A life settlement fund is an investment fund which invests primarily or exclusively in life settlements. By investing in large numbers of life insurance policies, this type of investment fund spreads investment capital in order to minimize the risk of loss and maximize potential returns.
In a life settlement investment, a private investor or an investment fund buys unwanted whole life insurance policies from insured individuals through a broker known as a life settlement provider. The investor pays the insured person an amount equal to the cash value of their policy, plus a premium. When the investor buys the policy from the insured person, the insured person names them as the beneficiary of the policy. The investor must cover the cost of the insurance premiums from the time that they buy the policy from the insured individual until the insured individual dies. When the insured individual dies, the investor collects the death benefit.
The total investment needed is impossible to calculate because there is no sure way of knowing when the insured individual will die. Because of this, investing in just one or several life settlements brings a fair amount of risk.
Because investment funds typically control much larger amounts of capital than individual investors, they are able to invest in hundreds or thousands of policies. This balances the risk because while some of the insured individuals may live to a very old age, most are likely to have average lifespans and some will likely live shorted than average. The death benefits collected for insured individuals who have below-average and average lifespans balance the cost of premiums for policies belonging to individuals who have above-average lifespans. Collected benefits are pooled and distributed to fund shareholders as dividends.
This balanced risk makes buying shares in life settlement funds a more secure investment option for investors than buying life insurance policies directly through life settlement providers. Instead of having to cover the cost of premiums themselves on an ongoing basis, investors can simply make one-off investments in fund shares and reap ongoing dividends. However, the potential returns for investors are also lower.