Most investors haven’t heard of life settlements, and those who are aware of this opportunity usually do not have a full and fair understanding of the pros and cons. It is relatively easy, with no specialized knowledge or experience required, but there are a few unattractive aspects.
The process is simple. An agent will arrange the deal for you and get you all of the information and documents that you need. Best of all, the debt is paid by a regulated “A”-rated insurance company, which is about as secure as you can get.
Investors buy a life insurance policy from a “life settlement” company that buys life insurance policies from people who do not want the life insurance policy any longer. The insured person is selling the policy because he or she wants to “cash out” for a price that is higher than the “cash value” that the life insurance company would pay, and less than the full death benefit that will be paid out upon settlement of the life insurance policy.
The policy holder must be at least 65 years of age, and the insurance policy must be aged beyond the time for any challenge by the insurance company, so the investor acquires a contractual right to be paid by an “A”-rated life insurance company upon the death of the insured. Investors buy the policies at attractive discounts to the eventual payoff value, so the profit is determined and locked in when the investment is made.
Everyone has heard the old saying about “buying low and selling high.” Here is an opportunity to buy a rock-solid future payment for a deep discount. No research, no economic predictions, no market fluctuations. The only questions is when will the policy pay off, and can you trust the life settlement company that structures the transaction?
Summary Points:
- No Specialized Knowledge: Just call a life settlement company
- Reasonable Capital Requirement: $10,000 and up
- Scalability: Yes. There is large supply for investors.
- Poor Liquidity: There is no set time period for payoff of this investment. Resale is possible but typically at a discount.
- Barriers to Entry: Investors must be qualified with income and assets.
Why Would a Policy Holder Sell a Life Insurance Policy?
People buy life insurance for many reasons, and over the course of their life, circumstances change, making the policy unnecessary. Many people buy a life insurance policy when they land their first job or get married. Years later, if they are widowed with no children or close heirs, they have no reason to maintain the policy. Others simply can’t afford the annual premiums or need cash. Many people retire with what seems to be sufficient savings and a well-planned budget, only to see their financial stability destroyed by the volatility of the stock market and artificially depressed interest rates. Anyone who retired a few years ago planning to earn interest of 4–5 percent on bank savings was in for a nasty surprise as bank interest rates have plummeted to under 1 percent. The chart above illustrates how treasury bond yields have plummeted in recent years, leaving fixed-income investors in a financial squeeze.
Current interest rates make it very difficult to survive on most retirement budgets. Many retirees are faced with tough financial decisions, and they find the idea of selling a life insurance policy to be more appealing than alternatives such as selling their home.
Some common reasons for a policy holder to sell a life insurance policy include:
- No longer can afford annual premium payments on the policy;
- No longer has a need for the policy due to changed circumstances such as no heirs;
- Need for immediate cash payment for medical, housing, or other pressing needs;
- Federal estate tax laws have changed, increasing the exemption limits, so many life insurance policies that were purchased for estate planning have become less important.
Too Morbid for You?
If you are sensing an “ick” factor as you read this, you are not alone. Most investors feel at least hesitant about profiting on someone’s death. It is certainly understandable if you feel that this investment option is not for you.
In fact, I have not personally invested in this field. Before you turn to the next chapter, however, just consider a few factors:
1. Helping the Insured
As addressed above, there are several rational and compelling reasons for some policy holders to sell their policies. As more investors learn about and accept this opportunity, the increased demand will lead to higher sale values for the people who decide to sell. If the insured defaults on premium payments, the policy is cancelled, and the insured gets nothing. If the insured returns the policy to the insurance company for its cash value, he or she will receive less than the sale value. There is no question that policy holders who choose to “cash out” get a benefit from selling.
2. No Moral Difference from an Inheritance
Most of us have inherited, or will inherit, money through an estate or life insurance policy at some point in our lives. I have never heard of anyone turning down an inheritance or life insurance payment because they don’t want to “profit on the death” of another. Why should this investment vehicle be different? In fact, the investor provides financial assistance to the insured, so it could be argued that the investor is on higher moral ground than an heir who, in most cases, provides no financial assistance to the policy holder.
3. Dealing with an Agent and Insurance Company
Investors have nothing to do with the policy holder who has already made the decision to sell the life insurance policy. The investor deals entirely with (1) a life settlement agency that brokers the sale and (2) a life insurance company that is already obligated to make payment whether the policy is sold or not.
4. Significant Investment and Risk
Aside from the purchase price, investors may have to make annual premium payments for an undetermined period of years before receiving payment. Investors take risk and pay for the reward. There is no windfall or undeserved gain.
Aside from the “ick factor” discussed above, there are a few risks that must be carefully managed.
(To be continued...)
This excerpt is taken from “How to Invest in Debt: a Complete Guide to Alternative Opportunities” by Michael Pellegrino. To read other articles of this book, click here. To buy this book, click here.
The Epoch Times Copyright © 2023 The views and opinions expressed are those of the authors. They are meant for general informational purposes only and should not be construed or interpreted as a recommendation or solicitation. The Epoch Times does not provide investment, tax, legal, financial planning, estate planning, or any other personal finance advice. The Epoch Times holds no liability for the accuracy or timeliness of the information provided.
