What Every Investor Should Know About Life Settlement Funds
In recent years, life settlement funds have become lucrative investing opportunities for money managers who are interested in diversifying their portfolios through alternative assets. However, you may be wondering, “What are life settlement funds in the first place?”
While life insurance policies are meant to support families after one passes, they can also be sold prior to death in the form of a life settlement. This is an option for older adults and those with terminal health conditions who can no longer afford their policy or need to liquify their policy in order to pay for long-term healthcare or living costs.
When the life insurance policy is sold, the investor becomes the owner/beneficiary and continues to pay premiums until the insured passes away. At that time, the policy death benefit is paid out to the investor.
Before you decide to invest in life settlement funds, it is important to understand how they work and if a life settlement fund is the best investment option for you.
What Is a Life Settlement Fund?
A life settlement is the legal sale of an existing life insurance policy to a third party. The owner of the policy sells their life insurance policy to a life settlement provider in exchange for cash. More often than not, these policy owners are senior citizens looking to sell their policies in order to help pay for long-term healthcare costs or end-of-life expenses. However, in some cases, policy owners may be young adults.
Example: Eleanor is 78 years old and owns a $750,000 life insurance policy. Over the past few years, her chronic health problems have progressed, and she now needs full-time nursing care. Rather than continuing to pay for a life insurance policy, Eleanor sells it to a life settlement provider in exchange for cash. She can now use this cash to pay for long-term care.
How Does Selling a Life Settlement Work?
Selling a life insurance policy is a legal, worthwhile option for those who no longer need their policy. While the process can vary, it is important to note that it takes more than a month and is highly regulated to prevent fraud and protect the uninsured.
A senior with a need to sell their life insurance policy finds a life settlement broker.
The broker obtains as many bids on the policies as possible to get the best price for the insured.
Once the broker has chosen a bid, the insured must complete a series of medical examinations and paperwork. A life expectancy report is conducted on the insured to get an accurate estimate of the policy's worth.
Once they have these figures, the insured will sign the policy over to the broker, and they will get a cash payment in exchange.
Once the process is complete, the provider will hold the life settlement on its books and eventually sell it to another party for a small markup.
Why Should I Invest in a Fund Instead of Buying Life Settlements Directly?
While it is possible for investors to buy life settlements on their own, it can be a difficult process to navigate. To start, investors need a substantial investment amount to reap the benefits of investing in policies; more than a few million at least. Additionally, an investor and their team should have extensive knowledge of the industry to ensure they are getting the expected ROI.
The most successful life settlement funds perform well because they have the deal flow and policy procurement strategy that supports the return that investors expect from the asset class. Without proper knowledge of the industry, investors can easily end up buying policies that may have little to no return.
By investing in a fund structure, investors get the benefit of the team, knowledge, and time in the industry as well as the potential profit. A fund usually has much lower minimums than investing on your own, as most funds offer investing opportunities for as little as $100,000.
It’s also important to think about liquidity. When buying policies on your own, you are committing that capital for many years, and in the meantime, you have to make policy premium payments. With a fund structure, the fund has relationships with other third parties; they can buy and sell policies much more easily than your typical investor, resulting in much shorter lockups than buying into single policies.
Why is This a Lucrative Investment?
Because life settlements are not correlated to any other investment, this makes them one of the rare opportunities that allow for true diversification. When the stock market goes down, life settlements do not go down in lockstep. In fact, life settlements have historically shown to be very stable in their growth.
Compared to investing in the S&P 500 from 2012-2018, life settlements outperformed with significantly less volatility. While life settlements do not offer quick returns like the stock market can, they do give investors access to steady, compounded growth over a long period of time.
The History
People have been selling their life insurance policies in exchange for a cash settlement for over 100 years. In 1911, the Supreme Court ruled in Grigsby v. Russell that selling and buying a “life settlement” is a legal transaction, no different than selling or buying any other asset. However, it wasn’t until the 1980s, during the AIDS epidemic, that selling life insurance policies became normalized
Unfortunately, as sales increased, fraud became prevalent as well. To prevent this, the industry is now heavily regulated; and life insurance companies build policy documents that are more robust than they used to be. Additionally, many states offer consumer protections and all life settlement providers/brokers must be licensed.
Why Do People Sell Their Policies?
People sell their policies for a number of different reasons. However, there are three main reasons that a person would choose to sell their life insurance policy in exchange for cash.
They no longer need the policy
Many times, an insured will no longer have a beneficiary for the policy. This is common for those with grown children, people who are divorced, or widowers. In other cases, the original need for the policy no longer exists. For example, if someone has a policy, but no longer has a beneficiary, they may not want to incur the expense of paying the premiums.
Healthcare costs
Many seniors find themselves inundated with medical expenses because their health is deteriorating. Oftentimes, the expense of policy premiums proves to be overwhelming. In these cases, seniors have a few options. First, they surrender the policy to the insurance company, which usually will only pay pennies on the dollar for the policy. Secondly, they allow the policy to lapse, losing out on any potential value of paying the policy premiums. Lastly, they sell the policy to a third party, which can offer up to 11 times the amount of money for the policy compared to surrendering it to the insurance company.
The policy is underperforming
If the life insurance policy is underperforming, it may no longer make sense for someone to continue paying the premiums. In these cases, people will sell their policies in exchange for a lump sum. This allows the policyholder to use the cash to invest in other opportunities with more potential for growth.
Who Qualifies for a Life Settlement?
Anyone with a policy can potentially qualify for a life settlement. However, there may be some circumstances where it doesn’t make sense for them to sell their policy. Health and age are the two main factors to determine whether or not a person should sell their life insurance policy.
In most cases, you must be 65 or older to sell a life insurance policy. In some cases where a younger patient has a terminal health condition, they may sell their policy (also called a viatical).
Secondly, investors typically prefer to purchase policies from people with shorter life expectancies to attain the greatest ROI. While there is no health requirement to sell one's policy, to get the most out of a policy, the insured would need to have serious health impairments. If the policyholder is not health impaired, it is unlikely their policy will ever turn into a life settlement.
Who Is This Investment Opportunity Right For?
While life settlements are a great opportunity for building wealth, you should consider whether adding them to your portfolio is a good option before you invest. Life settlements are right for investors who:
Want to protect and compound their wealth in an asset class that will shield them from the majority of typical market fluctuations.
Are looking for a historically steady rate of return.
Want to diversify their portfolio with historically low volatility, uncorrelated, long-term investment opportunity.
Benefits of Investing
Adding life settlements to your portfolio makes sense for a variety of reasons including:
Life settlements are typically low-risk, creating peace of mind for investors.
They outperform the stock market, with returns typically ranging in the high single digits to low double digits.
Life settlements offer compounding returns.
Life settlements are a win-win. Both the buyer and seller typically end up in a better financial situation.
Want to Know More?
In conclusion, investing in life settlement funds can be an advantageous opportunity for those who are interested in diversifying their portfolios with low-risk, high-return investments. By working with the team at Aspen Alpha Advisors, you will have access to the expertise, knowledge, and experience of our team.
Want to learn more? Speak with our investor relations team today!
