The Evolving Life Settlement Market: Insights and Opportunities (1 of 2)

Estimated Reading Time: 5 Minutes

Introduction

In this 2-part series, we explore the life settlements industry and its overall impact. Part 1 of this article examines the fundamental transaction, the ethical considerations, and the regulatory frameworks designed to ensure the market’s integrity. In Part 2, we will examine key drivers for the future of the Life Settlements industry as well as how the actuary plays a key role in its success.

Life Settlements 101

A life settlement is when a policyholder sells his or her life insurance policy for a lump sum that is more than the policy’s cash surrender value (the amount the insurer would pay if the policy is cancelled) but less than its death benefit (the amount paid to beneficiaries when the insured passes). This arrangement benefits the policyholder by receiving instant liquidity and eliminates the burden of future premium payments. The buyer becomes the new policy owner, pays premiums to maintain the policy, and receives the death benefit when the insured passes. The buyer bears the longevity risk of the insured outliving expectations. This transaction is often mutually beneficial since the seller gets immediate market value for the asset, and the buyer gains an investment opportunity based on an actuarial calculated risk and a known future payout. 

Cash Surrender Value <  Life Settlement Price  <  Net Death Benefit

For example, if a policy has a cash surrender value of $50,000 and a death benefit of $500,000, the selling price might be $200,000 based on life expectancy and future premium payments. This $200,000 sale price is higher than the cash surrender value and lower than the death benefit. This pricing reflects the buyer’s desired investment return while providing the seller with more immediate value than the cash surrender option. There are no restrictions on how the proceeds of a life settlement can be used.

Ethical considerations

Life settlements provide a legitimate and valuable option for individuals who no longer want or can afford their life insurance. By selling their policy, policyholders gain immediate liquidity, which can help cover medical bills, living expenses, or other urgent needs. The transaction is voluntary, and sellers are compensated with more than they would get from surrendering their policy to the insurer. Regulatory frameworks in the US also aim to protect sellers by requiring full disclosure and fair dealings. Life Settlements creates optionality, breaking the natural monopoly of insurers as sole buyers of their policyholders’ lapsed policies.

The ethical concerns around life settlements are centered around vulnerable individuals, such as elderly with declining health, who may be in financial distress. Critics argue that buyers are profiting from a lack of liquidity and awareness, potentially exploiting the sellers' urgent need for cash. Sellers may feel pressured to accept less than fair value for their policies because they lack better financial alternatives. Moreover, life settlement feels like shorting a stock, where investors speculate upon a company losing money to make gains (life settlement gains profit if the insured person dies earlier than anticipated).

Partnering with an experienced Life Settlement professional

Given the complexities and potential pitfalls, it is paramount that policyholders considering a life settlement proactively engage in thorough due diligence. This includes understanding the true value of their policy, exploring multiple offers from licensed providers, and carefully reviewing all terms and conditions. Seeking independent financial and legal counsel can further empower policyholders to navigate the process confidently and ensure they receive fair value for their assets. This emphasis on informed decision-making underscores the importance of the regulatory framework established in almost every state, to protect policyholders throughout the life settlement process.

State regulations around Life Settlements

US regulations aim to prevent life settlements from being predatory or exploitative by implementing measures that ensure fairness, transparency, and the protection of policyholders. These include:

1. Licensing Requirements: Life settlement providers and brokers must be licensed in most states. This helps maintain professional standards and ensures that only qualified entities engage in these transactions.

2. Disclosure Requirements: Regulations mandate that brokers disclose all transaction details to the seller, including the offer amount, any fees, the policy's fair market value, and whether the broker represents the seller or the buyer. This transparency empowers sellers to make informed decisions.

3. Cooling-Off Periods: Many states require a rescission period (e.g., 15 days) during which the seller can cancel the transaction without penalty. This allows time for reconsideration.

4. Market Value Assessment: While not always explicitly defined by a specific formula, regulations often emphasize the requirement for offers to be reasonable and reflect the fair market value of the policy including the consideration of the insured’s life expectancy and the policy’s cash surrender value.

5. Consumer Protections: Laws prohibit deceptive practices, such as misrepresenting the value of a policy or pressuring policyholders into selling. In some cases, sellers must meet specific criteria (e.g., age or health condition) to qualify for a life settlement, targeting those most likely to benefit.

   

Conclusion

The life settlement market has grown significantly in recent years, driven by an aging population and increasing awareness of this financial option. It provides a unique opportunity for individuals to unlock the value of their life insurance policies, transforming them into a liquid asset. The industry is also becoming more regulated, with stricter oversight to protect consumers and ensure fair practices. With careful planning and professional guidance, a life settlement can be a strategic move to enhance financial well-being and provide greater flexibility in managing life's changing circumstances. By considering this option, policyholders can make informed decisions that align with their financial goals and evolving needs, ensuring they make the most of their assets during retirement and beyond.