Life settlement investments have become popular because of their attractive returns and disconnection from the stock market’s ups and downs. While they have many rewards, they also have potential risks you should consider before adding them to your portfolio. Here’s a closer look at these assets, why they’re attracting attention, and the pros and cons of life settlement investing.
LIFE SETTLEMENTS 101: HOW THEY WORK
A life settlement is when a person sells their life insurance policy to an investor instead of surrendering it to the insurer or letting it lapse. For many people, it’s a win-win; the policy owner gets cash to cover needed expenses now, and you eventually get to collect the full death benefit when the policyholder dies. Your profit will be the difference between the death benefit and the total costs you paid for the policy (purchase price + premiums paid).
REWARDS OF INVESTING IN LIFE SETTLEMENTS
Investors are taking notice of life settlement investment returns and their steady performance and portfolio diversification abilities. Here’s a look at life settlement risks and rewards.
Potential for Attractive Returns
Investors typically buy life insurance policies at a significant discount, such as 20% to 30% of their face value. This built-in profit margin provides for the potential of substantial returns when the insurer pays out the benefit.
Life settlements can also help create a diversified portfolio with more predictable cash flows because policies generally mature at different times.
Life Settlements Don’t Follow the Stock Market
Life settlement investments remain steady, unlike stock market investments that fluctuate with market conditions. That’s because life settlements are non- correlated alternative investments based on actuarial calculations.
For example, traditional investments were on a roller coaster ride during the Great Recession and the COVID-19 market disruption, while life settlement portfolios maintained stable valuations.
A Growing Market
Each day, 10,000 people in America turn 65, with older adults expected to represent 20% of the population by 2050. As people age, many find they can’t afford the premiums on a fixed retirement income or no longer need these policies to financially protect their family.
Rather than only receiving a small portion of the policy’s worth by surrendering it or losing everything by letting it lapse, a growing number of older adults are turning to third-party investors who can buy their policy. As the market expands, investors can more easily find policies suited to their portfolios.
RISKS OF INVESTING IN LIFE SETTLEMENTS
While this type of investing is on the rise, life settlement risks like lower-than- expected ROIs and high minimum investment amounts mean you should consider them carefully before jumping in.
Possibility for Lower Returns
The life expectancy risk in life settlements is always the elephant in the room. If the policyholder lives longer than initially projected, you’ll have to keep paying premiums, decreasing your returns when the policy matures. Artificial intelligence tools and other technology are making life expectancy estimates more accurate, but the results are still only estimates and not a given.
Low Liquidity
You can call your broker when you want to sell your stocks and bonds for cash, but you can’t do the same with life settlement investments. Life settlements aren’t traded on public exchanges, so there’s no readily available market. You’d have to find a private buyer, such as another investor or someone with a high net worth who is interested in this alternative investment strategy. The market for reselling policies may grow in the future, but for now, it’s limited. Because of this, life settlements should be considered a long-term investment.
High Financial Commitments
You might pay around $50,000 (20%) up front on a policy with a $250,000 death benefit. Then, you need to make sure you have the capital reserves to keep paying the policy’s premiums until the insured passes away. Letting the policy lapse would result in a complete loss of your investment.
HOW TO MITIGATE RISKS IN LIFE SETTLEMENT INVESTING
Diversification is one of the best ways to mitigate the risks of any investment. Owning interests in multiple policies across different ages, health profiles and insurance carriers spreads your risk effectively. Another way to spread risk is to have other asset classes, such as stocks, bonds and real estate, in your portfolio.
Working with experienced medical underwriters and professional life expectancy (LE) providers is also crucial in getting as accurate a life expectancy as possible for the policyholder. Along with mortality tables and actuarial calculations, you’ll have the best information to decide whether a particular policy will be a good investment.
IS LIFE SETTLEMENT INVESTING RIGHT FOR YOU?
Investing in life settlements might make sense if you:
- Are an accredited investor (typically at least $1 million net worth, not including your primary residence)
- Want to diversify your portfolio with uncorrelated assets
- See life settlements as a long-term investment
You may want to look at other types of investments if you:
- Think you’ll need quick access to your money
- Wouldn’t be left with enough capital to keep a diversified portfolio
- Don’t feel comfortable with the uncertainty of when you’ll get a payout
THE FUTURE OF LIFE SETTLEMENTS AS AN INVESTMENT CLASS
The life settlement market is growing exponentially, thanks to high returns and low volatility, but it’s a long-term commitment rewarding only those with the patience and capital to see the policy to maturity. For those who understand this and carefully select their investments, life settlements can be a valuable addition to a well-diversified portfolio.
Working with experienced partners like i2 Advisors can help you determine if life settlements deserve a place in your investment strategy. Speak to one of our professionals to discuss the best life settlement investment strategies for you.