I was asked about life settlements recently by two different people, so that is the topic this week. Life settlements are a somewhat recent development, within the last 20 years or so, and they involve selling your life insurance to a third party, usually through an intermediary (broker).
First a little background. To prevent gambling (or murder!), an insurance company will only sell a life insurance policy to someone who has an insurable interest in the insured. That is, the owner of the policy must have a vested interest in the survival of the insured.
In other words, I couldn’t buy a life insurance policy on Bruce Springsteen. But if I own a policy, on myself or someone else, I can sell it to anyone willing to buy it, provided it is past the contestability period.
Historically, the only buyer of a life insurance policy was the company that issued it; they would buy it for the cash surrender value. That worked okay for whole life policies, but not so well for the other types.
Enter hedge funds, which at the time were flush with cash and looking for alternative investments. The concept was simple: the funds would pay cash for the policy, become the owner and beneficiary, be responsible for all future premium payments, and collect the face amount when you die.
The funds have learned from their experience and life settlements are not nearly as lucrative to the sellers as they were 10-15 years ago. But settlements are still a viable option in the right circumstances.
First and foremost, you must either no longer need the life insurance or can no longer afford the premiums. But meeting either of those requirements won’t necessarily qualify you for a settlement. These days, most brokers want the insured to at least age 70 and preferably 75, absent some serious health issues.
The most marketable policies are term policies still within the conversion period and universal life policies. Variable life policies, while saleable, are not as attractive from the buyer’s viewpoint because of the high guaranteed premiums required to fund them.
To start the process, the broker, with your authorization, will obtain your medical records and use them to estimate your life expectancy (LE). Let’s say you’re 70 and not the healthiest specimen. Not terminal, but on several meds and feeling every bit your age, so life expectancy is estimated at 10 years.
Let’s further say that your $500,000 universal life policy requires annual premiums of $15,000 to carry it to age 85, which is five years past your life expectancy. If the hedge fund targets a 10% return at two years past LE, they could afford to offer you approximately $45,000 for your policy.
You would then have to determine if you’re better off with $45,000 now or your beneficiaries with $500,000 10-12 years from now. If you could afford the $15,000 annual premium, your internal rate of return be 21% if death occurred at LE and 15% if you lived two years past LE.
This is obviously just a simplistic overview. But for that very small segment that it applies to, it can be extremely beneficial. If you would like additional information, please call or email.
Happy Thanksgiving!