Investing In Other People's Life Insurance Makes a Comebackby
The market for life settlements—the sometimes-controversial pre-death life insurance cash-out—may be coming back from the dead.
The buying and selling of life insurance policies is not for the sentimental. It also has its uses. Senior citizens may have life insurance policies they don’t want anymore, and research (PDF) from London Business School suggests that seniors receive four times more by selling to an investor (either directly or through a broker) than they do from selling their policies back to insurance companies. If they let the policy lapse, they get nothing at all. (Insurance companies make up a large share of settlement buyers: Owning other companies’ policies is seen as a good hedge against their own outstanding contracts.)
Life settlements were born of the related practice of buying the life insurance policies of those who are terminally ill. In the 1980s, when AIDS patients needed cash to pay health-care expenses, they found they could sell the life insurance policies provided by their jobs. Early viatical settlements assumed that the policy-holder would die within two years but as HIV drugs became more effective and people started living longer, the settlements became less profitable. So investors instead began to buy the insurance policies of wealthy seniors.
Compared to terminal patients, the timing of a senior’s death is more variable, making life settlements a riskier proposition: Investors might pay premiums for 10 or 20 years before collecting a benefit. Yet the market grew. The annual volume of life settlements increased sixfold from 2002 to its peak in 2007, swelling from $2 billion to $12.2 billion, according to Conning Research & Consulting.
After the financial crisis, investor appetite for these esoteric, illiquid, high-risk, long-term investments dried up. The market also faced more regulation, and investors lost money when one-time policyholders lived longer than expected. By 2012, just $1.26 billion worth of settlement contracts traded.
There are new signs of life in the market, which increased 20 percent in 2013, according to a survey conducted by the Deal. Analysts expect it to grow again in 2014, lifted by investors seeking higher yields. There’s also been more activity among hedge funds, which buy bundles of settlements from banks and insurance companies. This is potentially a good thing: If investors can easily sell securitized settlements, the market gets more liquid and more stable.
Conning Research offers a mixed assessment of the market’s future. Investors who have been burned in the past—especially insurance companies and investment banks—may not be eager buyers; on the other hand, a case study written by Harvard Business School professor Lauren Cohen claims that others in the market see investors coming back.
What does seem certain is that the potential supply of policies is vast. Many retirees need cash to finance large end-of-life health expenses, and life settlements allow seniors to turn existing life insurance policies into a kind of long-term care insurance. How much they’re able to get will depend on how quickly investors return.