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Life

Settlement Investments

Explained

Life settlement investments occur when an investor purchases an existing life insurance policy from its owner for an immediate payment and then assumes the insurance premiums until the insured dies. Once the insured dies, the investor which is also the new policy owner, collects the death benefit. A very simplistic way to calculate the profit or internal rate of return (known as an IRR) for life settlement investments or viatical investments is to sum the cost to acquire the policy, add ongoing premiums and investor overhead. Then subtract this subtotal from the death benefit that is paid to the individual or organization that made the life settlement investment or viatical investment. Life settlement providers have anecdotally reported that they are buying policies for life settlement investments or viatical investments with a target IRR of 13%-19%. Life settlement investments and viatical investments are viewed as highly attractive, since they are somewhat low risk and offer investment vehicles that are an uncorrelated asset class. Meaning a life settlement investment or a viatical investment are not directly affected by the stock market, bond market or price of commodities. Strategically, life settlement investments or viatical investments provide a place to diversify an investment portfolio.

A Life Settlement Investment Or Viatical Investment is Levered To Life Expectancies

Life settlement investments and viatical investments are not risk free, contrary to popular belief. It is common sense that an insured will eventually die and the life insurance policy, if in force, will mature. So in that sense, a life settlement investment or viatical investment is low risk. However, for someone with life settlement investments or viatical investments there are a number of meaningful risks that should not be underestimated or trivialized. The most obvious risk is the longevity of the insured in a life settlement or viatical investment. Companies making a life settlement investment or viatical investment rely on internal underwriting and / or third party underwriters to evaluate the health and well being of an insured. Based on the underwriters’ opinions of the insured’s life expectancy, the company making the life settlement investment or viatical investment has a foundation for estimating future premium obligations. Basically, how much are they going to have to continue to pay to keep the policy in force and realize a return on their life settlement investments or viatical investments? This one element alone can be the determining factor in a positive or negative return for life settlement investments and viaitcal investments. On a case by case basis this aspect really affects a life settlement investment or viatical investment return. However, companies that have portfolios with large numbers of life settlement investments or viatical investments benefit from the law of large numbers. With enough policies in the portfolio, the variances in mortality should even out to the statistical longevity assumptions (if done correctly). Although, life settlement investments can be further hedged in the financial services marketplace. Companies with life settlement investments will take out their own quasi insurance in case the insured outlives their projected life expectancy. These are much like credit default swaps, with the counter party being companies that need to hedge against short life expectancies. Life insurance companies profit from insureds living a long and health life. From a business standpoint, it is not preferred to pay the full death benefit of someone who dies earlier than expected. Therefore life insurers, who have an interest in hedging against short life expectancies are eager to participate in these arrangements. Essentially a company making a life settlement investment enters into an agreement with a life insurance company in which, if the insured lives "too long" the life insurance company will pay the company with the life settlement investment. Conversely, the company making the life settlement investment will agree to pay the life insurance company if the person dies relatively soon. The life insurance company and the company making the life settlement investment are essentially insuring each other for a risk they have. Although, this isn’t necessarily true with viatical investments since the company making the viatical investment isn’t overly concerned with an extraordinarily long life expectancy for obvious reasons.

Miscalculations or erroneous assumptions for life settlement investment or viatical investment portfolios can be devastating. In 2008, life expectancy certificate providers announced a revision to their mortality tables. Essentially they changed the general assumptions upon which they base individual insureds’ life expectancies. That made everyone holding a life settlement investment or viatical investment question the value or projected IRR of their portfolios. To that point, third party life expectancy certificate providers now offer mark to market services. Much like banks have to mark to market their holdings, companies holding life settlement investments or viatical investments continually value their portfolio holdings with mark to market activities

Other Risks With Life Settlement Investments

Life settlement investments and viatical investments have risks beyond insured longevity. They can be affected by the insurance companies of the policies that hold. This risk became more obvious during the credit crisis and recession of 2008 and 2009. If the life insurance carrier rating is downgraded there is an increased risk that the company making the life settlement investment or viatical investment won’t be able to collect the death benefit. Some states have funds that will pay a portion of the death benefit if the life insurance carrier becomes insolvent, but it is usually a reduced amount. Since life settlement investments and viatical investments do not offer extremely high margins any reduction in the death benefit could equate to a money losing investment. Life insurance companies are rated for their credit worthiness and overall financial health by companies such as Moody’s and Standard & Poor’s. Companies making a life settlement investment or viatical investment will research an insurance company’s credit rating before buying a policy. In addition, Life settlement investments and viatical investments are subject to risks such as changes in tax laws, state insurance regulations or even investor liquidity.

Life Settlement Investment or Viatical Investment Process

Life settlement investments and viatical investments are said to have the highest transactional cost of any asset class. The process of investing in life settlement investments and viatical investments is also called a highly inefficient value chain. There are a number of factors that contribute to this. Firstly, the Life settlement investment and viatical investment acquisition procedure has many layers with many different parties. For example, an insurance agent or financial planner may tell a policy owner that their life insurance policy may be unneeded and have value on the secondary market. If the policy owner agrees, the insurance agent will refer the policy to a life settlement broker. The life settlement broker will then "shop" the life insurance policy to a number of life settlement providers. The life settlement providers are the companies that buy life insurance policies. Sometimes they buy policies for their own portfolios, while in other instances life settlement providers are actually buying on behalf of another company that wants to make life settlement investments or viatical investments. For example, Coventry First is one of the most active life settlement providers in the market today, but they buy a life settlement or viatical investment on behalf of AIG, while EastPort Capital makes life settlement investments with Goldman Sachs funds. So there are several potential layers of intermediaries in between the policy seller and the end party that is making the life settlement investment or viatical investment. Furthermore, sometimes these policies are grouped together or securitized, then sold off as part of an entire portfolio. Therefore a company can make a very large life settlement investment or viatical investment in one instance. This market for trading entire portfolios of life settlement investments or viatical investments is called the tertiary market.

Want to make Life Settlement Investments or Viatical Investments?

It is possible to make a life settlement investment or viatical investment on your own. However, depending upon the state buyers of existing life insurance policies must be licensed as a life settlement provider. Due to their overall attractive nature, life settlement investments and viatical investments are popular among financial institutions. Therefore, a new purchaser of life settlement investments or viatical investments must understand there is serious competition to buy policies. Life settlement providers have anecdotally reported that their average win rate of a life insurance policy purchased as a life settlement investment or viatical investment is 1-3%. Meaning for every 100 policies a life settlement provider bids on, they should reasonably expect they are going to capture 1-3 policies. That means significant resources and overhead are expended reviewing and acquiring policies. Some small boutique firms and funds have risen up to serve the high net worth, individual investors. However, they too face the challenge of competing with the large life settlement providers that buy hundreds of millions or even billions worth of life settlement investments or viatical investments each year. In addition, with smaller amounts of policies in their portfolios they are more sensitive to insured longevity variances.

Viatical Investments Are More Difficult

A Viatical investment is a more difficult strategy to invest in compared with a life settlement. There are far fewer life insurance policies available as a viatical investment than there are with willing, healthy seniors. This is due to broader life insurance products that provide for illness with things like accelerated death benefits and or specialized riders that can be accessed by terminally ill insureds. In addition, due to the shortened life expectancy of insureds, a viatical investment is more difficult to underwrite, price and acquire. Viatical investments also entail more stringent state regulations making the overhead and administrative expenses high. As a result, there are only a handful of viatical providers in the marketplace which means opportunities for a viatical investment through a provider are limited. Unless an individual or organization have the ability to become a viatical provider themselves in which case they can make a viatical investment directly. However, the risks and capital requirements of becoming a provider in order to facilitate viatical investments often prohibitive. As a result viatical investment activity has shifted towards that of life settlements. Viatical investments are available, but the market and opportunities are more limited.