Life settlements have emerged as an increasingly popular alternative investment in recent years. As an investor, a life settlement allows you to purchase existing life insurance policies from policyholders and continue paying the premiums. When the insured individual passes away, you as the investor receive the death benefit payout from the insurance company. Life settlements can provide stable, uncorrelated returns not tied to broader financial markets. In this article, we will explore the basics of life settlement investing and walk through a detailed example to illustrate the potential returns. With proper due diligence, life settlements can be an attractive addition to a diversified portfolio.
How life settlements provide returns for investors
A life settlement investment involves purchasing an existing life insurance policy from a policyholder for more than the cash surrender value but less than the death benefit. As the new owner of the policy, the investor takes over payment of premiums and receives the full death benefit when the insured individual passes away.
For example, consider a 70-year old policyholder with a $1 million policy. Due to health changes, they can no longer afford the premiums but the cash surrender value is only $200,000. An investor offers $500,000 to purchase the policy. This is profitable for both parties – the policyholder gets more than the cash surrender value, while the investor pays less than the $1 million death benefit they will eventually collect. The investor profits from the spread between the premiums paid and ultimate death benefit received.
The key is for investors to work with actuaries to accurately evaluate life expectancy and ensure policies are purchased below the actuarial value. Life settlement investing requires deep expertise in evaluating policies, managing premium payments, and mitigating longevity risk.
Illustrative investment example
Let’s walk through a detailed example to illustrate the mechanics and returns of a life settlement investment:
– A 75-year old policyholder owns a $5 million policy with annual premiums of $100,000
– Based on actuarial data, their life expectancy is estimated at 7 more years
– The cash surrender value of the policy is $200,000
– An investor offers $1 million to purchase the policy from the policyholder
– Investor projects paying $100,000 annual premiums for 7 more years, totaling $700,000
– In 7 years, when the insured individual passes, the investor will receive the $5 million death benefit
– So the investor will profit $5 million – $1 million purchase price – $700,000 premiums = $3.3 million return
– That equates to about 21% annually over the 7 year period
This demonstrates how life settlements can generate stable, uncorrelated returns by profiting from the spread between premiums paid and the ultimate death benefit collected. Proper actuarial analysis is key to accurately projecting life expectancy.
In summary, life settlement investing involves purchasing existing life insurance policies and generating returns from the spread between premiums paid and death benefits collected. When executed properly, life settlements can provide attractive risk-adjusted returns uncorrelated to broader markets. However, deep actuarial expertise is required to accurately evaluate policies. Overall, life settlements represent a compelling investment opportunity for qualified investors seeking diversification.