Understanding the risks and rewards of life settlement investments

If you're considering life settlement investments, you must first familiarize yourself with their risks, which include illiquidity, potential carrier insolvency, and longevity risks. However, you should also know they can deliver many rewards.

From the potential for high returns to low correlation with traditional markets, tangibility, and predictability, these are some of the perks of life settlements.

Considering the many potential benefits of these alternative investments, it's no wonder they've become a multi-billion-dollar market. According to a November 2024 article published by PR Newswire, a market review estimates the annual face amount of new life settlements to reach around $5 billion.

Understanding the risks and rewards of settlement investments can help you determine whether you should include them in your financial planning and portfolio diversification.

What Are Life Settlement Investments? 

Life insurance policies, if optimized properly, can serve as an alternative asset class, as explained by Abacus Global.

One way to optimize life insurance policies is through a life settlement, also called "senior life settlements (SLS)." With an SLS, a policyholder, usually a "senior" aged between 65 and 79 years old, sells their life insurance policy to a third-party investor. A broker typically facilitates the transaction.

The policyholder sells their policy for a price less than its face value but higher than the net cash surrender value.

According to the Life Insurance Settlement Association (LISA), policyholders can receive anywhere from 10% to 50% of their policy's face value. The average, however, is about 20%.

Face value refers to a policy's guaranteed death benefit (i.e., the amount beneficiaries should get upon the policyholder's passing). The net cash surrender value is the policy's cash value (minus loans, interest owed, and surrender charges) available to the policyholder should they cancel the policy prematurely.

Once sold, the investor who purchased the policy takes over the responsibility of paying for its future premiums. When the senior who originally purchased the policy passes, the investor receives the policy's death benefits.

What Is an Example of a Life Settlement? 

An example of a life settlement investment is when a senior sells their life policy with a death benefit of $250,000 to an investor for 25% of the policy's face value.

In the scenario above, the senior should receive 25% of $250,000, which amounts to $62,500. The investor will then continue to pay for the policy's premiums until the original policyholder passes away. When the senior passes away, the investor should receive the full death benefit of $500,000 from the life insurance carrier.

What Are the Disadvantages of a Life Settlement? 

One of the primary risks of life settlement investments is their illiquidity. Illiquid means they're not easily tradable or convertible to cash, unlike traditional investment strategies like bond or stock investing.

If you invest in a life settlement, your capital will remain tied for many years. You'd only be able to "recover" it (and its potential profits) when the policy matures due to the insured person's passing.

Although rare, there's a risk of carrier insolvency, too. The life insurance company backing the policy could become insolvent or bankrupt, unable to pay the investor the death benefit.

Investing in life settlements also carries longevity risks. In this case, the risk is that the policyholder could potentially live longer than their estimated life expectancy. If so, you, the investor, would have to keep paying premiums, resulting in a reduced potential profit.

What Are the Rewards of Life Settlement Investments? 

One of, if not the biggest, draws to life settlement investments is their potential for high returns. According to a post by Financier Worldwide Magazine, they offer higher yields compared to traditional fixed-income assets, with annual returns of high single digits and even low double digits.

Another benefit of life settlement investments is their low correlation with market trends affecting traditional asset classes. Many assets, such as stocks, commodities, and real estate, fluctuate due to market events and factors like economic recession and inflation.

Life settlement investments, on the other hand, depend more on mortality events.

Because typical market situations don't have a drastic impact on life settlements, they make for an attractive option for portfolio diversification. While they won't eliminate all risks, they can still help reduce your overall portfolio risk.

There's also their tangibility. When you invest in a life settlement, you'll gain ownership of an actual policy with an intrinsic value.

Last is predictability. You can rest easy, knowing that you've invested in something with a predictable payout source, which, in this case, is a highly reputable U.S. life insurance firm.

Frequently Asked Questions 

Why Do Seniors Choose to Sell Their Life Insurance Policies?

Seniors sell their life insurance policies for many reasons, such as requiring immediate cash for healthcare, living expenses, or retirement funding. They may work with a life settlement investment broker because they need additional funds for assisted living, for instance.

In other cases, seniors choose to sell their policies because their original purpose is no longer applicable. An example is when they no longer have heirs or dependents.

Some seniors may also sell their life insurance policies because their premiums have skyrocketed and are already impractical and unaffordable. Rather than just letting the policy lapse, they work with brokers so they can at least monetize even just a portion of the policy.

Is Life Settlement a Good Investment? 

If you're a high-net-worth investor who wants to diversify your portfolio, then yes, life settlement investments could be an attractive asset. While they require a high upfront investment, if you do your due diligence and research your options well, you can earn potentially high returns from non-market-correlated media.

You should also consider the socially responsible aspect of these investments. They're like a valuable service to seniors who can no longer pay their premiums or need quick access to funds for their healthcare and living costs.

By investing in their policy, you can help them get a lump sum that's higher than their policy's cash surrender value.

Be a Smart and Savvy Investor

Life settlement investments are not for everyone, but for those who can afford them, they can serve as an attractive asset with potential high returns. However, they can be complex, which is why they're often more suitable for accredited investors.

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This article was prepared by an independent contributor and helps us continue to deliver quality news and information.