What are Life Settlements?
How does a Life Settlement Work?
What are the Main Benefits of Life Settlements as an Investment?
What Risks are Associated with this Asset Class?
Why do Seniors Sell Their Policies?
Why don't Insured Persons Surrender the Policy to the Insurer for Cash Value?
Are Life Settlements Good for the Consumer?
Is it Common Practice to Sell a Life Insurance Policy?
What is the Biggest Public Misconception Regarding Life Settlements?
Who Purchases Life Settlements?
How much does a Policy Cost?
Who Determines Life Expectancy?
Who Pays the Premiums?
What if an Insurance Company Becomes Insolvent?
Why Should I use Universal to Purchase Policies and not go Directly to the Market?
Are Life Settlement Transactions Regulated?
What Timelines are Associated with the Acquisition Process?
How do Investors know if a Policy is in Good Standing?
How have Recent Market Conditions Affected the Life Settlement Asset Class?
What kind of Investment Benefits are Associated with Life Settlements?

What are Life Settlements?

Life settlements are life insurance policies purchased from seniors on the secondary market in the United States. With a life settlement, the interest in an existing life insurance policy is transferred (sold) by the owner to a third party for more than its cash surrender value, but less than its net death benefit. The purchaser then becomes the beneficiary of the policy and is entitled to receive the insured sum upon maturity of the policy. In a life settlement, the insured is generally 65 years of age or older and does not have a terminal or chronic illness. Life settlements benefit senior citizens by offering a valuable option for unneeded or unwanted life insurance policies over the alternative of surrendering it or allowing it to lapse.

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How does a Life Settlement Work?

Life settlements typically begin with the filing of a life settlement application by a policy owner and insured, together with necessary documentation. A life settlement provider will verify the insurance coverage and the insured’s medical status, and will determine the policy’s viability for a life settlement (including reviewing the case for potential fraud). The life settlement provider will also determine suitability for funding and will match the policy with an appropriate institutional funding source to acquire the policy. The life settlement provider will then relay an offer to the advisor of the insured or the owner of the policy, as the case may be. Once a price is agreed upon, funds are typically placed in escrow with a third-party trustee, not unlike the closing of the sale of a house. Once the offer is accepted, a closing package will be delivered to the advisor of the insured or the policy owner. Signed documents are then returned to the life settlement provider and the insurance carrier is notified. Following written verification of the change of ownership of the policy from the insurance company, settlement funds are transferred to the insured or policy owner (as applicable) from escrow.

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What are the Main Benefits of Life Settlements as an Investment?

Life settlements offer an excellent opportunity for growth in an alternative asset characterized by low volatility and minimal correlation to equity markets. Life settlements are not linked to movements in interest rates, commodity prices and generally, most other macroeconomic factors. Investors holding assets of this nature do so to enhance the balance and stability within their portfolios, given that the correlation of the life settlement assets to the other assets in the portfolio is likely to be very low.

Assets having low volatility are attractive to investors. Volatility within the life settlement asset class is a function primarily of the longevity risk (the most important risk factor of life settlements). Life settlements must be maintained through the payment of life insurance premiums necessary to keep a given policy in good standing until policy maturity. Longevity risk is defined as the probability that the insured individual lives beyond his or her life expectancy, which presents the potential problem of the death benefit arriving later while the ongoing premiums diminish the investment returns. Longevity risk can be argued to have limited volatility. Industry analysts agree that longevity is improving among US seniors, but it is doing so at a fairly predictable and steady rate, in contrast to the volatile stock market swings seen recently and the gyrations in, for example, currency markets or oil prices.

Finally, policies are able to be acquired at relatively attractive expected performance levels. Internal rates of return ranging from 10% to 15% are typical, assuming that policies mature more or less as expected based on the assumptions at acquisition. In case of early maturities the annualized return on investment can be substantially higher.

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What Risks are Associated with this Asset Class?

The underlying risk to this asset class is known as “extension” or “longevity” risk. That is the risk that you underestimate the actual life span of the insured at the point of policy purchase. For example, the purchase of an 80 year old insured male’s policy is contemplated, with the investor expecting him to live eight years. If the insured ends up living 12 years, there will be a negative impact on the performance of that policy from the investor’s point of view. There is a detailed analysis in Appendix B.

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Why do Seniors Sell Their Policies?

A life settlement may provide a better alternative than allowing an unneeded policy to lapse or to be surrendered for its cash value. Sometimes policies are no longer needed or wanted, because of divorce, death of a spouse, or because heirs are financially independent. In other cases money could be needed for health care and living expenses. Occasionally, premium payments become unaffordable as policy owners grow older. Other reasons for considering selling include changes in estate, tax or financial plans causing a policyholder to consider lapsing or surrendering policy.

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Why don’t Insured Persons Surrender the Policy to the Insurer for Cash Value?

Investors (purchasers of life insurance policies on the secondary market) will pay more than twice (sometimes 3-5 times) the cash surrender value paid by the insurance company.

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Are Life Settlements Good for the Consumer?

Yes. More than $9.7 Trillion of individual life insurance was in force on 167.7 Million policies at the end of 2004, according to the 2005 Life Insurers Fact Book, compiled by the American Council of Life Insurers, and almost 9 of 10 universal life insurance policies are lapsed or surrendered (approximately 40 percent in the first five years from the date of issuance of the policy).

The average life settlement pays a policyholder at least more than twice the cash surrender value of the policy. Since 2001 over a billion dollars in excess of the cash surrender value has been paid to senior citizens who chose to sell, rather than lapse or surrender, their life insurance policy.

The money that seniors receive may be used to improve a home, fund a grandchild’s education, start a small business, pay medical expenses, repay debts or deal with an unexpected life change. For those consumers, the ability to sell some or all of their life insurance policy provides flexibility to meet pressing financial needs with money that ultimately belongs to the policyholder.

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Is it Common Practice to Sell a Life Insurance Policy?

Legal and financial advisors, as well as insurance agents and brokers, are becoming more knowledgeable about life settlements, as are senior citizens. According to industry estimates, over $16 Billion of policies were sold in 2007 and purchased through life settlements, and this is expected to increase several fold in the future, as more senior citizens and their advisors and agents, as well as institutional investors, learn about life settlements.

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What is the Biggest Public Misconception Regarding Life Settlements?

The biggest misconception among the public is that investors are taking advantage of seniors. In actuality, research on this asset class has shown that the biggest benefactors of the secondary market for US life insurance policies are the policy owners themselves.

Before this market existed policy owners had little if any options in terms of being able to liquidate the enhanced value within their policy. Policyholders have the option of not paying premiums and utilizing any existing cash which has been built up within the policy to fund the premium payments necessary to maintain the policy in good standing until eventually the policy lapses. In this case, insured individuals receive no value once the policy lapses. Alternatively, insured individuals may choose to surrender their policies; however, the surrender value of most policies is very low compared to the price they are likely to achieve by selling them on the secondary market.

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Who Purchases Life Settlements?

Today, multi-national banks, international corporate conglomerates, global insurance companies, pension funds, hedge funds and other major financial institutions—the same institutions that invest in life insurance companies—are purchasing life insurance policies through life settlements. Two of the largest insurance holding companies in the US, Berkshire Hathaway and American International Group, have been significant purchasers of life insurance policies.

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How much does a Policy Cost?

Price is determined by a number of factors, including the face amount of the policy, the amount of premiums that will have to be paid to keep the policy in force, the cash surrender value of the policy and the life expectancy of the insured individual.

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Who Determines Life Expectancy?

Policies must be accompanied with a current Life Expectancy report. Specialized actuarial firms certify life expectancy (LE) after reviewing medical records and lifestyle of insured. Typically, the policy owner or their representative submits the insured’s medical records to one or more of LE providers. The entity submitting the records for assessment pays the fee.

Each LE provider assigns an underwriter to review the submitted medical records and determines a life expectancy in months. This life expectancy determination is based on the number of deaths in a pool of 1,000 lives that are of the same age and gender as the insured.

The LE service providers are not regulated and there is no standard system of analysis in place among the industry’s LE providers. Each company asserts that they are the most accurate. The companies make no guarantees as to the accuracy of any particular LE report.

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Who Pays the Premiums?

Investors must pay the premiums on the life settlements they hold. Universal shall advise the investor in a timely fashion as to when these premium payments are due.

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What if an Insurance Company Becomes Insolvent?

Throughout history, there has never been a case where a death benefit was not paid due to insolvency of an insurance carrier. In cases where insolvencies have occurred in the past, the insurer either restructured successfully or the insurance division of an insolvent insurer was acquired by another carrier. In addition, there is an organization known as the National Organization of Life and Health Insurance Guaranty Associations (NOLHGA), which was founded in 1983 when the state guaranty associations determined that there was a need for a mechanism to help them coordinate their efforts to provide protection to policyholders when a life or health insurance company insolvency occurs. State guaranty associations provide coverage (up to the limits spelled out by state law) for resident policyholders of insurers licensed to do business in their state. NOLHGA assists its member associations in quickly and cost-effectively providing coverage to policyholders in the event of a multi-state life or health insurer insolvency.

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Why Should I use Universal to Purchase Policies and not go Directly to the Market?

Universal offers a complete turnkey solution for investments in the life settlement industry. Investors can certainly buy directly in the market. However, there are many potential pitfalls for new entrants wishing to invest directly in life settlements without the benefit of a trusted and experienced company specializing in life settlements to help them with the investment process.

It is important to note that Universal has built a reliable network of policy brokers throughout the US. Having operated in this space for over a decade, Universal is well aware of all the complexities related to appropriate licensing, documentation, pricing, and policy underwriting procedures to ensure an effective life settlement.

"The market for the buying and selling of life insurance policies for investment purposes had a rational basis in the beginning - but appears to have evolved too often into transactions where the main purpose is to procure obscenely high fees and commissions."

If the intent is to cut out the fees that Universal will earn by dealing directly with policy brokers, the investor is far better off paying these nominal fees and having the peace of mind in knowing that they hold quality policies which will pay out when maturities occur. Further, the investor is relieved from the burden of maintaining the policies, tracking the insured’s and filing the death claims.

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Are Life Settlement Transactions Regulated?

A life settlement broker is a person or entity who on behalf of a policy holder and for a fee, commission or other valuable consideration, offers or attempts to negotiate life settlements between a policy holder and one or more life settlement providers.

In 1993 the National Association of Insurance Commissioners (“NAIC”) adopted its first Viatical Settlements Model Act (the “Model Act”). The National Conference of Insurance Legislators (“NCOIL”) created its own version of a settlement act in 2000 (the “NCOIL Act”), which was significantly updated and revised in 2007. By the middle of 2008, 41 states had adopted some form of regulation over the secondary market for life insurance, most based on the NAIC Act, but several adopting the provisions of the updated NCOIL Act.

Unfortunately, every state has adopted its own “spin” on the Model Act or NCOIL Act, so rather than having one set of consistent regulations with which to comply, industry stakeholders find themselves stretched across up to 41 separate jurisdictions, dealing with up to 41 separate regulatory agencies.

Generally speaking, the various state statutes and regulations based on both the Model Act and the NCOIL Act regulate the sale of life insurance policies, and the individuals or entities involved in these transactions in a number of ways, including, but not limited to: 1) provider and broker licensing, including, in many states, extensive background checks and fingerprinting; 2) requiring that all contracts and related documents be filed and approved; 3) requirement for annual reports; 4) restrictions on disclosing financial or medical information; 5) requiring payment through escrow accounts, and mandating time periods for funding the escrow accounts and paying the policy owner; 6) permitting the policy owner to rescind a sales transaction for 30 days after execution of the sale agreement, or 15 days after receipt of the settlement proceeds; 7) extensive disclosure requirements; 8) minimum payment requirements for terminally ill individuals; 9) restrictions on advertising; and 10) criminal and civil penalties for violations of the laws.

Link below to state by state regulations for life settlements.
The Voice of The Industry Report

Universal is fully cognizant of the various state regulations for the acquisition of life insurance policies on the secondary market in the US. With respect to the sale of life settlements in the province of Ontario, Canada where Universal is headquartered, in late 2006 the Ontario Securities Commission (OSC) ruled that the sale of life settlements is deemed to be a security-related transaction regulated by the OSC. The Act states that the sale of these securities can only be conducted through an appropriately licensed entity.

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What Timelines are Associated with the Acquisition Process?

Universal requires the deposit of funds in trust after a policy has been identified as suitable and before a formal offer is made to the policy holder or their agent. In the case of a large portfolio of policies being acquired on a policy by policy basis, Universal will require an agreed upon tranche of funds to be placed in trust. As policies are sourced, and Ownership and Beneficiary Changes completed, funds are disbursed from the trust account. After funds are placed in trust, policy acquisition begins immediately and fulfillment occurs within a matter of weeks. As the trust account becomes depleted, another tranche of funds will be placed in trust by the investor in order to continue the acquisition process.

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How do Investors know if a Policy is in Good Standing?

When Universal enters into an agreement to purchase a policy, an extensive policy review is performed, including an extensive anti-fraud assessment. If a policy meets the investor’s criteria, insurance underwriting is completed by Universal to ensure that the policy is valid and meets the necessary standards. Verification of Coverage is requested from the insurance company both before the policy Ownership and Beneficiary Changes are executed and after, to ensure that nothing has changed in the interim.

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How have Recent Market Conditions Affected the Life Settlement Asset Class?

Despite the recent crisis in the financial markets, interest from investors in acquiring life settlement assets has escalated. There are three main reasons for this: 1) Options available to investors looking for “safe” investments are limited, with traditional safety-oriented investment vehicles such as Treasury Bills, for example, offering extremely low rates of return at the moment. Investment returns have the potential to be far greater than traditional safe products and are largely uncorrelated to capital markets with lower volatility. 2) In the past, the life expectancy underwriters were producing much more aggressive life expectancy assumptions; underwriters have adopted much more conservative models as of September 2008. 3) The current relative inactivity of the banking sectors’ participation in the acquisition of these assets due to the recent credit issues has resulted in less pricing pressure on the available policies, translating into higher returns to investors.

Summarized, the combination of more conservative pricing assumptions and higher return projections comes together with a climate of low interest rates (which govern returns on safety-oriented vehicles such as T-Bills), to provide a great opportunity to achieve better value for the investor in the asset class. The demand for this type of asset is increasing, and forecasts indicate this trend will continue over the next decade.

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What kind of Investment Benefits are Associated with Life Settlements?

Life settlement investments are positioned to provide market competitive returns in the current economic environment and even above average returns in some cases. Such investments also provide greater portfolio diversification for improved risk return metrics, and it is important to note that this particular asset class enables an investor to vary risk and return throughout the investing life cycle, regardless of time horizon.

The following are important benefits which should be considered when contemplating the purchase of a life settlement portfolio:

      • Returns hold limited correlation to traditional markets.

Life settlement investments will likely benefit from a surge in portfolio diversity as the finance industry recovers and stops to examine what went wrong and how portfolios should be structured in the future.

The lack of correlation between longevity-based financial instruments and other financial instruments is significant. It is probably incorrect to discourse generically about non-correlation. To be precise, the focus should be about the lack of correlation between the underlying mortality of life-based instruments and other financial instruments.

      • Lower volatility of returns.

Life settlement investments generally fluctuate less wildly than the general markets. However, lower volatility is enhanced through the acquisition of a sufficient number of assets in the portfolio.

      • Sizeable and growing asset class.

Conning Research and Consulting projects life settlement market growth at $90 to $140 Billion by 2016. Given the recent credit crisis, it is likely that the Conning figures will overestimate the market size this year but the market may grow faster than predicted in the following years because of the increased search for risk mitigation from portfolio diversification among all classes of investors.

      • Potential for high returns.

Life settlement investments offer the opportunity to potentially outperform historic rates of return; and it can be argued that they certainly offer more competitive rates of return than those offered by many other investments at this time.

The driving factors in calculating the return are the quality of underwriting and actuarial assessment of a life and then meeting the cost requirements, premiums and purchase costs, of paying out that policy in the meantime. As with any financial instrument, the better the data, the better the ability to make financial judgments around individual assets and around constructing a portfolio.

      • Improved mortality data accuracy.

Several life expectancy providers made changes to their mortality tables as a result of data published in the Valuation Basic Table (VBT) 2008. It is likely that the changes will ultimately improve the quality of their estimates and help build investor confidence in the quality of the estimates.

There is now much greater correlation between qualitative and quantitative based assessment which gives more robust confidence to the investment process.

      • Increasing regulation adding to strength and stability of industry.

The life settlement industry continues to see a rising number of legislative and regulatory proposals being introduced in states across the US. The likely result of this will be an increase in investor confidence in the stability of the investment process once a regulatory structure is in place.

There is now increasing regulatory risk for life insurance companies who are trying to restrict the deployment of life settlements as an option because, under the US Supreme Court case Grigsby v. Russell, life settlements are a recognized asset. The result of this should be that in the future it will be very hard for life insurers who attempt to restrict life settlements to demonstrate that they are not doing so when legally challenged.

      • Strength of the underlying asset is highly rated.

Policies are only purchased from highly rated insurance companies. Given the recent crisis in the financial markets including the life insurance sector, it is essential that investor’s ensure they have appropriate levels of diversification, even among life insurance carriers.

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