Monday, January 4, 2010

A very morbid investment

A surgical team from Wilford Hall Medical Cent...Image via Wikipedia
The business of "life settlements", is a morbid one, and unregulated, but there is an opportunity there, for both the buyer, and the seller, and the agents in between.

The idea of life settlement is very simple. Someone bought a nice big chunk of life insurance with "cash value". It's part life insurance, part savings account, so to speak. If the holder surrenders the policy, he gets the cash value back, and that's it (assuming he pays the annual premiums). If the holder dies, the insurer pays out the benefit amount to whoever the holder chooses. So say, you're old, you can no longer keep up the lfie insurance policy yearly payments, and the cash value is negligible, you can opt to sell the policy to a "life settlement investor" (through brokers, escrows, and whatnot), and yield bigger returns.

Forbes Magazine gave an example recently (October 5, 2009 issue, page 48, "Death Squads"). An 82-year old, in so-so health, has a universal life insurance for $500000 upon death. However, the cash value for the policy is a mere $7000. His annual premium is 35000 (i.e. he had to pay that much for the policy to remain in effect). He eventually sold his policy and yielded 224000, which, after various fees and commission, netted him 183000, much better than 7000 cash value, but MUCH lower than his 500000 insured amount.

And in case you are wondering, this is perfectly legal, because it was a Supreme Court ruling at the early 20th century that gave the insured rights to sell their policy to others. And now, in bad economic times, business is booming, as people are still hoping for high returns in a down market.

This is a morbid business, no other way to say it. As an investor, you are basically hoping that the insured keel over as soon as he signs over his policy and get paid. The longer he stays alive, the less return you yield.

In the above case, the investor has basically taken over the policy of that 82-year old. The investor pays the $35000 yearly premium, and gets the 500000 benefit upon the insured's death. Minus the 224000 he paid, he is basically betting that the 82-year old dies within 10 years, the sooner the better. He probably had medical experts go over the insured's medical records and render their "expert" opinions on how many years the man is expected to live, and often, the insured is required to give annual checkups or health updates.

The insurance industry is NOT happy about this, but they can do nothing, as it is completely legal. It also messes up their actuarial calculations (i.e. probability studies) as a lot of their profit comes from surrendered or lapsed policies, and policies sold to investors are something they have a hard time predicting. You can be sure the insurance industry won't help either side.

As the insured, you need to beware that this is NOT a well-regulated industry, therefore your legal protection is minimum, and a life settlement process can take MONTHS during which your life's history will be gone over with a fine-toothed comb to ensure they know EVERYTHING about your medical history and thus can evaluate your life expectancy. Brokers and investors are out to make money, not to help you reach the best decision for you. Fraud is rampant, and you may be easily cheated out of more than you should. As mentioned before, insurance companies won't help you as they don't want you to sell in the first place; it messes up their calculations. You will also need a tax advisor as sometimes this sort of settlement is taxed heavily depending on the details. Brokers would not warn you about things such as taxes. You need a consultant to go over ALL the options with you, and you need to pay this consultant out of your own pocket, just to make sure he is doing this for YOUR benefit.

As an investor, you also need to be aware that this is not a well-regulated industry and full of people who want to make a lot on commission (could be 18% or so) on the settlement amount, so they are out more for the commission than for YOUR benefit. And with new medical treatments and medicine every day, and health care reform on the way, life expectancy is going UP. On the other hand, baby-boomers are reaching their retirement years and the the rising cost of geriatric care is forcing more and more seniors, who bought those policites long time ago, to consider selling them to raise cash. It is an opportunity, but it is risky, and someone else's life is not exactly under your control.

There are money to be made in this arena, but the risks are tremendous, even worse than the stock market, much worse. Let both sides be aware of the risks.

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