Life Settlement Investment – Scam or Legit? A friend of mine sent me an interesting “investment opportunity” today which entailed what seemed to be some sort of sales pitch, wining and dining with an investment advisor who has access to life settlement products. What was purported in the PDF invite letter immediately raised a red flag for me. He promised “guaranteed 7% returns or more with no risk of loss“.
No Risk of Loss?
To me, no risk of loss means one of two things. Either an FDIC insured account under the present limit of $250,000 or a US government issued bond. Ironically, even the latter is being questioned by a substantial portion of Americans these days. But let’s face it, the government can always issue more debt, so at least in terms of our US fiat currency system, Treasuries should be considered “safe”, hence they are usually used as a benchmark as a “risk-free rate of return”. Nonetheless, what I wanted to point out was that given your best Savings Rates, CD Rates [listings of best available in your area] and long-duration Treasury yields, you can’t even get 4%. So, how could someone offer a 7% yield risk-free?
That was red flag number 1.
Ever since the market crash in 2008-2009, something that financial advisors and marketers have latched onto is the mantra like “Why gamble in the stock market?”, “Stocks have gone nowhere in 10 years!” and basically use the prior decade’s lackluster market performance to induce fear and push you into alternative investments. Sometimes, these alternative investments benefit them and not you given their commissions earned. You take the risk, they take home the commissions. Nice arrangement – for them.
What is a Life Settlement?
Basically, let’s start with an individual policy. You’ve got a guy who has some terminal illness. He’s burned through all his cash and his doctor assures him he only has a year to live. He has a $1Million insurance policy that is tantalizingly attractive and cash-rich but he can’t touch it until he dies. OK, then he can’t touch it either – but his heirs can. Well, in comes the “financial innovation”. An investor can come in and offer this poor lad $500,000 for his policy so he can remain in his home, pay for his medical bills and have some semblance of dignity in his final months rather than dying a vagrant as he depletes his assets and loses his home. In this scenario where there’s no alternative, selling his life insurance policy may well be a better option than just waiting around do die. Surely, his heirs lose out, but is that really priority #1 to make your kids rich when you die?
Now, that first example sounds rather morbid and one might wonder if investors are “profiting from death”. Another common scenario though is a simple case where a person just wants the money or perhaps can’t afford to pay the premiums anymore. Rather than letting the policy lapse and get nothing, they figure, they’ll sell it for cash now. The investors continue to pay the premiums to keep the policy going and the seller gets up-front cash. Of course, there’s a profit in there for the investors, but isn’t that only reasonable given the risk they’re taking?
So, you can see where this vehicle has some value to people on either side of the equation. What’s a little more murky is the tangential issues, which we’ll get to.
Why Invest in Life Settlements?
As an investor seeking the benefits of diversification, a high investment return, non-market correlated returns and simple portfolio diversification, at face value, this “investment” seems like a winner. After all, if all pans out as planned, it’s the equivalent of a 7% or higher CD. Sure, your money’s locked up for some period of time, but where else can you earn 7% without any volatility? To further blunt risk of individual policy expectations not being met, firms securitize (remember that word from the mortgage mess?) many policies into a single fund and then allow investors entrance to the fund through shares or a transaction similar in nature. These days, many pension plans are modeled to return about 7% per year while trying to minimize volatility. If high-paid pension plan managers are satisfied with 7% returns, shouldn’t you be as an individual investor? If things worked out that way, sounds like a decent investment.
How to Invest in Life Settlements
Apparently, the market is pretty robust these days. Once relegated to life insurance companies, hedge funds and pension fund managers, now retail investors are being enticed with the prospect of high yields and low volatility. While I haven’t gone to see the financial professional advertising the life settlement investments, I checked in with a friend of mine who’s a CPA, Financial Advisor, etc. He said the premium over risk-free rates IS warranted and real because it’s a rather illiquid market and your money is tied up for a while. Of course, scams could abound, so it would behoove you to know and trust the entity selling the policies. In my case, I don’t know this guy at all so I’d need to research further before taking it seriously.
Where Can Life Settlement Fraud Occur?
Everywhere. That’s what gives me pause. Here are a few examples of where things could go south and as an investor, you don’t get nearly the return you anticipated:
- The fund doesn’t actually use your money to buy the life insurance policies, but just spends it on something else – like their own salaries, real estate or some other asset
- The insured end up living longer than anticipated. This happened a few decades ago when the industry relied on AIDS patients for income and rather than dying on the projected timeline, those darned pharmaceutical companies developed life-saving drugs that extended their lives, so many of those AIDS patients have now even outlived the initial investors themselves! Talk about poetic justice? So, in this vein, as medical advances continue, life expectancy in your pool may increase beyond the actuarial assumptions.Congress could eventually act to start taxing these premiums as income instead of treating them as non-taxable payouts to beneficiaries (since let’s face it, these are investments).
- The investment fund could end up being a Ponzi scheme. There are dozens of articles out there over the years highlighting those situations.
- The seller of the initial policies may have overemphasized the health risk of the insured, thus boosting the “assumed yield” with predictions of a near-term death, while they end up expiring much later.
If you put aside the notion that this is a rather morbid way to make money at face value – there are benefits and risks. I could envision some unexpected scenarios where I might end up either in court or out of luck altogether in trying to recover the returns I was initially promised. However, since I have virtually all my investable net worth tied up in equities globally, I could use some diversification and the prospect of a non-correlated 7% return is very appealling.
I’m not sure if I’ll pursue this opportunity any further, but as usual, about once a day, some new financial topic pops into my head or enters my personal life and I feel compelled to write about it. So, there you have it. Life Settlements.
Would You Invest in Life Settlements?
{ 19 comments… read them below or add one }
My gut reaction is that any company ghoulish enough to be active in this market might also be prone to taking the principal and profits and “investing” it in yacths and retreats in the Bahamas.
I view it as just making a market for one of the many things in life where no market previously existed. So, for some guy with a million dollar policy who has cancer and needs the money now, you wouldn’t view this as a valuable option to be able to derive income now while alive?
No problem at all with free markets. Just of the opinion that this particular market would draw the kind of characters that are prone to misappropriation of funds. Much like a used car dealership or high-end furniture store draws salespeople with a preference for slick suits and slick talk. Caveat emptor.
I’m with 101C although there are crooks everywhere in general.
I’m not sure why anyone thinks companies involved in this would be any more prone to fraud or frivolous spending than any other financial service. Like brokers, realtors, etc.
I am not worried about the scam part as much as I would be about lobbying against these companies. The life insurance industry hates these set ups (Google: STOLI – stranger owned life insurance) and see how much lobbying there is against them.
One piece of legislation can crash the entire industry.
Other than that I am with you Darwin (as I often agree) there is a market and turns an illiquid asset/product – into a liquid commodity.
I’ve heard about the whole STOLI thing. Also about companies buying insurance policies on their individual employees where the employer is the beneficiary – without the employee’s knowledge. Kind of sounds slimy but it is what it is.
I’ve heard about the whole STOLI thing. Also about companies buying insurance policies on their individual employees where the employer is the beneficiary – without the employee’s knowledge. Kind of sounds slimy but it is what it is. Good article.
Run away! Run away from these investments. Between the wife and I we have 14 policies after 4 years.
We are starting to pay policy premiums already this year. With no one passing away yet.
I calculated by the end of next year we will be paying ~$10K in premiums.
The medical credentials of the individual evaluating these policies was to liberal and now we are stuck.
So RUN AWAY from these fast.
M Cooper, are you still paying and not receiving anything in return?
5/23/2012
Cooper-
You made the mistake of buying individual policies rather than shares of a life settlement fund. Had you done so you might now own participation in a hundred or more policies for diversification purposes rather than the 14 you are now stuck with in your portfolio. Further, you would have a fund manager, preferably one who co-invests with you, to do the extensive due diligence on life expectancies of each policy thus ensuring the policies are properly valued. A professional life settlement fund manager’s due diligence will also avoid purchasing STOLIs (stranger owned life insurance) and those purchased with premium finance. Both practices (STOLI and premium finance) range from improper to illegal depending on the various state laws. The fund, if properly managed, would also hold sufficient cash to pay policy premiums up to and slightly beyond actuarially determined life expectancy.
Life settlement, done the right way, according to industry best practices is a great investment. More and more institutional pension funds are enjoying consistent double-digit returns from this emerging asset class.
The truth is that only huge bankers were involved in this type of activity over 20 years ago! They wanted to keep it a secret from other little investors so they would not have any competition! The ROI on these investments is huge because it is legal and safe to invest in Life Settlement Policies! Not only that but the investors are helping decrrease the 88% default on premimums to the Life Insurance. So what if somebody makes allot of money on this train and buys a yacht and lives in the Carribiean like me, I was just a smart investor! Lesson 101 invest smart and enjoy the ROI !
I have a number of these also. M Cooper, have you done the math? I could pay the premiums on these for six years longer than the life estimates and still beat bank rates and annuity rates. None of them are STOLI policies. Basically I have a contract with a highly rated major insurance company for a specific payout. I know exactly what I put up and exactly what I’ll get paid. It may take a while to get paid, but that’s ok. I figure even after paying in addittional premiums if the insured individuals beat the odds and live a long time, I will still come out alright. To actually lose 10% on my principal, all of these people would have to live to be about 105 to 107 years old.
Hey I just had to use my “Key Man” life insurance product and collateral for my bank to consolidate my business loans and acquire a new line of credit. Isn’t the bank doing somewhat of the same thing. If I die they want to get theirs first! In this new economy the people with a large net worth that they want to protect would look at this opportunity for diversity and that protection.
Doesn’t any fund have the capability to just take your money and not invest it in the way they represented? Bernie Madoff did that and he owned an equity fund. Life settlement funds are actually less prone to fraud in its most modern form because of the stringent regulations imposed on the industry. Currently over 40 states regulate the industry.
In response to your second argument, analyzing risk is a part of business. Nothing ventured, nothing gained. The difference is that an effective Life Settlement manager will take steps to hedge those risks.
Your third point is the same as your first.
Now about the “Ghoulishness” of the industry… There may be a bit of morbidity, but 80% of life insurance policies end in lapsing. Life settlements are an alternative to this. No one is making an individual settle a policy, but the life settlement industry provides an alternative. There are multiple reasons that a policy owner may want to settle a policy, but most importantly, it allows policy owners to monetize an asset they have been paying into for years. There is a lot of value in this industry. Pension funds perform better when individuals die early, but it is hard to argue against the value of a pension system.
What a great idea! I mean, it’s wonderful on all fronts. Profits from the early death of people that can help us create the next bubble and give a boost to our financial titans. What could be wrong with any of that? What could possibly go wrong with this scheme?
It’s like a casino run by ghouls. There is absolutely no value added to anything by this nutty plan, that reads like a parody of gilded-age Wall Street. Read Paul Krugman’s article on the blind arrogance and willful stupidity of economists, contributing factors to the recession, and contrast it to the foolish ideas expressed by the financial geniuses that want to securitize death.
The value added to this “nutty plan” is that it gives people an alternative to cashing in unneeded, unwanted policies. Life settlement will almost always pay them more than the insurance company’s cash surrender value.
A few stats from the life insurance industry* might be helpful:
– $10.5 Trillion individually owned life insurance in U.S.
– Annual lapse and surrender rate of 7.2%
That’s over $750 billion in face value each year……a windfall for the insurance companies. Life settlement takes a portion of that windfall from the insurance companies and puts it into the pockets of policy sellers and investors.
*Statistics from American Council of Life Insurers Fact Book 2011 (ACLI)
Obviously, the integrity of the company is a major factor in all investments. People have creatively been ripped off by FDIC insured banks since the inception of FDIC. But, if you really give this some serious thought (and given that the currently regulation regarding life insurance product do not change dramatically), life settlements make a lot of sense. Those who think that the issue of death somehow makes this a “morbid” subject are most likely those who are living outside of reality. What makes this any less reasonable than investing in State lottery systems or gambling? Dignity and death planning are a part of life and these settlement products do have a real growing market (in a world full of financial turmoil) and can serve an important purpose.
To comment further on the morbidity issue, is it really any different than buying stock in an insurance company that sells annuities? The sooner you die the less the company pays out. So the insurance company actually wants you to die in that case. As long as they don’t do anything to expedite that process there’s absolutely nothing wrong with it. The fact is that most policies are sold by healthy, well-to-do individuals who have simply outgrown their need for the policy. Life settlement offers them an alternative to cashing in to the insurance company and gives them a greater payout.
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