What is a Life Settlement?
A life settlement, sometimes known as a Traded Life Policy
(TLP), is the term given to describe a financial transaction
in which a policy holder sells their life insurance policy
to a third party – usually a financial institution – at
a discount to its maturity value. The purchaser pays all
remaining premiums and receives the life insurance benefit
when the policy matures.
Investors are attracted to life settlements because they offer long-term growth
potential that is generally not affected by interest rate movements, volatility
in the equity markets, global events or economic downturns.
Why is there a market for
life settlements?
The market exists because of the disparity between what
insurers are willing to pay to buy back policies and the
market price. The market price is often higher due to commercial
realities i.e. face value minus premiums and price paid equals
profit, where as the life companies only wish to buy back
the residual value or premiums paid. Where there is opportunity
to generate a profit, markets inevitably will appear.
Why might someone sell their policy?
There are many reasons why the insured may wish to sell their policy. For example:
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The policy may no longer be needed or wanted
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The Premium payments may have become unaffordable
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The policy holder Owner could be considering lapsing or surrendering of the policy
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There may have been a change in estate planning needs
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The beneficiary for whom the policy was originally purchased is now deceased or no longer has a need for the policy
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The policy holder requires funds to pay for medical expenses or for new or experimental treatments for themselves or someone close to them
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The sale of the policy would allow the policy holder to maintain a desired standard of living
Is the Life Settlement market a risky one?
Like any other investment life settlements carry risk.
The major difference with life settlements however is generally
that the risk is not “if” you will get your
money back, it’s “when”. You will have
bought an insurance policy which has a fixed pay out at
maturity. The actual return will be governed by the amount
of time you hold the policy before it matures.
Is the Life Settlement Market reputable?
In the early days buyers and sellers were prone to fraudulent
practices and genuine errors. Fortunately, this has
changed, as increased compliance and regulatory measures
have created a fundamental shift in the industry’s
attitude towards transparency.
Practices like ‘cleansheeting’, where life insurance applications
were forwarded with incorrect medical information to boost the policy’s
trade value, and ‘wet ink’ transactions, where healthy people took
out policies with the specific intention of selling them immediately, are not
common, and most companies now insist that policyholders take legal advice before
selling a policy.
What factors can impact the value of a policy?
Changes in the life expectancy tables, general economic
conditions, including interest rates, inflation rates,
government regulations, overall industry conditions, competition,
political conditions, volatility in the financial markets
and legislation could all impact the value of a policy
or the ultimate return to an investor.
LPG’s buying expertise mitigates this risk. Utilizing deep experience sourcing
and valuing policies, the management team has demonstrated a track record of
buying policies at the appropriate price in order to maximize investor value.
How are Life Settlements valued?
The purchase price of any life settlement is based on several variables, including but not limited to:
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The net death benefit of the policy
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The life expectancy of the insured covered by the policy
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The expected rate of return sought by the investor
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The cost of insurance and other expenses associated with maintaining the policy
What should investors understand about maturity dates and the uncertainty of life expectancy?
The value of the policies in the life settlement market
depends, among other things, upon the life expectancy of
the insured. Life expectancies are estimates of the expected
longevity or mortality of an insured and are inherently
uncertain, especially in small sample sizes. There can
be no assurance that any life expectancy obtained on an
insured for a policy will be predictive of the future longevity
or mortality of the insured. The actual maturity date of
the policies may therefore be longer than projected, which
would negatively impact the time and therefore the return
on investment. In addition, improvements in medicine, disease
treatment, pharmaceuticals and other medical and health
services may enable insureds to live longer.
To the extent actuarial assumptions differ from actual results, as to life expectancy
or other assumptions made in the pricing or valuing of policies, an investor
may over-pay for a policy. In addition, to the extent an investor obtains any
policy based on the perceived life expectancy and such perception is inaccurate,
distributions from the maturity of the policy may be delayed; in some cases,
such delays could be significantly long.
Current mortality tables are relied upon in part to forecast future cash flows
in determining the prices paid to acquire policies. However, future mortality
experiences may not resemble the mortality experiences of the past. It is possible
for insureds with a certain life expectancy to experience a different mortality
rate in the future than experienced by insureds with the same traits in the past.
To address the risks inherent with life expectancy estimates, LPG uses at least
two independent consultancy companies to assess the maturity dates for policies
with a face value of $500,001 and over. For policies with a face value of $500,000
and below, the company uses one independent consultancy’s assessment and
a telephone underwriting service.
What are Stranger Originated Life Insurance transactions (STOLI)?
An investor investing in policies will assume the credit
risk associated with policies issued by various life insurance
companies. The failure or bankruptcy of any such life insurance
company or annuity company could have a material adverse
impact on an investor’s returns.
However, the risk of bankruptcy is low and to date, we
know of no death benefit that has been unpaid as a result
of the bankruptcy or financial difficulties of any U.S.
life insurance company. To further reduce this risk, Life
Policy Group only purchases policies issued by life companies
with B+ or higher ratings issued by A.M. Best, the leading
rating agency for the insurance industry.
What risk is there of an insurance company going bankrupt?
An investor investing in policies will assume the credit
risk associated with policies issued by various life insurance
companies. The failure or bankruptcy of any such life insurance
company or annuity company could have a material adverse
impact on an investor’s returns.
However, the risk of bankruptcy is low and to date, we know of no death benefit
that has been unpaid as a result of the bankruptcy or financial difficulties
of any U.S. life insurance company. To further reduce this risk, Life Policy
Group only purchases policies issued by life companies with B+ or higher ratings
issued by A.M. Best, the leading rating agency for the insurance industry.
Can insurance companies contest payouts on policies?
Life insurance policies typically have a contestability
clause, which permits the issuing life insurance company
to contest its obligation to pay a death benefit based
upon any material misrepresentation or omission made by
the applicant or the insured on the life insurance application
within, generally, the first two (2) years of the policy
issue date. Life insurance companies may also contest policies
based on a lack of insurable interest, which claim may
survive the expiration of the two (2) year contestability
period. To mitigate these risks Life Policy Group purchases
policies from regulated providers which have passed the
contestability period and were bought for the purpose of
insuring a life and not engineered, premium financed or
STOLI transactions bought for the purpose of making an
investment return. In addition, legal checks on sellers
and agents are completed and all policy documentation is
reviewed for legal compliance.
Do some life insurance companies object to investment transactions involving life settlements?
Some U.S. life insurance companies have voiced concerns
about the life settlement industry generally and the transfer
of policies to investors. These life insurance companies
may be averse to transferring or honoring a policy by third
parties unrelated to the original insured/owner, especially
when they may believe the initial premiums for such policies
might have been financed, directly or indirectly, by the
purchaser. Certain improperly originated policies are sometimes
known as Stranger Originated Life Insurance transactions
or STOLI.
To avoid this risk, Life Policy Group performs due diligence intended to prevent
the purchase of STOLI policies.
Is there any threat of challenges by former beneficiaries or heirs of the insured?
Former beneficiaries or heirs of the policy may challenge
the validity of the sale of the policy and consequently
contest, obstruct or delay the payment of the proceeds
of a policy following an insured’s death, based on
a variety of factors including a lack of insurable interest,
mental capacity of the insured, applicable periods of contestability
or suicide provisions.
Recognizing this risk, Life Policy Group employs a rigorous process to ensure
that beneficiaries agree with the transaction and confirm this in writing at
the time of sale.
Is there an age limit on some policies?
Some insurance policies terminate if the insured lives
to the age of 100, or in some cases at age 95. If the insured
outlives the policy, an investor owning such a policy may
get nothing on that policy as the insurer is relieved of
its obligation. Such a policy termination would result
in a loss of investment return on the policy. As a result,
LPG will always screen out such policies.
Will policies pay out on euthanasia, war or terrorism?
Once a US policy has passed the non-contestability period
(two years) it will pay out even in the event of suicide
or euthanasia. However, most policies are not covered in
the event of war or terrorism. That said, as LPG purchases
policies of insureds over the age of 65, the likelihood
of them being exposed to ‘war’ risk is extremely
low.
How does the policy buying process work?
A typical Life Settlement transaction begins with a policy
owner obtaining an expected life expectancy (LE) report
from an independent, third party medical underwriter. Based
upon health and medical information, an evaluation can
be made and life expectancy determined by an independent
medical underwriting firm. Each policy is medically underwritten.
Once a life expectancy report is produced and other conditions
are satisfied, a policy is purchased by an institutional
purchaser or trust, pursuant to a purchase agreement and
other ancillary closing documents that transfers the legal
ownership and beneficial interest in the policy to the
purchaser.
All policies offered by LPG are purchased pursuant to documentation
that, among other things, ensures that the former beneficiary
and spouse, where applicable, waived any future claims or
rights to the policy.
Are the policies purchased direct from the original life?
No, the policies offered by LPG have previously been purchased
from the original life assured by LPG Capital. This greatly
speeds up the process of purchase. In addition Mills Potoczak
and Co (MPC) acts as the servicing company for the policies
in any communication with the original owners i.e. for
mortality checking.
How can I be sure that the insured actually exists and how will I know when they die?
The policies sourced by LPG are serviced by Mills Potoczak
and Co (MPC) a public accounting firm in the USA with many
years expertise in providing services to the life settlement
industry.
MPC was founded in 1991, and in 1994 began providing services to the Life Settlement
market. Over time MPC’s services to the Life Settlement market have grown
steadily and it presently services the needs of over 60 financial institutions
worldwide. MPC has administered the acquisition of over 4,200 policies with a
face value of approximately $5,000,000,000 and presently services over 3,000
policies with an estimated face value of approximately $6,000,000,000. MPC is
widely regarded as a leader within the Life Settlement industry.
MPC tracks and periodically monitors the health and life status of the insured
so that when a policy reaches maturity (the death of the insured), the servicing
entity is aware of the development and can take action to collect the proceeds
due under the relevant policy.
Is there risk regarding
premium increases or failure to pay premiums?
If a life insurance company increases the cost of insurance
charged for any policies, the premiums due for these policies
may increase, causing investors to incur additional costs. This
may adversely affect the secondary market sale value of
such policies.
LPG is able to mitigate this risk by purchasing a wide
spread of policies from a diverse group of carriers, leveraging
our buying expertise to buy policies at appropriate prices
and avoiding policies that have high premium costs built
in.
Separately, failure by an investor to pay premiums on the
policies when due will result in termination or “lapse” of
the policy, meaning the investor would lose any money invested
to buy policies or pay premiums.
LPG mitigates this risk by augmenting its own disciplined
monitoring process with the employment of a third party,
Mills Potoczak and Company (MPC). MPC is a specialist
provider of trust services and administers in excess of
10,000 policies. The company has responsibility for premium
servicing, policy closing, policy tracking and maturity
claims.
What are the tax implications for the investor when the policy matures?
Policy proceeds may be subject to tax. Investors should
seek independent professional advice on their individual
tax and legal circumstances.
Is there risk regarding premium increases or failure to pay premiums?
If a life insurance company increases the cost of insurance
charged for any policies, the premiums due for these policies
may increase, causing investors to incur additional costs.
This may adversely affect the secondary market sale value
of such policies.
LPG is able to mitigate this risk by purchasing
a wide spread of policies from a diverse group of carriers,
leveraging our buying expertise to buy policies at appropriate
prices and avoiding policies that have high premium costs
built in.
Separately, failure by an investor to pay premiums on the policies when due will
result in termination or “lapse” of the policy, meaning the investor
would lose any money invested to buy policies or pay premiums.
LPG mitigates
this risk by augmenting its own disciplined monitoring process with the employment
of a third party, Mills Potoczak and Company (MPC). MPC is a specialist provider
of trust services and administers in excess of 10,000 policies. The company has
responsibility for premium servicing, policy closing, policy tracking and maturity
claims.
What are some of the other risks to consider when investing in life settlements?
Supply risk. An inability to source insurance policies
in the secondary market that meet specified criteria can
create a performance drag. To mitigate this risk,
investment managers must leverage relationships with a
wide range of suppliers to ensure adequate supply of small
face policies. The development of several new trading
platforms and marketplaces has also increased the supply
of policies.
Counter-party risk. The insurance company that issued a policy bought by
the fund may default on its obligations to pay out on maturity. One way
investment managers mitigate this risk is by only buying policies backed by US
insurance companies with ratings above B+ and again, remaining well diversified
across a wide range of insurance companies so that no one company represents
more than 10% of all policies in the combined portfolio.
Administration risk. Performance could be adversely impacted if premiums
are not paid on time or benefits are not collected in a timely matter. To
mitigate this risk for investors, investment managers use a custodian bank and
escrow agent to handle all money transfers including premium payments, and a
tracking agent notifies the custodian bank when a policy’s benefits are
due to be paid.
What investment vehicles are available or popular?
Investors have a range of options that include direct
investment in individual policies, custom portfolios of
policies, and funds that invest in pools of life settlements.
In the past, investors typically purchased individual large value policies directly.
While this approach can yield attractive returns, there is an obvious lack of
diversification. Even older funds typically focused on relatively small numbers
of large value policies.
Today, providers have developed more efficient methods for sourcing and pricing
policies. This has made it possible to provide better diversification by making
it viable to invest in a broad number of lower value policies (policies with
face values as low as $50,000).
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