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 investment if their policy lapses. 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 generally work in favor of life insurance policyholders by allowing them to recover the money which they invested in life insurance which they no longer need or want.
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. Policies may also have living benefits, meaning the insurance benefit can be collected when the insured person reaches a certain age or becomes terminally ill rather than after their death.
What investment options are available?
The life settlement market is primarily made up of U.S. life insurance policies, but Swiss investors can access this market in a number of ways:
1. Life settlement funds. A life settlement fund is an investment fund which invests in unwanted life insurance policies using capital pooled through the sale of fund shares to private investors. 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. There is no need for ongoing investment on the part of investors once they have purchased fund shares, so funds provide a passive means of investing in life settlements.
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; what share clases are offered; 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).
Only a handful of life settlement funds are listed on regulated stock exchanges. Because these are specialized funds, not all Swiss securities brokers list their stocks. Examples of life settlement funds traded by many Swiss brokers include Ress Life Investments A/S (DK0060315604) and Life Settlement Assets (GB00BF1Q4D29).
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 an investor must be able to meet all premium payments throughout the remainder of the insured person’s life. They also bear the risks posed by possible legal issues and longevity.
However, investors with the financial capacity to follow through on direct investments stand to gain significant returns as they can collect the full death benefits. Direct investment is also more secure in that investors own the actual insurance policies (rather than shares in a fund) and have a direct claim against insurance companies. While an insurance company may fail, this is less likely than a life settlement fund failing.
Understanding how the policy underlying a life settlement is structured is key. For example, some life insurance policies have fixed premiums, while the premiums of others increase – sometimes significantly – as the insured person ages. Being able to calculate the entire cost of premiums over the full investment term is crucial to determining whether you can afford a life settlement and whether it will deliver investment returns.
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 life settlement 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. The same consideration applies to life settlement pools as apply to life settlement funds.
What are the disadvantages of life settlements?
1. The risk of changes in legislation. 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. The ongoing controversy has led to numerous attempts at changing U.S. legislation surrounding the ownership rights of life insurance policies. Should new legislation be passed at some point, you as an investor bear the risk of losing your investment.
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 purchase and brokerage fees. More importantly, you need to be able to cover the ongoing payment of premiums until the insured person dies.
3. 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 at a profit. In this 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 pay fairly high brokerage fees for the service. As a general rule, life settlement brokers charge a fee equal to 6% of the policy’s 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. 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. 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.
6. Low liquidity. The tertiary market for life settlements is relatively small. If for some reason you want or need to exit your investment positions and recover your capital ahead of the death of the insured individual, you may find it difficult to find a willing buyer for the policy. If you are not completely sure that you can afford to service life insurance policies on your own indefinitely, investing through an open-end fund which guarantees the repurchase of your shares is a better way to invest in life settlements.
How can you minimize risk in life settlement investments?
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 profit or even losses (due to legal issues or extraordinary longevity, for example).
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