History of Life Settlements > Insurance Carriers > Policies > Investors
A Life Settlement is defined as the purchase of an existing in force life insurance policy.
The policy owner being an individual who no longer wants or needs it as part of their current financial planning, and who also does not suffer from any terminal illness. Life settlement policies are sold as high return investments, and the secondary market for life insurance products has fully developed into an asset class of it’s own with guaranteed principle protection and significant returns.
These policies are backed by the strength of highly rated US life insurance companies.
The market opportunity exists because life insurance companies offer policy holders low cash surrender values (CSV). However around 1995 the early pioneers of Life Settlements began offering higher purchase prices than the cash surrender values.
This new market efficiency allowed the insured to liquidate their asset using life settlements to increase the embedded cash surrender value built into the policy.
Innovative capital markets combining the strength of US life insurance companies have created one of the most secure and lucrative asset classes to have emerged in decades. The overwhelming uptake of life settlements by investment banks and institutional investors have seen this asset class held out of the public arena.
Toward the end of the seventeenth century, London’s growing importance as a centre for trade increased demand for marine insurance. In the late 1680’s Edward Lloyd opened a coffee house that became a popular haunt for ship owners, merchants and captains and a reliable source of the latest shipping news. It became the meeting place for people wanting to insure cargoes and ships. Of vital importance were the ships captains whose lives were insured. Thus the initial policies were issued.
Developments in Life Insurance were relatively staid until the Wall Street firm EF Hutton unbundled the components of life insurance policies in the 1970’s and created a product known as Universal Life (UL). UL policies brought a new era of flexibility for policy owners as it allowed them the ability to manage their policies via the facility to adjust both premiums paid and the death benefit.
Life Settlements came about in the mid 1990’s as the initial wave of insured’s born during the Depression Era were now trying to seek relief from some of their financial burdens and taking advantage of the legal tax avoidance protections available via trusts and gifting. These developments found that many of them were over-insured or constrained for cash flow. Life Settlements is a process where the owner of the policy sold their life insurance policy to another purchaser as personal property, and then the new owner could change the owner and beneficiaries to be themselves or whomever they designated. Life Insurance policies had been a largely overlooked and under appreciated asset by their owners and their network of advisers. It was only realized what the real value was in a life insurance policy over and above the cash surrender value, when in 1995 pioneers of the life settlement industry began to offer higher cash surrender values than insurers. This is possible because they are able to re-price the policies based upon the present health circumstances of the insured. This was the first time that the insurance company's monopsony power of paying low cash surrender values was exploited. Previously no option existed but to surrender it back to the insurance company or lapse it
Ron James, an original founder of the Life Settlement market and Director of James Settlement Services LLC, was approached by one of his insurance clients in 1995 regarding exploring the options on the disposal of her policy apart from surrendering it at the low cash price to the issuer. Ron was a nationally leading life insurance producer of policies at this time and realized that there was value beyond the surrender offer from the insurance company when taking into consideration the life expectancy of his client, the quality of the issuer and the threshold of needing to at least exceed an artificially low price offered by the Insurer. From this simple event and the questioning from his client, he transacted his first Life Settlement investment. His clients, instead of selling the policy back to the originating insurance company at less than market value, or allowing the policy to lapse and forfeiting the value, the life settlements allowed another exit option that maximizes the policy owner’s value. Consequently, life settlements have quickly developed into a viable and attractive alternative product.
According to a Bernstein Research report (Mar 2005) “Industry sources estimate that the life settlement market has grown from $0 in the mid 1990’s to around $13 billion today. While still small within the context of the $9 trillion of individual life insurance in force, we see numerous drivers of growth going forward”.
Life Settlements are now being utilized and invested in by many of the largest investment banks on Wall Street and have regularly been purchased by some of the earliest adopters of this asset class, the European investment community. The projections for growth have been easily exceeded as the adoption rate is far higher. Capital Settlements Ltd is New Zealand’s portal to this American based asset class.
No American life insurance company has ever filed for bankruptcy.
This is so because the largest industry in the US is regulated by state and federal laws with safeguards that guarantee the insurance companies future liabilities. The Legal Reserve system is regulated by State Insurance Commissions’ and ensures that the huge capital adequacy requirements of insurance companies are maintained.
Also, insurance companies are audited monthly by the State Departments of Insurance to strictly monitor their asset to liability ratios. If these ratios are exceeded they risk being liquidated and their assets sold off to another insurer. The majority of an insurer’s assets are held in real estate, cash and government bonds. The only policies accepted for life settlements are those issued by carriers whose financial strength is rated at least ”A“ by A.M. Best, “AA” by Moody’s or “A“ by Standard and Poors.
Ironically insurance companies have found themselves in an unusual situation; where they have severely underestimated the value of their own life products. They have hamstrung themselves with their own low cash surrender values, which they are unable to increase to compete against an increasingly efficient secondary market. (Class vs individual).
There are numerous reasons why an Insured would want to sell their life insurance policies. Their circumstances may have changed since taking out the policy and it is no longer affordable, especially if they also have expensive ongoing medical treatments. They may outlive their spouse or beneficiaries, they may also have loaned against the policy but for the most part they have a reduced need for life insurance in shielding assets from inheritance tax.
Historically 89% of all Universal Life policies never result in a death benefit claim because they are lapsed, surrendered or replaced. Once the policy is no longer a component of any current or future financial planning it may then be considered for sale as a life settlement. Only Universal life policies are considered for life settlements and they must be beyond the two year non contestability period.
Once the insured has sold their policy as a Life Settlement they no longer have any further involvement. The investor assumes the premium obligations, and upon maturity is paid the full death benefit directly from the insurance company.
The identifying and sourcing of viable policies is the most challenging aspect of the life settlement market, as only a small percentage will meet the right economic criteria to become a life settlement.
The original purchasers of life settlements were individual investors seeking market opportunities that offered unusually high rates of return. This developing market became increasingly attractive to institutional investors who began aggregating policies into larger pools
Investments in this asset class have no correlation to shares and bonds and are independent of any market fluctuations. Life settlements are liquid investments, shown by Warren Buffet’s purchase and resale of a $US$600 million pool of life settlements.
A July 2007 Business Week article, lists Credit Suisse, J P Morgan, Goldman Sachs, Merrill Lynch, UBS, Bear Sterns and Wells Fargo bank as some of those purchasing life settlements. Even some insurers have made no secret of their involvement. With a low cost of capital, Life Settlements are extremely attractive to institutional investors seeking a safe haven with significant returns. Venture capitalists have also found a new tool to hedge against risk.
Capital Settlements Ltd has been formed in New Zealand to facilitate the purchase of US life insurance policies as investments, with policies ranging from $US250K to $US10M. They can be purchased individually or in portfolios for pooling.
Places where Life Insurance and capital markets meet: