Traditionally, a life insurance policy is considered to have value only after you die. What if there was a way to purchase life insurance and then sell any or all of the coverage for a profit while still alive?
“Life settlements are a whole other market; it’s the other side of life insurance,” says Chris Christensen, president and CEO of Advanced Strategies Group.
Smart Business talked to Christensen about life settlements and how they can provide a source of income while the policyholder is still alive.
How does a life settlement work?
Let’s say a business owner bought $5 million in term insurance on his brother, who is also his business partner. The brother took out a similar policy on him and it was termed a buy-sell agreement so that if one of them died while still owning the business the survivor would have the liquidity to buy out the other one. Now they are 20 years older and don’t feel that they have the need for this life insurance. There may be value in that policy beyond what the cash surrender value is.
Some investors will buy that insurance policy from for a price and continue to make premiums on the policy and at death receive the proceeds.
How long have life settlements been around?
The life settlement market was created in the early 1980s to provide liquidity for AIDS patients. It was for folks who needed money to pay for their treatments and one of the only real assets that they had was a life insurance policy, which was worth nothing until they died.
In 2006, the secondary market for life insurance will be somewhere between $12 billion and $15 billion of death benefit. That’s a huge number. That’s because today it’s more prominent in the older-age marketplace with people around the prime age of 75.
How can you sell a policy for a profit?
There’s an arbitrage between the way life insurance companies price their product based on an actuarial life expectancy and the way an investor would view what it’s going to cost to keep that policy in force to life expectancy in order to make a profit.
I have an 80-year old female client who two years ago bought a $10 million life insurance policy from me for the sole purpose of reselling it 24 months later in the secondary market. It cost her $400,000 on that policy to keep it in force for 24 months and then we sold it for $2.1 million, netting her a $1.6 million profit.
Who invests in this market?
These investors are major financial institutions such as banks, international hedge funds and mutual funds. They are buying life insurance policies for their investors just as they would buy real estate, stocks and bonds or anything else that’s part of a balanced portfolio. They view life insurance as an asset, just like any other asset they acquire. And they know that one day that asset will pay off, so when they underwrite the policy they’re running a mortality study based on the client’s current health condition and gathering their medical records just like the life insurance companies do.
How do investors determine how much they’re willing to pay?
They look at life expectancy and probability of making a profit on a policy. Of course, they don’t have just one policy on one 80-year old but rather pools of hundreds of millions of dollars that they are investing on hundreds of thousands of lives.
Some of these people will live to be 100 and the investor will have to pay yearly premiums, thus losing money on the transaction. But others who are healthy at 80 may pass away at 84 or 85. Since the investors know the averages for life expectancy, they price the product by balancing out all the averages.
Can life settlements help in estate planning?
It can help if you have a policy that you no longer need or want. If you presented it to the secondary market you could get up to three times the cash surrender value.
Also, life settlements can be used to create wealth. If a client needs $5 million in insurance to pay their estate tax and are in the prime age range between 74 and 83, I suggest they buy two $5 million policies, keep them for the two-year contestability period, and then sell one of them for a profit.
CHRIS CHRISTIANSEN is president and CEO of Advanced Strategies Group. Reach him at (248) 359-2480 or [email protected].