How to Invest in Life Settlements

Life settlements provide an alternative asset class that is largely uncorrelated with traditional markets, offering diversification and the potential for attractive returns. They can be particularly appealing to investors seeking steady, predictable payouts. However, investing in life settlements also carries risks, including regulatory challenges, life expectancy inaccuracies, and liquidity constraints.

This guide will cover the basics of life settlement investing, including how it works, its benefits, risks to consider, and steps to get started.

What Are Life Settlements?

Life settlements are an alternative investment that involves buying and selling life insurance policies on the secondary market. They differ from life insurance policies, which provide a lump sum payment to beneficiaries upon the insured individual's death. In a life settlement transaction, the original owner of a life insurance policy sells it to a third party for a one-off cash payment. 

The buyer pays the seller (also known as the policyholder or viator) higher than the insurance company's surrender value but lower than the policy's death benefit. The buyer becomes the new owner and beneficiary of the policy, paying the premiums until the insured person dies. The buyer then collects the death benefit from the insurance company. Life settlements are regulated by state laws in the U.S. and are subject to taxation.

Types of Life Settlement Funds

Investors can choose from different life settlement funds depending on their risk appetite, return expectations, and liquidity preferences. Discussed below are a few of them.

Lump Sum Payment Life Settlement

Investors in this common life settlement fund purchase one or more life insurance policies from sellers by paying a lump sum. They become the sole owner and beneficiary of these policies, paying all future premiums until maturity. Upon maturity, the investor receives all future death benefits.

This type of fund offers high potential returns but also involves high upfront costs, risk exposure, low liquidity, and long-term commitment.

Retained Death Benefit Life Settlement

Investors can purchase a portion of one or more life insurance policies from sellers in this type of life settlement fund. They share ownership and beneficiary rights with the sellers, paying a proportional share of future premiums until maturity. Investors receive a proportionate share of future death benefits when the policies mature.

This fund offers low upfront costs, less risk exposure, and a shorter-term commitment. However, investors have less control and ownership over policies and lower potential returns.

Viatical Life Settlement

Investors can purchase life insurance policies from terminally or chronically ill individuals with life expectancies of under two years. The investor becomes the sole owner and beneficiary of the policies, paying future premiums until maturity and receiving all future death benefits.

Returns can be high, but upfront costs, risk exposure, and liquidity are also high. Long-term commitment and special licensing may be required in some states and ethical concerns for some investors may arise.

Benefits of Investing in Life Settlements

Investing in life settlements can offer several benefits for investors seeking alternative ways to diversify their portfolios and enhance their returns. 

• High Potential Returns: Life settlements can offer higher returns than traditional fixed-income investments like bonds, CDs, or annuities. They're priced at a discount to the policy's face value, with returns based on the difference between purchase price and death benefit. 
• Low Correlation with Traditional Asset Classes: Life settlements offer stability and diversification to portfolios as they are based on the mortality risk of the insured, independent of market fluctuations. This weak correlation makes them immune to the stock and bond market and the economy, reducing overall volatility and risk.
• Steady Income Stream: Investors seeking steady income can turn to life settlements, which offer predictable and consistent payouts upon policy maturity. 
• Alternative to Other Fixed-income Investments: Life settlements can provide a more profitable and stable alternative to low-interest fixed-income investments. Unlike those investments, life settlements are not sensitive to interest rate fluctuations and can hedge against inflation. Death benefits remain fixed over time, ensuring their value doesn't diminish.

Risks Involved in Life Settlements

Investing in life settlements is not without risks and challenges. Investors need to be aware of this alternative asset class's potential pitfalls and drawbacks and how to mitigate them.

• Market Risk: Changes in market conditions and demand/supply factors can cause prices to rise or fall. A surplus of policies or a shortage of buyers can lead to price declines, while a scarcity of policies or high demand can increase prices.
• Longevity Risk: Investing in life settlements carries the risk of reduced returns and increased costs from insured individuals living longer than expected. This longevity risk can result in investors paying more premiums and waiting longer to receive death benefits.
• Due Diligence Risk: Life settlements carry due diligence risk, meaning investors may lose value due to incomplete or inaccurate information about policies or insured persons. Hidden clauses or exclusions, undisclosed medical conditions, or lifestyle habits that affect mortality risk can lead to unexpected outcomes.
• Regulatory Risk: Regulatory risk can impact the value of life settlements when laws or regulations affecting the industry change. For instance, stricter rules or increased taxes may lead to higher costs or lower returns for investors.

Steps to Invest in Life Settlements

If you are interested in investing in life settlements, follow these steps to help ensure a successful and profitable experience. 

Gain an Understanding of the Life Settlement Industry

Understand the industry's history and evolution, fund types and characteristics, benefits and risks, and legal and ethical aspects. Familiarize yourself with industry terminology and concepts such as face value, cash surrender value, and mortality rate. Read books, articles, reports, and blogs or attend seminars and courses. Consult experts when necessary.

Decide How You Want to Invest

Consider your investment objectives, risk tolerance, capital availability, and liquidity needs. Also, compare the pros and cons of different types of life settlement funds, such as lump sum payment, retained death benefit, and viatical life settlement funds.

There are different ways to invest in life settlements, such as:

• Direct Purchases of Life Insurance Policies: Buy life insurance policies directly from sellers to become the sole owner and beneficiary. Pay future premiums and collect death benefits. You may gain high potential returns but with upfront costs, risk exposure, and illiquidity.
• Direct Fractional Life Settlements: Invest in a fraction of life insurance policies alongside other investors. Share ownership and beneficiary rights while paying a proportionate share of future premiums and receiving a proportionate share of future death benefits. Enjoy lower upfront costs and risk exposure but expect lower potential returns.
• Life Settlement Private Equity Fund: Invest in a life insurance policy fund managed by professionals for diversification, liquidity, and a share of net profits. Pay a management and performance fee but expect lower returns and higher fees than direct investments.
• Life Settlement Exchange-traded fund (ETF): Invest in an ETF that tracks an index or basket of life insurance policies. Pay the provider a brokerage fee and expense ratio and receive dividends and capital gains. It provides easy access, low cost, and high liquidity but with lower returns and higher volatility than direct investments.

Select a Reliable Life Settlement Provider

When investing in life settlements, selecting a reliable provider is key. Providers act between sellers and buyers of life insurance policies and handle tasks such as sourcing policies, conducting due diligence, and distributing death benefits. Trustworthy providers have valid licenses, transparent pricing, and strong customer support.

Check the Life Insurance Settlement Association website for licensed providers in your state and review online ratings and reviews. Compare providers based on their experience, expertise, fees, and customer satisfaction to find one that suits your needs.

Evaluate Investment Opportunities and Assess Risk Factors

Investing in life settlements involves evaluating investment opportunities and assessing risk factors. To analyze policies, consider the face value and purchase price, premium payments, life expectancy of the insured person, and discount rate. Tools like life settlement calculators, brokers, and appraisers can help you make informed decisions.

Apply due diligence and critical thinking to assess market, longevity, due diligence, and regulatory risks. By thoroughly evaluating investment opportunities, you can determine their value, return potential, risk profile, and suitability for your portfolio.

Life Settlement Investments: High Returns, Low Risk

Life settlements offer high returns and low correlation with traditional investments but can be complex and risky. To invest wisely, gain an understanding of the industry and investing process, decide how to invest, select a reliable provider, and evaluate opportunities and risks. The steps discussed above will help you make informed and profitable decisions.

Frequently Asked Questions