How hedge funds and pension plans earn 15% to 20% a year buying life insurance policies from unwary individuals. Why it is better to keep your permanent life insurance rather than sell it as part of a life settlement.
In this episode you’ll learn:
- What are life settlements and viaticals and how is the market developing.
- How well have life settlement investments performed and what drives the performance.
- Why insurance companies discourage selling life insurance policies in the secondary market even though it is permitted.
- What are better financial alternatives than selling your life insurance policy.
Should You Sell Your Life Insurance Policy?
When I was in my mid thirties, I took out two term life insurance policies for $500,000 each. The policies are good until I reach age 95 but the guaranteed premium of approximately $400 each lasts only twenty years, at which point the premiums skyrocket to thousands of dollars annually.
The purpose of these policies was to help take care of my family if I died prematurely. Now that my kids are grown and we have sufficient investments, we don’t need the policies to the same degree we did when my family was younger.
What does one do with something they no longer need? Sell it or give it away.
Trying To Sell My Policy
So I called an insurance broker, specifically the Ashar Group, based out of Orlando Florida. They put me through to Jason Mendelsohn, who is the company president. I shared my age and health status and he kindly informed me my policy couldn’t be sold.
At my age in order to sell my policy I would need to be “significantly impaired” with less than four years to live. I would need a terminal condition. The only way I could sell my policy if I had decent health is if I was older than 74.
Even if I weighed 300 pounds and had diabetes I wouldn’t be able to sell my policy if my condition could be managed with medication.
But had I been seriously impaired and I could medically prove it, then Jason’s company could have facilitated the sale of my policy to a pension plan or some other institutional investor.
At that point, I’d get a lump sum cash payment for my policy. Ashar Group would get a commission equal to the lesser of 8% of the death benefit or 30% of the sale price, and the institutional investor or hedge fund would make the premium payments on my policy. The sooner I died, the higher the return on their investment.
A Growing Market and Excellent Performance
In 2015, according to data compiled by The Deal, 1,123 individuals in the U.S. sold their life insurance policies as part of life settlements with a face value of $1.65 billion with investors paying approximately 20% of the death benefit.
Investors in life settlements have done extremely well. The AAP Investable Life Settlement Index tracks the performance of non-U.S. based open end life settlement funds, most of which are buying life insurance policies issued in the U.S.
The index shows a $100 investment in December 2012 would have grown to approximately $178 by month-end September 2016, equating to a 16.6% annualized return.
Similarly, the Long Term Growth Fund, a life settlement hedge fund based in Luxembourg and managed by Carlisle Management, has returned 21.9% annualized since its inception July 1, 2009 through September 2016.
What is amazing about the track record is the fund has only experienced four negative performing months in its seven plus year history, and the worst monthly return was -0.47%.
How does the fund generate such excellent returns?
According to the manager, “Its strategy is to build a large diversified portfolio [of life settlements] across numerous sectors, including but not limited to carrier concentration, expected maturities, gender, age, medical impairment, geography and face value size.”
“In order to properly implement a buy and hold strategy, the fund seeks to isolate mortality risk and build a large sample size. Since policies are held through maturity, the managers employ extremely detailed actuarial and financial analysis to ensure that policies purchased are accounted for longevity risk as well as other variables of the statistical profile.”
In other words, the way to make money with life settlements is to not pay too much for policies and correctly estimate how quickly people will die.
Investors like life settlement investments because they are uncorrelated to other asset classes. The performance driver is people dying, not central bank policies or corporate profitability.
Leaving Money On The Table
The fact that a hedge fund can generate 20% plus returns with little market risk while a broker facilitating the transaction can earn up to a 30% commission suggest there is someone on the other side of the trade who is leaving a great deal of money on the table.
That someone is the person selling his or her life insurance policy.
Most permanent life insurance policies, such as universal or whole life, are surrendered before death and the cash value paid out, usually because the policy holder can’t afford or doesn’t want to continue to pay premiums.
According to LIMRA, a large trade association representing major life insurers, 25% of permanent insurance policies (i.e. whole and universal life policies) lapse within the first three years of purchase and 40% within 10 years.
Insurance companies earn substantial profits from these lapsing policies according to a paper by Daniel Gottlieb and Kent Smetters. They lose money when policy holders keep their permanent insurance. Hence, policy holders who let their policies lapse end up subsidizing those that keep their policies.
Gottlieb and Smetters point out the insurance industry “lobbies intensely to restrict the operations of secondary markets” where policy holders could sell their policies as part of life settlements because it would result in less policies lapsing and hurt insurance company profitability.
Still, the Supreme Court ruled way back in 1911 that life insurance policy holders have a right to sell their policies.
But just because you can sell, should you? Particularly given the high returns being generated by life settlement investors and the fact insurance companies prefer policy holders let their policies lapse.
Better To Keep Your Policy
That suggests policy holders are better off finding a way to hold onto their policies.
Policy sellers give up a huge tax benefit. Death benefits paid to beneficiaries of life insurance policies are tax free. Whereas, policy holders who sell their life insurance policies on the secondary market pay taxes on a portion of the proceeds and the buyer of the policies also pay taxes on the death benefits. That is one reason proceeds for selling a policies are so low.
Eleanor Laise in Kiplinger writes that life settlement gross purchase prices before deducting taxes, commissions and other transaction costs are usually 10% to 25% of the death benefit. Transaction costs which includes the commission can eat up 10% to 20% of the gross purchase price.
Another downside to selling a life insurance policy is the potential loss of privacy. Selling your policy requires medical underwriters reviewing your medical records and preparing a mortality profile with a summary of your expected medical conditions and life expectancy.
Given the high transaction costs, low percentage payouts, loss of tax benefits, and potential privacy risk rather than selling a policy it is more financially advantageous in most cases to borrow against the policy, see if the premium payments can come out of the cash value or even have your beneficiaries make the payments.
And if someone has a short-life expectancy due to a terminal illness, it is always possible to negotiate directly with the insurance company for an accelerated death benefit rather than turning to the secondary market.