Life settlement
Encyclopedia
A life settlement is a financial transaction in which the owner of a life insurance policy
sells an unneeded policy to a third party for more than its cash value and less than its face value. Until recently, if a policyowner opted out of a policy by surrendering the policy or allowing it to lapse, the additional value was relinquished back to the issuing life insurance company. In some cases, an insured’s health may have declined since the policy was issued and the policy may be worth considerably more than the surrender value. A life settlement is an alternative to this surrender or lapse of a policy, or when the owner of a life insurance policy no longer needs or wants the policy, the policy is underperforming or can no longer afford to pay the premiums.
. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to third parties.
While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after commissions, and more.
Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a broker will benefit the client. In many states, brokers must be licensed to do business in that state.
In regulated states there are material regulations as to procedure, privacy, licensing, disclosure and reporting which must be met and which in some cases carry criminal penalties.
LEPs are typically made up of actuaries and medical underwriters who utilize actuarial models based on published or proprietary mortality (life) tables and medical underwriting based on various debits/credits for various morbidity characteristics similar to the medical underwriting performed by life insurance company underwriters and reinsurance underwriters. Until recently, the most commonly used mortality table was the 2001 Valuation Basic Table (VBT) published by the Society of Actuaries based on data supplied by contributing life insurance carriers. In 2008, the Society of Actuaries published a new table, the 2008 VBT, that is based on 695,000 lives representing $7.4 Trillion in death benefits which is almost 3 times more lives than the former 2001 VBT. Included with 2008 VBT are relative risk tables (RR Tables) that separate insured lives into various underwriting categories based on the health/morbidity of the insured at the time the policy was issued. Note that no impaired lives are included in any of the RR tables, but rather were designed for companies that subdivide their standard policies into more than one sub-class. Most LEPs have factored in the experience data underlying the 2008 VBT, as well as their own experience data and other factors, as a basis for their mortality tables. This resulted in a significant lengthening of average LEs in the fourth quarter of 2008 for some LEPs. All major LEPs have continued the practice of developing and using proprietary and confidential mortality tables based on extensive medical research and mortality experience. One new LEP has adopted the use of the 2008 VBT RR Tables as a replacement for proprietary multipliers, despite the fact that Relative Risk Factors are in their infancy and not designed for impaired life nor life settlement underwriting.
The Policy as Transferable Property
The Supreme Court case of Grigsby v. Russell (1911) established the policyowner’s right to transfer an insurance policy. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policyowner could transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policyowner.
This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Viatical Settlements Model Act defining guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policyowners who no longer needed a given policy. Strong demand for life settlements policies is driving a rapid market expansion that continues today.
Another study by Conning & Co. Research, "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements.
A life insurance industry sponsored study by Deloitte Consulting and the University of Connecticut came to negative conclusions regarding the life settlement market.
http://www.quatloos.com/uconn_deloitte_life_settlements.pdf
is used.
sells an unneeded policy to a third party for more than its cash value and less than its face value. Until recently, if a policyowner opted out of a policy by surrendering the policy or allowing it to lapse, the additional value was relinquished back to the issuing life insurance company. In some cases, an insured’s health may have declined since the policy was issued and the policy may be worth considerably more than the surrender value. A life settlement is an alternative to this surrender or lapse of a policy, or when the owner of a life insurance policy no longer needs or wants the policy, the policy is underperforming or can no longer afford to pay the premiums.
Providers
Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the client a cash sum greater than the policy's cash surrender valueCash surrender value
The sum of money an insurance company will pay to the policyholder or annuity holder in the event his or her policy is voluntarily terminated before its maturity or the insured event occurs. This cash value is the savings component of most permanent life insurance policies, particularly whole life...
. The top providers in the industry fund many transactions each year and hold the seller's policy as a confidential portfolio asset. They are experienced in the analysis and valuation of large-face-amount policies and work directly with advisors to develop transactions that are customized to a client's particular situation. They have in-house compliance departments to carefully review transactions and, most importantly, they are backed by institutional funds.
Life Settlement providers must be licensed in the state where the policy owner resides. Approximately 41 states have regulations in place regarding the sale of life insurance policies to third parties.
Brokers
Financial advisors who choose not to submit cases directly to a settlement provider may opt to work through a life settlement broker. Life settlement brokers are intermediaries who bring together policyowners who wish to sell a policy and providers seeking to purchase them. Brokers, in exchange for a fee, will shop a policy to multiple providers, much as a real estate broker solicits multiple offers for one’s home. Not all buyers are alike and a life settlement broker will help ensure that cases are sold to reputable buyers who are likely to close without significant difficulties. It is unlikely a financial advisor will achieve the highest possible price without going through an experienced life settlement broker.While it is the broker's duty to collect bids, it is still incumbent on the advisor to help the client evaluate the offers against a number of criteria including offer price, stability of funding, privacy provisions, net yield after commissions, and more.
Compensation arrangements vary significantly and should be fully disclosed and understood to determine if engaging a broker will benefit the client. In many states, brokers must be licensed to do business in that state.
In regulated states there are material regulations as to procedure, privacy, licensing, disclosure and reporting which must be met and which in some cases carry criminal penalties.
Investors
Life settlement investors are known as financing entities because they are providing the capital or financing for life settlement transactions (the purchase of a life insurance policy). Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures. The life settlement provider is the entity that enters into the transaction with the policyowner and pays the policyowner when the life settlement transaction closes. In most cases, the life settlement provider has a written agreement with the life settlement investor to provide the life settlement provider with the funds needed to acquire the policy. In this scenario, the life settlement investor is effectively the ultimate funder of the secondary market transaction. However, in some life settlement transactions, the life settlement provider is also the investor; the provider uses its own capital to purchase the policy for its own portfolio.Life Expectancy Providers
Life Expectancy Providers (LEPs) are specialized independent companies that issue life expectancy reports (LERs) that estimate the life expectancy (LE) of an individual (typically the insured individual on whose life a life insurance policy involved in a life settlement is based). Life expectancies are not a prediction of how long an individual will live, but rather are the average survival time amongst a particular risk cohort. Risk cohorts are typically grouped by age, gender, smoking, and relative health/morbidity. LE is a key component in the pricing of a life settlement.LEPs are typically made up of actuaries and medical underwriters who utilize actuarial models based on published or proprietary mortality (life) tables and medical underwriting based on various debits/credits for various morbidity characteristics similar to the medical underwriting performed by life insurance company underwriters and reinsurance underwriters. Until recently, the most commonly used mortality table was the 2001 Valuation Basic Table (VBT) published by the Society of Actuaries based on data supplied by contributing life insurance carriers. In 2008, the Society of Actuaries published a new table, the 2008 VBT, that is based on 695,000 lives representing $7.4 Trillion in death benefits which is almost 3 times more lives than the former 2001 VBT. Included with 2008 VBT are relative risk tables (RR Tables) that separate insured lives into various underwriting categories based on the health/morbidity of the insured at the time the policy was issued. Note that no impaired lives are included in any of the RR tables, but rather were designed for companies that subdivide their standard policies into more than one sub-class. Most LEPs have factored in the experience data underlying the 2008 VBT, as well as their own experience data and other factors, as a basis for their mortality tables. This resulted in a significant lengthening of average LEs in the fourth quarter of 2008 for some LEPs. All major LEPs have continued the practice of developing and using proprietary and confidential mortality tables based on extensive medical research and mortality experience. One new LEP has adopted the use of the 2008 VBT RR Tables as a replacement for proprietary multipliers, despite the fact that Relative Risk Factors are in their infancy and not designed for impaired life nor life settlement underwriting.
Life Settlement History
Although the secondary market for life insurance is relatively new, the market was more than 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.The Policy as Transferable Property
The Supreme Court case of Grigsby v. Russell (1911) established the policyowner’s right to transfer an insurance policy. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policyowner could transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policyowner.
This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:
- Name the policy beneficiary
- Change the beneficiary designation (unless subject to restrictions)
- Assign the policy as collateral for a loan
- Borrow against the policy
- Sell the policy to another party
A second milestone occurred in 2001 when The National Association of Insurance Commissioners (NAIC) took a crucial step by releasing the Viatical Settlements Model Act defining guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policyowners who no longer needed a given policy. Strong demand for life settlements policies is driving a rapid market expansion that continues today.
Major Study Findings
An academic study that showed some of the potential of the life settlement market was conducted in 2002 by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title "The Benefits of a Secondary Market For Life Insurance." This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their underperforming life insurance policies, an opportunity that was not available to them just a few years before. It has also been stated by Neil A. Doherty, the professor at Wharton, that this practice drives up the cost of insurance to all other consumers purchasing life insurance.
"We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policyholders who have exercised their option to sell their policies at a competitive rate." - Wharton Study, pg 6
Another study by Conning & Co. Research, "Life Settlements: Additional Pressure on Life Profits." This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements.
A life insurance industry sponsored study by Deloitte Consulting and the University of Connecticut came to negative conclusions regarding the life settlement market.
http://www.quatloos.com/uconn_deloitte_life_settlements.pdf
Viatical settlement
In the case of a life expectancy of less than two years the term viatical settlementViatical settlement
A viatical settlement is the sale of a life insurance policy by the policy owner before the policy matures. Such a sale, at a price discounted from the face amount of the policy but usually in excess of the premiums paid or current cash surrender value, provides the seller an immediate cash...
is used.