How much can you make with life settlement investments?
In the U.S., life settlements have been a successful alternative to the traditional stock market for more than a century. While they are relatively unknown, they are a unique opportunity for investors who are looking to diversify their portfolios and maximize ROI.
Life settlement funds are lucrative in that they are low-risk while offering substantial returns. Because the insurance industry is highly regulated, investors can feel confident that they will receive their payout when the seller of the life insurance policy passes.
How do life insurance settlements work?
Life insurance settlements work in a number of ways. To start, there are two sides to a life settlement transaction. The first is probably what initially comes to mind when you think of life settlements, investing. This piece is important because it provides the investor with returns that are not correlated to the general stock and bond markets. Investors are always looking for better ways to make money. Life settlements allow them to diversify their portfolios in a way that is not usually achievable through most investment firms or markets.
The other side of the transaction is something that oftentimes gets forgotten but is quickly becoming a larger part of the conversation. Many investors are looking for opportunities to not only get returns but also to focus their investment strategies on Environmental, Social, and Governance (ESG) guidelines.
So, how do life settlement funds fit ESG metrics?
To start, the person receiving the cash payout for the policy is usually a health-impaired senior. This is the industry’s term for an older person whose health is deteriorating. A health-impaired person who is selling their life insurance policy is typically in great need of medical care, but in order to keep the policy active, they must continue paying the premiums. Otherwise, the policy will lapse or the insurance company will look for a third party that will pay a much higher price for the policy. When an insured person sells their life insurance policy directly to a third party, they can get as much as 11 times the cash surrender value. Once they receive their payment, they can finally focus on their health and pay for the medical care they desperately need.
Life insurance settlements cover many bases for investors. On one hand, the lack of market correlation and better diversification is appealing to many investors. Additionally, life insurance settlements fit ESG guidelines, solving financial issues for seniors when they need it the most. It is one of the few ways that investors can both invest with direct impact and still have great return potential.
Life settlement vs. viaticals
While life insurance settlements and viaticals are similar, there are a few elements that differentiate the two. First, life settlements are specific to senior citizens, typically 65 or over, who want to sell their life insurance policies. Usually, the senior would be terminally or chronically ill, although that is not always the case. The insured will have a life expectancy between three to ten years.
Viaticals, on the other hand, deal with policyholders that are younger. Usually, the insured is between 30-60 years and has a life-threatening illness. In these cases, the insured’s life expectancy is two years or less.
How do you determine the cash value of life insurance?
The value of a life settlement has three main components: life expectancy, premiums, and death benefit. The premiums and death benefits are simple because they are set in stone through the policy. The life expectancy of the insured, on the other hand, gets a little more complex. While it is difficult to determine how long someone will live, it is essential to get a good life expectancy estimate, or you could end up overpaying for the policy.
To get a fair life expectancy estimate, you must first consult a life expectancy company. These companies use medical records, actuarial tables, and other tools to get a reasonable idea of how long an insured person will live. Occasionally, a life settlement broker may request more than one estimate to feel confident about an agreed-upon purchase price. It is crucial to choose a trusted life expectancy company as they will give the most reasonable reports on the insured.
Are life settlements tax-free?
While life insurance settlements are lucrative investment opportunities, they are not tax-free. However, there is an inverse correlation between the amount you have paid in premiums and the amount you will pay in taxes. Simply put, the more premiums you have paid on a life settlement, the lower the federal taxes will be.
So, how does it work? First, sale proceeds up to the amount of the cost basis are not taxable. Any sale proceeds above the cost basis, and up to the policy's cash surrender value, are taxed as ordinary income. Then, any remaining sale proceeds are taxed as long-term capital gains.
However, a fund format works differently. In the case of a fund format, the fund will have maturities, expenses, and sometimes capital gains. If a policy is sold for more than it was purchased for, or if a policy matures, then investors will pay a tax bill for the profits in that year unless the investment is held inside of an IRA. The profits and losses are distributed to the investors on a pro-rata basis through a K-1 federal tax form.
What factors determine the payout of a life settlement?
A life insurance policy's contract will outline the total amount to be paid to designated beneficiaries upon the death of the insured. This amount is payable by the life insurance carrier. However, the Net Death Benefit may be more or less than the original face value of the life insurance policy. This can be due to a variety of factors. For example, if the client takes withdrawals or loans or chooses to increase or decrease the death benefit over time.
What reasons might life settlements not pay?
It is extremely rare for a life insurance policy to not be paid out. This usually happens in the case of STOLI, or stranger-owned life insurance, where an investor takes out a life insurance policy without insurable interest on the insured. In these cases, the expectation is that the investor will eventually sell that policy for profit. However, to obtain insurance on a person, you must have an insurable interest in that person. Because of this, STOLI policies are generally illegal and difficult to obtain. Due to the broadly unethical nature of STOLI policies, most funds will not buy them in the first place, making the risk of investing in one low to non-existent.
Get Started
Overall, life settlement fund payouts vary based on a variety of factors including the insured’s life expectancy, the policy’s premiums, and the death benefit. Regardless, life settlement funds are oftentimes a profitable, low-risk investment option for investors who are interested in diversifying their portfolios.
If you are interested in learning more about investing in life settlement funds, our investor relations team is here to help. Get in touch to speak with someone on our team today!
