone. But for those who understand the market and are comfortable with its unique characteristics, life settlements can offer an intriguing way to potentially enhance portfolio returns and diversification.
As the market continues to evolve and mature, it will be fascinating to see how life settlements fit into the broader landscape of alternative investments. Whether you’re a seasoned investor or just starting to explore beyond traditional assets, keeping an eye on this $50 billion market could open up new avenues for financial growth and portfolio optimization.
References:
1. Braun, A., Cohen, L. H., Malloy, C. J., & Xu, J. (2021). Introduction to life settlements. Journal of Risk and Insurance, 88(1), 5-27.
2. Xu, J. (2020). Mortality risk and the value of a life settlement. Journal of Risk and Insurance, 87(2), 339-371.
3. Bhuyan, V. B. (2009). Life markets: Trading mortality and longevity risk with life settlements and linked securities. John Wiley & Sons.
4. Rosenfeld, S. (2009). Life settlements: Signposts to a principal asset class. University of Pennsylvania Press.
5. Siegert, P. (2010). Life settlements and longevity structures: Pricing and risk management. John Wiley & Sons.
6. Stone, C. A., & Zissu, A. (2006). The securitization of senior life settlements: Managing extension risk. Journal of Derivatives, 13(3), 66-72.
7. Aspinwall, J., Chaplin, G., & Venn, M. (2009). Life settlements and longevity structures: Pricing and risk management. John Wiley & Sons.
8. Doherty, N. A., & Singer, H. J. (2003). The benefits of a secondary market for life insurance policies. Real Property, Probate and Trust Journal, 38(3), 449-478.
9. Gatzert, N. (2010). The secondary market for life insurance in the United Kingdom, Germany, and the United States: Comparison and overview. Risk Management and Insurance Review, 13(2), 279-301.
10. Ortiz, C. E., Stone, C. A., & Zissu, A. (2008). Securitization of senior life settlements: Managing interest rate risk with a planned duration class. Journal of Financial Transformation, 23, 35-41.
Would you like to add any comments? (optional)