Frequently Asked Questions About Life Settlement Investment and Viatical Investment
Q: What are the key factors life settlement investors must address when considering investing in life settlements (a.k.a. viatical investments)?
Q: What is the minimum amount of capital a life settlement investor should consider dedicating to a life settlement investment program?
Q: How are life settlement brokers and providers compensated?
Q: How is the life expectancy of an insured determined for purposes of evaluating a life settlement investment (a.k.a. viatical investment)?
Q: What types of life insurance are most suitable for life settlement?
Q: Why are universal life policies more attractive from a life settlement perspective than other types of life insurance?
Q: Can “second-to-die” or survivorship policies be sold as well?
Q: What about variable life policies?
The information on this page is general information intended for institutional investors who are considering investing in life settlements. This information is not intended for use by individual investors who should consult with their investment advisors. This information is not investment advice. As used in this page, the terms “life settlement investors” and “viatical investors” are synonymous.
Q: What are the key factors life settlement investors must address when considering investing in life settlements (a.k.a. viatical investments)?
A: There are many issues to be considered by life settlement investors, such as:
- The investor’s approach to life expectancy estimation - There are several companies which offer medical underwriting services for use by life settlement investors. Each of them employs different methodology for estimating life expectancy, and none of them can yet make a legitimate claim to be more accurate than any of the others. The life settlement market is too new, and the average life expectancy of a qualifying insured too long (relative to the age of the industry), such that the quantity of data necessary to fairly and reliably “rate” life expectancy providers is not yet available. However, each of these companies has a different and highly developed process they apply to the evaluation of senior insureds. Institutional life settlement investors (a.k.a. viatical purchasers) are strongly encouraged to meet with each of these firms to explore this critical element of the life settlement transaction.
- The investor’s expected rate of return - Most institutional life settlement investors base their pricing formulas on a target IRR (Internal Rate of Return). However, because there are two primary forms of life settlement pricing used in the marketplace — “deterministic pricing” and “probabilistic pricing” — the targeted rate of return of one viatical investor can vary greatly from the targeted return sought by another viatical investor. Generally speaking, the “cost of capital” is a crucial element of any investor’s ability to compete for life settlement policies. Viatical purchasers and institutions providing senior life settlement financing to life settlement providers must compare their expected rates of return with the actual prices being offered in the market. Programs for which the cost of capital and the expected returns are too high can experience extensive delays in purchasing policies. Investing in life settlements is an attractive opportunity for many institutional investors provided their expectations are aligned with the market’s current levels.
- The life settlement investor’s purchasing criteria, both in terms of individual life insurance policies and the portfolio of all policies purchased — life expectancy estimation and expected rate of return considerations are both impacted by the purchasing criteria of the life settlement investor. The life settlement investor’s willingness to purchase the entire range of life insurance policies offered to the market, coupled with their ability to purchase large numbers of policies covering large numbers of unique lives, enables the investor to take advantage of more attractive rates of return while mitigating “life extension risk” (the risk associated with an insured living longer than expected) through the application of the fundamental insurance principle known as the Law of Large Numbers. The narrower the criteria, the longer it can take for viatical purchasers to obtain life insurance policies which “fit” their portfolio. The smaller the amount of capital available to invest in life settlements, the more difficult it is to acquire a diverse portfolio.
Q: What is the minimum amount of capital a life settlement investor should consider dedicating to a life settlement investment program?
A: The amount of senior life settlement financing provided by the investor depends upon the structure of the program and the investor’s strategy (i.e., a buy-and-hold investor may be willing to invest differently and with different amounts than an institution with plans to securitize a portfolio of life settlements). The total invested capital can vary. In general terms, given the average life expectancy of the typical insured entering the market and the average face amount of policies being offered in the market, a $100 million commitment is now considered minimal or “entry level” when making a life settlement investment. Placement of smaller amounts is possible but the risk-reward characteristics of smaller portfolios must be carefully considered by viatical purchasers.
Q: How are life settlement brokers and providers compensated?
A: Life settlement brokers represent the sellers of policies in the market. They are typically paid a commission deducted from the total cash settlement amount offered by the life settlement provider for the policy. Though the broker is paid by the life settlement provider (out of the proceeds payable to the policy seller), it is important to remember that a broker owes a fiduciary duty to the seller of the policy, not to the provider. Life settlement providers purchase policies on behalf of life settlement purchasers who provide life settlement financing to the market in large sums.
Life settlement providers, when acting as originators of life insurance policies for the life settlement investor, are paid a fee per policy purchased. This fee, often referred to as an origination fee, is usually stated as a percentage of the policy’s death benefit. The amount and conditions applicable to the payment of the origination fee are typically a key element of the origination agreement or master purchase agreement. It is also not uncommon for the fees described in this agreement to include one or more incentive mechanisms to motivate the life settlement provider to purchase policies for the investors at the best possible prices.
Q: How is the life expectancy of an insured determined for purposes of evaluating a life settlement investment (a.k.a. viatical investment)?
A: There are two business models currently used by life settlement investors to determine life expectancy. The most common approach is to send the medical records of the insured to one or more medical underwriting companies or “LE providers” which specialize in evaluating medical information and other data about an insured individual (i.e. age, gender, lifestyle, etc.). Each LE provider uses their own proprietary system to develop a life expectancy estimate for each insured. The alternative method, which is far less common, though viable, is for the life settlement provider to conduct the same kind of analysis “in-house” and to develop their own life expectancy estimates for the cases they wish to purchase. Most viatical investment programs require providers to use life expectancy estimates produced by a third party medical underwriting company currently serving the market.
Q: What types of life insurance are most suitable for life settlement?
A: The overwhelming majority of life settlement transactions involve the sale of “flexible premium adjustable life” or “universal” life policies. Term life insurance policies, particularly if they are convertible to a universal life policy, and some “ordinary” or “whole life” policies may qualify as well.
Q: Why are universal life policies more attractive from a life settlement perspective than other types of life insurance?
A: Universal life insurance policies generally do not have fixed premium payment requirements, so it is possible to pay more or less than the scheduled amount shown in the “in force” illustrations used by life settlement providers to evaluate each policy. For this reason, the ability of life settlement providers to pay more for this type of insurance relative to the cash surrender value of the policy is often greater. In addition, since the introduction of this type of policy in the 1980s, this form of life insurance has become extremely common and widely available, so that many of these policies are now being offered for sale in the life settlement market.
Q: Can “second-to-die” or survivorship policies be sold as well?
A: Yes, the evaluation process for policies which cover more than one insured are slightly more complex, but it is possible to sell survivorship life insurance.
Q: What about variable life policies?
A: Variable life insurance policies are considered securities. As such, the parties who can sell, buy, transfer or be compensated for transactions involving variable life insurance policies are governed by state and federal securities laws and regulations, separate and apart from any applicable life settlement regulations. The vast majority of life settlement providers are not currently able to purchase these policies, and many life settlement brokers may not be properly licensed to sell them. This does not mean such policies do not qualify. Rather, the market as a whole has simply not yet developed the mechanisms through which to purchase them consistently and efficiently.
