Life settlement

A life settlement is the legal sale of an existing life insurance policy (typically of seniors) for more than its cash surrender value, but less than its net death benefit, to a third party investor.^[1] The investor assumes the financial responsibility for ongoing premiums and receives the death benefit when the insured dies. The primary reason the policy owner sells is because they can no longer afford the ongoing premiums, they no longer need or want the policy, or they need money for expenses.^[2]

The investors consider five variables when pricing a policy for purchase:

• Life expectancy of the insured (health status)
• Cost of future premiums
• Policy face value (the payout)
• Policy maturity date (risk of policy lapsing with zero payout)
• Investors targeted return (discount rate)

As a general rule, policies for insured persons under the age of 70 do not qualify unless there are severe medical problems.^[3]

The term viatical settlement refers to a life settlement where the life expectancy was under two years because the person was terminally ill.^[4] However, some states, like Maryland, refer to any life settlement as a viatical settlement.^[5]

Life settlement history[]

The U.S. Supreme Court case of Grigsby v. Russell, 222 U.S. 149 (1911) established and legitimized the life insurance industry, ruling that policy as private property, which may be assigned at the will of the owner.^[6] Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner may transfer without limitation.^[7]

Despite the Supreme Court ruling, life settlements remained extremely uncommon due to lack of awareness from policy holders and lack of interest from potential investors. That changed in the 1980s when the U.S. faced an AIDS epidemic.^[6] AIDS victims faced short life expectancies, high unanticipated expenses related to medical care, and selling a life insurance policy that they no longer needed as a way to pay these expenses made sense. ^[6] However, by the mid-1990s, this investment strategy had faded away because of the rise of antiviral drugs.

In its place arose a new strategy focusing on acquiring policies of the elderly, although a niche business (roughly 2% of the market) persists to this day acquiring policies on terminally ill of all ages. Policies of terminally ill patients are rare for two key reasons. First, the market size of terminally ill insured interested in selling their policies is small. Second, carriers now offer accelerated death benefit riders, which pay out if the insured is terminally ill, so there is no need for a settlement.

Market size[]

Life settlements remain a niche asset class. For the year ending 2020, according to the Life Settlement Report by the Deal, there were 3,241 policies purchased with a total face value of $4.6B on the secondary market (from the original policy owner). This was up from 2019 when 2,878 policies for a total face value of $4.4B were purchased on the secondary market.^[8] In contrast, as of 2018, there were 267M life insurance policies in force in the United States. ^[9] Moreover, it is estimated that roughly 10M policies a year lapse.^[10] Since the policy owner would always be better off selling rather than lapsing, many believe the life settlement market has tremendous growth potential.

Major trends[]

There are three major industry trends. One is the rise in asset capital. More institutional investors are funding life settlements and have invested billions of dollars in assets since the early 2000s.^{[11][12][13][14]} For reference, in the primary market, insurance companies sell life insurance policies to market individuals, who become policy owners. In the secondary market, policy owners' polices are sold to third parties such as life settlement providers, who purchase policies on behalf of third party investors such as institutional investors. In the tertiary market, third party investors trade policies, which are included in the asset class.^[15][16]

Another major trend is direct-to-consumer marketing. To increase market individuals' awareness of the life settlement option, providers are utilizing marketing and advertising strategies to reach them. By eliminating the intermediate financial advisors and other professionals hired to identify potential policy owners, the policy supply has increased and transaction costs paid by policy owners have decreased. This results in a greater return on investment for buyers.^[11][12][17]

The final trend is more efficient medical underwriting. It is the result of new technologies and more reliable data from systems that are utilizing prescription and clinical database searches. While the market for life expectancy companies has grown more competitive, mangers have become more adept with analytics and are better able to estimate more accurate life expectancies for life settlement transactions. This mitigates the risk of serious financial losses heightened by prior underwriting methodologies and increases profitability and investor demand for policies.^{[11][12][17][18][19]}

Industry challenges[]

Although it has dramatically improved, the life settlement industry faced challenges early on. One challenge is aggressive and deceptive marketing motivated by high sales commissions for providers and brokers. As the market for policies grew more competitive, these intermediaries gained the potential to earn as much as 30 percent of the sale price of a life settlement. This incentivized intermediaries to push life settlement sales in the secondary market, despite policyholders' level of interest in selling, surrendering or lapsing their policies.^[20]

Another challenge is fraudulent activity. These include: Ponzi schemes, false life expectancy evaluations, poor premium reserves that increase investor costs, false promises of high profits with low risk, clean-sheeting (not disclosing a life-threatening illness in a policy application), dirty-sheeting (falsely claiming a life-threatening illness in a policy application), and wet-ink policies (policies sold during the contestable period). In February 2010, the American Council of Life Insurers recommended a ban on the securitization of life settlements because they could increase fraud associated with the strongly-opposed wet-ink policy known as Stranger-originated life insurance (STOLI).^[20] According to New York state insurance law, STOLI is defined as “any act, practice, or arrangement, at or prior to policy issuance, to initiate or facilitate the issuance of a life insurance policy for the intended benefit of a person who, at the time of policy origination, does not have an insurable interest in the life of the insured under the laws of” the state.^[21] This includes “an arrangement or other agreement to transfer the ownership of the policy or the policy benefits to another person”.^[21] Despite variations in states' definitions of STOLI, it is designed to allow an investor to initiate and profit from a stranger's life insurance policy.^[20] STOLI arrangements may also be called "zero premium life insurance", "no cost to the insured plans", "new issue life settlements", "high-net-worth settlements", or "non-recourse premium finance transactions".^[22]

Life settlement regulations have been adopted across the Unites States to prevent fraud and promote fair practices. As of 2010, 44 U.S. states adopted a form of the model uniform law developed by the National Association of Insurance Commissioners. Federal level regulations were developed under the U.S. Securities and Exchange Commission (SEC). ^[20]

Intermediaries[]

Life settlement providers serve as the investor's representative in a life settlement transaction. In almost all states (42 of the 50), investors are required to use a state-licensed life settlement provider when purchasing a policy. Most providers represent multiple investors. Life settlement brokers represent the original policy owner on the sale of a life settlement contract. They shop the policy to life settlement providers (who then shop the policy to their investor network). In most states, the life settlement broker must be licensed by the state.

Regulation[]

Most states regulate life settlements and impose a two-year waiting period.^[23] However, New Mexico, Michigan, Massachusetts, and Delaware only regulate viatical settlements, while Wyoming, South Dakota, Missouri, Alabama, and South Carolina neither regulate viatical settlements nor life settlements.^[23]

Major study findings[]

An academic study that showed some of the potential of the life settlement market was conducted in 2002 by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title The Benefits of a Secondary Market For Life Insurance.^[24] This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their under-performing life insurance policies, an opportunity that was not available to them just a few years before. It also has been stated by Neil A. Doherty, the professor at Wharton, that this practice drives up the cost of insurance to all other consumers purchasing life insurance.

We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate. - Wharton Study, pg 6

Another study by Conning & Co. Research, Life Settlements: Additional Pressure on Life Profits, found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements.

A life insurance industry sponsored study by Deloitte Consulting and the University of Connecticut came to negative conclusions regarding the life settlement market.^[25]

References[]

External links[]

• Viatical and Senior Settlements at Curlie