Suddenly, a host of products allowing accredited individuals to invest in life settlements is coming to market. Since Day One, which only dawned this decade, the booming market where insureds sell unwanted policies has been dominated by institutional and foreign money. Wealthy individuals had limited access. Now that is changing.
Investing in life settlements could be attractive to far more of your client base than selling a contract is, says Curtis Cole, president of a Dallas field marketing organization for Life Partners Holdings Inc., a public U.S. company that has quietly been offering accredited individuals direct investments in life policies for years. "Selling requires clients in their 70s with compromised health who don't want their policies," says Cole, whose FMO is New Asset Advisors. But as an investment, life settlements' advantages offer broad appeal, he says.
The primary one is diversification. Life contracts could be The Next Big Non-Correlated Asset. Their cash flow-namely, death benefit proceeds-is driven by mortality, not whatever's going on with global financial markets. (A cataclysm that causes carriers to fold in lieu of paying off is excepted, of course.) Moreover, those who tout life settlements tell investors to expect double-digit returns, even if the market is so young that little actual return data exists.
But with potential reward lies risk. Investing in life policies might appear safe: You buy the policy at a discount and collect the face amount when the insured dies. That will happen, right? Yet, "it is possible to lose money," says Glenn Daily, a fee-only insurance consultant in New York City and operator of www.WhatsMyPolicyWorth.com, a life settlement evaluation service for policyowners.
A Beginner's Guide To Investing In Life Settlements
Ignoring for now the logistics of actually acquiring policies, suppose your client wishes to buy and hold until policy maturity (read: death of the insured). In order to collect at death, the investor must pay the policy premiums until the insured dies. An insured who lives beyond her estimated life expectancy thus drives up the investment's cost late in the game, potentially to the point of equaling or exceeding the death benefit. Did someone say, "Upside-down?"
Investors hoping to profit from changes in policies' market values face other risks, Daily says. Several variables affect a contract's worth in the marketplace. Some are systemic-that is, they inure indiscriminately to the entire life settlement market, or large swaths of it. Thus, they cannot be diversified away.
For instance, changes in interest rates. Like any asset, a life contract is valued by discounting its cash flows at the investor's required rate of return for the investment. When interest rates rise, investors' required returns likewise increase, and discounting at a higher rate lowers policy valuations, QED.
A change in how Fasano and the other life-expectancy appraisal firms estimate insureds' longevity could also cause the marketplace to reprice policies en masse, Daily points out. "Your policy loses value if a change in methodology lengthens life-expectancy estimates across-the-board," he says, adding, "We don't yet have much empirical data on life settlement mortality rates."
Still another way to lose is if capital flows to the market diminish or completely evaporate and demand for policies falls. Wall Street's woes have trickled into this cranny of financial services, according to attorney Jonathan Forster, who represents players from end-to-end of the life settlements industry as chair of Greenberg Traurig, LLP's wealth management practice and co-chair of life insurance. "The institutions have pulled back a bit. But there's also a lot of cash on the sidelines," Forster knows.
Next comes regulatory risk. Historically, policyowners were prevented from selling their contracts within two years of issuance because of the contestability period. A model act proposed by the National Association of Insurance Commissioners and supported by the insurance industry aims to increase the no-sell period to five years. Chicago attorney Scott J. Bakal, a partner in Neal Gerber Eisenberg's Private Wealth Services Practice Group who represents policyowners and insurance brokers as well as investors in life contracts, says, "If you purchase a policy in a state that subsequently adopts the NAIC five-year lock-up model, it will be very hard to sell that policy during the first five years" after issuance.