Investors have found unique and interesting ways to grow their wealth through numerous investment vehicles. One of the more grotesque investment opportunities is known as life settlements. Not to be confused with Viatical Settlements (policyholders who have less than two years to live), life settlements apply to any individual who wants to sell their insurance policy. Effectively, investors are betting on an insured individual dying sooner rather than later after purchasing their life insurance policy. Purchasing an insurance policy comes with a set of benefits for the insured and purchaser, but the idea of life settlements as a whole is morbid.
Life settlements refer to the sale of life insurance policies to a third party investor to retain the death benefit of the insured. These types of investments are transacted for the purpose of giving the policyholder cash which is valued higher than the surrender value on their contract, but less than the value of their death benefit. In exchange, the investor who purchases the insurance policy reserves the rights to the death benefit when the insured individual dies. In order to maintain the death benefit however, the investor must keep up with the premium payments.
There are multiple reasons why a policyholder may look for an investor to purchase their policy, the most common reason is that the policyholder can no longer afford the premium payments. In some situations they can choose to let the policy lapse or find an investor willing to purchase the insurance. If the policy is not properly valued and the life expectancy of the policyholder is misleading, the investor faces the risk of losing money on their investment. This is where Life Settlement investments turn morbid.
Once the investor purchases the life insurance they take ownership of the policy. The death benefit is dependent on the original policyholder’s death. Therefore, the older the individual, the more valuable the policy. Additionally, the faster an investor can cash in the death benefit, the amount of premium payments they would have made in order to keep the policy alive are reduced. Since the death benefit is more valuable than the surrender value that was used to purchase the policy, it presents itself as a significant return.
Overall, Life Settlement investments are beneficial for the individual receiving the cash on their policy because they are receiving more than what they would have if they surrendered the policy. Granted, they and their beneficiaries lose the rights to the death benefit, but they are no longer required to pay a premium on a life insurance product. It is also beneficial for the agent who transacted the sale of the insurance policy due to high commissions.
On the other hand, it is not always a beneficial investment to make for an investor. If the life expectancy of the policyholder is not reported properly, an investor may be stuck making premium payments for a much longer period than expected. There have been some lawsuits to the effect that brokers were misrepresenting policies to get more people to invest. Another common problem is that hidden fees find their way into the cost of a Life Settlement investment in which a portion of the investment goes towards paying the agent’s commission and other processing fees. Therefore, a policy may be valued at $200,000, but the total investment may cost $275,000 to cover the agent’s commission and other fees associated with the purchase. In many cases, the investor does not know that the extra cost goes towards covering those items. Further, on top of the extra charges, when the investor receives the death benefit from the investment, the money is considered taxable income. Of course, there are ways around having the return taxed as income, such as holding the money in an IRA.
In the end, the risk versus reward of life settlements does not seem to weigh beneficially for the investor, so much as it does for the policyholder and the agent, or firm. Similar to investments in Merchant Cash Advances and Litigation Funding, the process lacks transparency. What’s worse is that investing in life settlements is placing a bet on when the policyholder will die. This increases the risk on the investment and is extremely morbid to say the least. If the policyholder lives longer than expected, the investor could potentially lose money depending on the death benefit payout. Ultimately, life settlements feel more like purchasing real estate that can be flipped once the policyholder dies rather than an investment where the principal grows with interest.