Introduction to Life Settlements

A "life settlement" is the investor purchase of a life insurance policy that typically covers a senior-citizen insured who is not suffering a life threatening condition. The acquisition is made by an individual or investment group who pays the policy owner a discounted percentage of the policy's death benefit. The purchaser then registers as the beneficiary of the policy with the issuing life insurance carrier and pays the requisite premiums to keep the policy in force. When the insured matures (dies), the purchaser receives the death benefit from the insurance company. Most life settlements investments are made by acquiring universal life insurance policies issued by major "rated" insurance carriers on United States citizens that are over the age of 75.

Seniors chose to sell their policies for a variety of reasons. Often the policy premium exceeds the insured's financial liquidity, or the insured has reached a stage in their life where they no longer need the coverage. Rather than lapse the policy (and receive nothing) or surrender it to the carrier (for a nominal sum) many insureds elect to sell their policies in the life settlements market.

The life settlement investment is based upon the presumption that the value of the policy (expressed in a discounted present value of the future death benefit payment) exceeds the purchase price plus the premiums scheduled to be paid. Given that the premiums are relatively certain, and the death benefit is usually fixed, a policy value can be calculated when the insured's life expectancy is estimated. Independent, professional life expectancy providers calculate the insured's remaining life span by using medical records, mortality tables and the insured's demographic, family history and personal information. Often multiple life expectancy providers' estimates are averaged, and a policy value can be calculated by using various industry software to determine the present value of the policy at a selected discount rate.

Only certain policies have a positive present value when market-driven discount rates are utilized. Simply stated, many policies are not a "good bet" for investors because the insureds are likely to continue living so long that required premium payments will lower the investor's anticipated investment rate of return ("IRR") below a minimum threshold. Investors target those select policies where both the insured's life expectancy is short enough, and the premium requirement is low enough, to achieve a high targeted IRR. IRR is augmented by paying only the minimum premiums required to keep a policy in force rather than "overpaying" the annual premiums as depicted in most carrier's desired premium schedules. By selecting choice policies and optimizing premiums, an investor can minimize the future outlay of principal.

By acquiring a portfolio of policies comprising many insureds of varying ages, insurance carriers and life expectancies, an investor can diversify risk and better achieve a targeted IRR. When an investor has a large diversified group of insureds, the law of large numbers dictates that the pool should begin to perform according to estimated mortality. If the pool is carefully crafted with accurate quantitative analysis, the investor should start to see incoming death benefit cash flow from maturities outpace the required premium payments - and the portfolio becomes cash flow positive in its early years.