To successfully evaluate an investment in a life settlement policy, you need to understand the difference between economic feasibility and the amount escrowed for future premium payments. Since this can be somewhat complicated, based on the flexible premium feature of universal life policies, a quick study of how this works can make the difference between a successful investment strategy and an uncertain, and possibly disastrous outcome. In these uncertain times, with investors even more cautious than ever, we, as trusted advisors, need to fully understand these concepts.

Life expectancy (LE) is a key feature of any life settlement investment, but it should not be the only basis for making your decision. In 2008, the Society of Actuaries Valuation Basic Table team updated the mortality tables to reflect the fact that seniors are living longer. Many life settlement investments that relied solely on the insured passing away by the projected LE, or shortly thereafter, were found to be "underwater" and unprofitable for the investor. When properly underwritten, this does not have to be the case. The answer lies in the premium illustration for each individual policy.

There is a tremendous risk of losing your investment if you rely solely on LE calculations when analyzing the economic viability of a life settlement policy. As you will see in the examples presented below, economic feasibility in a "stressed situation" (i.e.: when an insured lives beyond the projected LE) is vastly different than determining the amount of money escrowed to pay future premiums. When properly underwritten, a life settlement provider obtains a premium illustration that shows a level premium that will carry the policy far beyond the life expectancy of the insured (usually 15-20 years or to age 100). When a proper policy analysis is done, the economic feasibility is highly stressed (i.e. even if the insured lives a long time and premiums have to be paid the whole time, the purchaser still has a positive return).  

 

You should request and obtain this kind of illustration for each and every investment policy under consideration.  You can also run a Return on Investment (ROI) calculation to determine for yourself that the return on each such policy is still economically feasible well past the insured's LE. You must include the payment of premiums beyond the amount escrowed with the initial investment. A reputable life settlement provider will be able to supply you with an ROI calculator and policy illustrations. If these are not readily available - beware - your investment dollars may be headed for disaster.

 

Consider what would happen if you did an economic feasibility analysis showing level policy premiums for only the life expectancy plus 2 years. You would have substantially lower premium costs, so a life settlement provider could afford to pay more in commissions to agents, ignoring the precarious position that the purchasers have been placed in.  With life settlements, the problem is that if the insured were to live LE + 3 or more years, your initial premium calculations are completely off, the premiums go way up and the policy becomes economically unfeasible.  This is similar to the problems that arise with an adjustable rate mortgage or a "teaser rate".  It works, but only if you can get out of the property before the interest rates go up. If not, you're underwater.

 

So, when presented with a life settlement investment opportunity, the first question you must ask is not how much is placed in escrow to pay premiums, but how many years will the estimated level premiums carry the policy.  If the term for positive economic viability is only the life expectancy plus 2 years, your client is at substantial risk of losing their entire investment if the insured lives longer than the escrow.

 

Real-life Examples

 

 

 

With level premiums illustrated for 16 years and an LE and premium escrow period of 5 years, you can see that the policy is still profitable 11 years beyond the 5 year LE of the policy, including payment of premiums throughout this time.

 

With level premiums only illustrated and escrowed for 7 years (5 year LE + 2 additional years), you can see that this policy becomes unprofitable after 7 years, and puts the purchaser's principal at risk immediately after the initial escrow period.

 

Since no one can predict life expectancy with 100% accuracy, you must have a policy with level premiums illustrated for many years past the LE. A reputable life settlement provider will be able to supply you with this mandatory information before you commit your client's funds.

 

Other Important Considerations

 

In the unfortunate age of Madoff and Stanford, you cannot be too careful about who you do business with. The following is a short review of "must-have traits" for your life settlement investment provider.

 

Valid Policy Illustrations

As shown above, the number of years that premiums will carry a policy in a profitable situation is much more important than simply the number of years escrowed.

 

Investment Funds in Escrow

Make sure that your client's investment dollars are being placed in a true escrow account. How can you tell? Funds placed in a true escrow account can only be withdrawn at the time a life insurance policy is actually closed and transferred into the purchaser's name(s). This happens at a "policy closing" conducted by a qualified escrow agent when 100% of the policy is transferred to the new owners and all details of the transaction are overseen by the escrow agent. Beware of a "progressive policy closing" where bits and pieces of a policy are transferred to purchasers over time. The ability to "over-sell" a policy is present in this case. How would you know if more than 100% of a policy was being sold?

 

Policies must be underwritten first-hand

Any reputable provider of life settlement investments will analyze and qualify each and every policy that they make available to investors. If they don't, how would you know who performed the initial policy analysis and what their criteria were? A quality provider will always do their own extensive underwriting of each policy they offer. As seen above in the economic feasibility discussion, if a current level policy illustration is not an integral part of the initial purchase decision, a disastrous outcome could occur, including loss of profit and principal.

 

Regulatory Credibility

Has the provider's business model been tested and upheld in state and federal courts. If not, they may be shut down at a moments notice for regulatory violations.

 

Actual Asset Purchased

Is the asset a discrete ownership interest in a life insurance policy, or is it a note issued to the company so they can buy life insurance policies with your money? Discrete fractional ownership is essential!

 

Complete Transparency of operations and financials

A publicly traded company will offer you the highest degree of transparency. If not publicly traded, what audited financials are available? How many years have they achieved their reported results? How much money does the provider have in the bank to sustain their operations?

 

Reasonable Commissions

As any fraud investigator will tell you, a classic characteristic of fraudulent schemes is the payment of substantially higher commissions than industry standards. Make sure you are not being enticed into a fraudulent investment scheme by high commissions.

 

In Conclusion

Life settlement investments offer a valid portfolio diversifier for many qualified investors. As with any investment or asset, there are right and wrong ways to do the deal. One needs to look past the obvious and ask the hard questions before recommending this investment to your clients. If you ask for detailed answers from your life settlement investment provider to the issued posed above, and insist on facts to back up their claims, you will find that this asset class may be an important addition to many investor's portfolios and a new source of income for you.

 

Many life settlement investors have enjoyed the predictable rewards that this non-correlated asset class offers. If you ask the right questions and do an in depth and thorough review, you will find that there are reputable companies that can truly make this a prudent investment instead of a risky proposition.

 

 

Curtis M. Cole is the founder and president of New Asset Advisors, LLC in Dallas, Texas and an expert in the field of life settlement investments. New Asset Advisors, LLC is committed to the education of agents, brokers and consumers of life settlement investments. He can be reached for comment or questions at 877-319-3999 - curtis@new-asset.com - http://www.newassetadvisors.com.  This article is for educational purposes only and should not be misconstrued as an offer to purchase life settlements. Life settlement investments are not available in all states.