It has been years since the wild, wild, west days of life settlements in the mid-2000s.
Life settlements are now regulated by 42 of the 50 states, covering over 90 percent of the US population.
The erroneously short life expectancy reports that were used in the pricing of life settlement offers have been corrected. Nonetheless, certain misconceptions linger from those bygone days.
Surveys have indicated that many producers do not discuss life settlements with their clients because they lack knowledge about them. This, sadly, deprives some consumers of the possibility of a life settlement for a policy they are about to lapse or surrender. Even more problematic than uninformed producers, however, are misinformed producers and critics who likely have never participated in a life settlement transaction, yet disseminate negative misinformation anyway. Of the various mistaken beliefs about life settlements, these five are particularly unfortunate and widespread:
(1) A life settlement is an alternative to keeping a policy.
A life settlement is an alternative to lapse or surrender — not to keeping a policy. Having been bitten once by erroneous life expectancies, life settlement investors are now twice shy, requiring more rigorous underwriting and higher returns to compensate them for what they perceive is an unproven asset class.
With target internal rates of return in the range of 15 percent per annum, one thing is clear: If investors can make such returns on a life insurance policy, just think how much the insured’s beneficiaries stand to gain if policy is kept and not sold. As a result, every effort should be made to find a place close to home for a life insurance policy rather than selling it on the life settlement market.
There are many alternatives to a life settlement, including gifting the policy to a loved one or borrowing to pay premiums. Only once it is determined that continuing the policy in force is not feasible, and the policy is about to be lapsed or surrendered, should a life settlement be considered.
Why is this misconception dangerous?
Policy owners could be parting with property that could have tremendous value to their beneficiaries. The glitter of a quick buck in a life settlement needs to be weighed against the long term value of the policy. A life settlement should only be considered as a last resort to lapse or surrender in order to maximize the policy’s salvage value.
(2) On average a policy is worth 20 percent of face amount on the life settlement market.
This is a misreading of the old statement: “The average value of a policy that is sold on the life settlement market is 20 percent.” For every policy that receives an offer on the life settlement market, however, 10 or more have no value whatsoever as a life settlement. This makes the average value of a policy on the life settlement market a lot closer to zero than to 20 percent.
Additionally, even the actual, correct statement about policies that are sold is probably no longer valid now due to the lengthening of life expectancies and rates of return demanded by life settlement investors today. Finally, averages mean little because policies are individually underwritten by the life settlement market based on the insured’s unique health condition and the pricing of the particular policy.
Why is this misconception dangerous?
It creates unrealistic expectations by would-be sellers. Thinking that 20 percent is a number they should be getting, policy owners could reject a fair offer and hold on to the policy thinking a better offer is out there somewhere.
As a result, people who might benefit from a life settlement could mistakenly continue to hold onto policies and pay additional premiums only to discover no better offer is available; and, by then, they will have paid even more into the policy. Perhaps even more dangerous is the misguided speculation this misconception can cause. People have been and can be misled into buying a policy solely based on the idea that they can make a quick buck by selling it for 20 percent down the road. That’s a dangerous and costly illusion.
(3) Use a life settlement to get your investment in the policy back.
Life settlement pricing is based almost entirely on the age, health and life expectancy of the insured and the cost to carry the policy forward. The policy owner’s investment in the policy is irrelevant to the prospective purchaser other than to ensure that the policy has not lapsed and the minimum premium requirements have been satisfied.