I have a growing concern about the marketing to investors of an investment called Life Settlements.
Even though they are now regulated by the Viatical Settlement Model Act, in my opinion they represent an inappropriate investment for many who salespeople are prospecting.
While Life Settlements -- formally known as Viatical Settlements -- have been a legal investment since the days when Oliver Wendell Holmes wrote the opinion for the Supreme Court which virtually authorized the transactions. TThey didn't become a popular investment vehicle until recent years.
The idea is that someone who owns a Whole Life or Universal Life insurance policy (it can either be on his life or that of someone else), who no longer has a need for the coverage, sells the ownership of the policy to someone else.
At that point, the buyer is named the beneficiary and makes all future premium payments on the policy until the insured dies. At that point, the face value of the policy is paid to the owner of the Life Settlement.
A life insurance contract, say for $250,000, would bring the original owner. in most instances, somewhere between $50,000 and $150,000.
The actual amount is dependent on the actuarial calculation which would determine the insured's remaining life expectancy.
So let's say you bought a $250,000 Whole Life policy insuring the life of a man who is 65 and in reasonably good health for his age. You pay him $50,000 for assigning ownership to you.
The actuarial life of the man, let's say, is 77 years. But that is not the same as a prediction as to how old he will be when he dies. He could die the day after you purchase his policy, so you would get an immediate profit of $200,000. However, he could live to, say, age 90.
Now the situation is entirely different. Your $50,000 has been tied up for 25 years, and you've had to pay the annual premium on the policy for those 25 years. Let's assume that annual premium is $7,000. Without calculating loss of return on investment, you have $225,000 invested and, as beneficiary, you will be paid $250,000 for a net "profit" of only $25,000.
In addition to that real and indeterminable risk, unlike most securities, there is no organized secondary market for Life Settlements. That means that should you need your $50,000 initial investment before the insured dies, there is no organized way to sell the Life Settlement to someone else. The best you can expect is to be able to surrender it to the insurance company for the policy's cash value which, in all likelihood, will be substantially lower than your gross investment.
There are a number of "financial advisors" who are marketing Life Settlements to senior citizens. Of all of the candidates, they are the ones for which this vehicle is the least appropriate. There is a better than reasonable chance that 1) they will need the money from the investment before the insured dies, and 2) the insured will actually outlive them.
Life Settlements are, at best, a hedge for other life insurance companies to put in their portfolios and for large perpetual trusts, say the University of Texas Alumni Scholarship Fund, to match low risk with reasonably high return. Even in those cases, the only way the investment makes sense is for the owner to have a number of policies insuring people of different ages and health conditions.
It is my opinion that Life Settlements (Viaticals) are rarely appropriate investments for individals.
We have a unbiased question and answer piece we developed and wrote about Life Settlements. If you are interested in having a copy, please email QandABooklet@aol.com. It's free, there is no obligation, and no salesman will call you. I wrote it for use as a public service.
BILL CHERRY, REALTORS
DALLAS - PARK CITIES
Now Entering our 46th Year
214 503-8563
Bill -Excellent information on life settlements. Thank you for sharing a very good blog.
You must have been an Insurance Salesman in your previous life...this will take me some time to absorb! My eyes tend to "glaze over"
Are you responding on here anymore or only on Facebook?
John and Miss Joanie --
Thanks for your comments. In addition to formally and informally studying investments, economics and banking since about 1960 or so, I actually did study in the Certified Life Underwriters (CLU) program. I wasn't qualified for the designation because I wasn't in the life insurance business. I didn't care, I just wanted to be sure I knew how that industry worked. My daddy had spent his business life as a top executive with a major life insurance company -- even written text books.
This blog was prompted because of the many financial hucksters who buy radio air time, all claiming they have the perfect formula for increasing investors' return and at the same time, decreasing risk. Most of their reasoning rhetoric simply doesn't hold water.
One of these people is a casual friend of mine.
For the heck of it, one day when I ran into him, I asked him to explain why he thought Life Settlements were a good investment for his retired clients. The man simply had never considered that there was no way to predict when the Life Settlement would pay off, that there was no secondary market for them, and that the investor's return could as easily be negligible as it could be a financial success.
While there are places for Life Settlements in the overall investment strategy of some, in my view most of us should not use them.
I guess I am naive. I had never heard of this before until I saw this post. Thanks Bill it was a fascinating read and I learned something new today
Charlie, for years insurance companies did their best to infer that these things were illegal. Their claim was that insurance contracts could only be owned by someone with an "insurable interest." In other words, I couldn't buy a life insurance contract on, say, Regis Philbin, because when he dies it will not financially affect me.
But that, of course, is nonsense. I can't take out a policy on Regis' life because I don't have an insurable interest in him, but I most certainly can purchase the interest in a policy that was taken out by Regis or someone who had an insurable interest in his life.
(Insurance companies restrict purchases of policies to those with an insurabl interest to keep the buyer from turning odds against the company. For an example, one could buy a policy on someone then make sure he was bumped off, thus being able to collect the death benefit.)
Insurance companies build into their formula for determining premium rates that a high percentage of policies will be cashed in or lapsed before the benefits have to be paid. When someone buys a Life Contract, at least on that policy, the insurance company knows it has an almost 100% that it will eventually have to pay the full claim
So they did everything the could to discourage the Life Settlement practice. The irony is that they are now buying Life Settlement on policies issued by other companies to hedge their losses resulting from paying claims resulting from the sale of Life Settlements on their own products.