Passive investment is typically associated with securities. The vast majority of investment products, be they ETFs and other investment funds, CFDs, options or futures, are in some way based on stocks, bonds or certificates. Alternatives to securities have typically included commodities and currency – with cryptocurrency more recently joining the fold. All of these investments are subject to volatility in capital markets.
Life settlements are a very different kind of investment vehicle because capital is invested in life insurance policies rather than in capital markets. Rather than being denominated by supply and demand, which is volatile, life settlement investments are denominated by human life expectancy, which is relatively predictable.
What is a life settlement?
A life settlement is the purchase of an unwanted life insurance policy by a third party. In the United States and some other jurisdictions, certain categories of life insurance policies are legally classified as movable private property. As such, policyholders are free to sell their life insurance policies to willing buyers if they so choose. The insured person remains unchanged, but the new owner of the policy accepts responsibility for the payment of premiums and obtains the right to claim the death benefit when the insured person dies. This is not possible with Swiss life insurance policies, which can only be surrendered to the issuing insurance company and cannot be sold to third parties.
There are many reasons why life insurance policyholders my want to convert their life insurance policies into cash. The purpose for their taking out life insurance (protecting a spouse, children, business or mortgage financially, for example) may no longer exist. They may want money to finance other interests, to invest, or to pay bills, pay off debts or a mortgage, or finance their retirement. Some policyholders reach a point at which they can no longer afford to meet premium payments, and risk losing their full investment if their policy lapses. Typically, policyholders are individuals who have reached legal retirement age.
Policyholders can normally surrender their policy to the insurance company in exchange for its cash value, but in doing this they forfeit the insurance benefit – and therefore lose a large portion of the money which they paid in premiums. Life settlements allow policyholders to recover a larger share of their life insurance investment because investors are willing to pay prices well above the cash value of policies in order to claim the high death benefits. In this way, life settlements often work in favor of life insurance policyholders.
Example: An investor purchases an unwanted life insurance policy with a face value of 50,000 Swiss francs from a policyholder for 100,000 francs – 50,000 francs more than the insured person would have received had they surrendered their policy. The policy has a face value equal to 500,000 francs which will be paid out as a death benefit by the insurance company when the insured person dies. In this example, the investor pays brokerage fees equal to 6% of the policy’s face value – or 30,000 francs – to the broker which connects them to the policyholder. The investor invests another 100,000 francs in premiums over the course of the insured person’s life. When the insured person dies, the investor claims the death benefit of 500,000 francs, recovering their 230,000-franc investment and making a tidy profit.
What factors affect the value of life insurance policies as investments?
Life expectancy of policyholders is the single biggest factor in determining how much a life insurance policy is worth as a life settlement investment. Specialized actuaries known as life expectancy providers estimate the potential lifespan of insured individuals based on their lifestyle, health condition, age and other factors and valuate life insurance policies accordingly. As a general rule, the lower the policyholder’s life expectancy, the more they can charge for their policy because investors can expect to invest less in premiums.
The longer the insured person remains alive after the policy is purchased by an investor, the more the investor must pay in premiums. The shorter the time between the point at which the policy is purchased by the investor and the death of the insured person, the lower the premium cost and the higher the return on the investment. The longer the time between the policy purchase and the death of the insured person, the higher the premium cost and the lower the return on the investment.
The type of life insurance in question and the terms and conditions of policies also directly affect the value of policies. Many different forms of life insurance are offered in the United States, including many varieties of term life insurance (standard term life, convertible term life, renewable term life) and multiple whole life insurance models (standard whole life, universal life, variable life). Policies may also have living benefits, meaning the insurance benefit can be collected when the insured person reaches a certain age rather than upon their death.
What investment options are available?
Life settlements can be invested in directly through the purchase of life insurance policies from policyholders. This is normally accomplished through specialized life settlement brokers which connect investors with policyholders who are looking to sell their life insurance.
Although the life settlement market is primarily made up of U.S. life insurance policies, a number of life settlement investment avenues are open to Swiss investors including:
1. Life settlement funds. These are the life settlement products which are most widely offered in Switzerland. A life settlement fund is an investment fund which invests capital pooled through the sale of fund shares to private investors into buying and servicing unwanted life insurance policies. Because life settlement investments require ongoing premium payments, life settlement funds typically withhold a portion of collected death benefits for this purpose. Surpluses are distributed to shareholders in the way of dividends. The largest life settlement funds are not domiciled in Switzerland, but Swiss investors can purchase shares in these funds through securities brokers.
Investing in life settlement funds requires less active involvement than investing directly in life insurance policies because screening, purchasing and management of policies and filing of insurance claims are all handled by the fund. It also allows for risk mitigation because risk is distributed across numerous policies (viable funds should hold thousands of individual policies). Funds pay out dividends on an ongoing basis. A direct investment, on the other hand, ends when a policy’s death benefit is paid out. However, you pay administrative fees in the way of the total expense ratio (TER) and possible front end loads and back end loads. You also have to hold your fund shares in a custody account, which may generate custodial fees. When you invest in funds, you receive relatively low, ongoing dividends rather than major windfalls (as is the case when you own and claim on policies yourself). It is important to note that when you invest in a fund, you do not own life insurance policies. You simply own fund shares which may increase in value if the fund grows and consistently pays out high dividends – but may also become worthless if the fund fails.
2. Direct life settlement investments. A number of life settlement brokers operate in Switzerland. These cater to experienced investors who want to purchase life insurance policies directly from U.S. life settlement providers. Direct investment typically requires larger amounts of capital and more active involvement than investing through life settlement funds. This is especially true if you plan to diversify your investment across multiple life insurance policies to balance risk. Investing this way requires higher risk capacity, as investors must be able to meet premium payments throughout the life of the insured person or risk losing their investment. They also bear the risks posed by possible legal issues and longevity. However, investors with the financial capacity to follow through on direct investments can collect the death benefits in full.
3. Life settlement pools. A life settlement pool, like a life settlement fund, holds numerous life insurance policies. Investors buy shares in these pools and earn returns in relation to their investment. An advantage of investment pools is that risk is spread across multiple policies (a viable pool should hold hundreds of policies). Another advantage is that investors can buy into pools even if they do not have enough investment capital to purchase life insurance policies directly through brokers.
What are the disadvantages of investing in life settlements?
1. Controversy. The fact that investors have a financial interest in the death of the insured person has made life settlements the subject of some controversy. In the past, viatical settlements made up a large share of life settlement investments and this fueled the controversy surrounding this type of investment. Today, sellers of life insurance policies are largely retired individuals who no longer need life insurance and many life settlement products (like life settlement funds) are structured in a way which prevents investors from accessing personal information about the insured individuals. This prevents conflicts of interest between insured individuals and the investors who buy their policies.
2. High investment capital requirements. Typically, a fairly large amount of capital is required at the onset of the investment. Life settlement funds often have high minimum investment requirements for participation (50,000 Swiss francs, for example). If you plan to invest in life settlements directly through brokers, you will need a large amount of capital for the initial investment in the purchase of life insurance policies and brokerage fees. Additionally, a large amount of capital must be available on a long-term basis for the payment of premiums.
3. Possible legal issues. There are instances in which life insurance policies covering individuals are created by third parties without the direct consent or knowledge of the individuals involved (stranger-originated life insurance) for the purpose of collecting death benefits. There are also instances in which the insured persons legal heirs may dispute the sale of policies or investors’ claims to death benefits (on the claim that a policyholder was incapable of good judgment at the time of the sale, for example). Another possible issue arises when individuals take out life insurance for the deliberate purpose of selling their policies to investors, in which case insurance companies may dispute claims under certain circumstances. In order to avoid these risks, it is important that life settlements are originated and managed completely legally by reputable life settlement service providers and that capital is invested in multiple policies.
4. Brokerage fees. If you plan to invest directly rather than through an investment fund, working with reputable life settlement brokers is a must. Good brokers will have all policyholders and policies screened by actuaries before making them available to investors, minimizing the risk of complications and ensuring that policyholders get their money and investors get the policies they pay for. But you have to be ready to pay fairly high brokerage fees for the service. As a general rule, life settlement brokers charge a fee equal to 6% of the policies face value. If a policy has a face value of 1 million Swiss francs, for example, investors can expect to pay a brokerage fee of 60,000 francs for the transaction.
5. Risk of longevity. Most of us want our fellow human beings to live and enjoy life for as long as possible. However, from a life settlement investment perspective, longevity is a normally a negative. For example, if an insured person lives 3 times longer than anticipated, the investor will have to invest 3 times more in premiums than anticipated. Having to cover life insurance premiums over an extended period can completely neutralize a life settlement investment. However, it is also important to balance the initial cost of life settlements with ongoing premium costs. Policies covering individuals with high life expectancy can generally be purchased at lower prices than policies belonging to individuals with low life expectancy. The lower initial cost may balance the higher ongoing premium costs. Because there is no way of accurately predicting life expectancy, you should always account for the maximum possible number of premium payments in addition to the initial investment and brokerage costs.
6. Low liquidity. The tertiary market for life settlements is still relatively small, which means that if for some reason you want or need to exit your investment positions and recover your investments ahead of the deaths of the insured individuals, you may find it difficult to find a willing buyer.
7. Taxes. Life insurance benefits are not normally counted as taxable income in Switzerland. However, dividends earned on shares in life settlement funds or life settlement pools must be declared as taxable income.
How can you minimize risk in life settlement investment?
As with all other forms of investment, diversification is key to mitigating risk in life settlements. It goes without saying that life settlements should make up only a small part of a balanced investment portfolio. Ideally, capital invested in life settlements should be divided between hundreds or even thousands of life insurance policies – as is the case with large life settlement funds. This way, returns on profitable life settlements balance losses on those which make little or no profit, or even losses (due to legal issues or extraordinary longevity, for example).
If you plan to invest through a life settlement fund, make sure you understand: where the fund is domiciled and regulated; what rights you hold as a shareholder residing in Switzerland; the TER and all additional, incidental fees and charges; whether it is an open-end fund or a closed-end fund; which life settlement provider or broker sources unwanted life insurance policies on behalf of the fund; what actuary handles the screening of life insurance policies on behalf of the fund; whether the fund is sustainable in that measures are in place which allow it to bridge shortfalls in liquidity (should average longevity increase, for example); whether the fund uses realistic calculations in estimating the longevity of insured individuals, and corresponding returns on investments; whether the fund pays out commissions to consultants for onboarding investors and how high these commissions are; how high dividends have been and how the fund has performed in past years (though this is no guarantee of future performance and figures are subject to inflation by fund managers). Reputable funds should list all fees transparently or provide detailed breakdowns upon request. They should also clearly state how potential conflicts of interest are managed (when actuaries are employed by the fund, for example).
In the case of direct investment in life settlements, if an investor does not have enough capital to continue to invest in premiums until the death of the insured person, the policy will lapse and the investor will lose their full investment. As a general rule, you should have enough capital to cover the maximum possible premium costs over the longest foreseeable lifespan. For example, if a policyholder’s estimated life expectancy is 75 years old, you should ideally be able to afford to pay premiums until the person is 90 years old, as there is a chance that they will live to that age.
Avoid consultants and investment advisors who try to sell you on life settlement investment products. They are likely receiving commissions for their sales efforts. Paying a consultation fee to get advice from an independent investment consultant who specializes in life settlements and can recommend products which suit your financial situation and risk tolerance is generally a better choice.
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