Life settlements bring together a willing seller and a willing buyer. As the policy owner, or seller of the life insurance policy, you know exactly what you are getting. When you negotiate and agree to a settlement with the life settlement provider, you receive an agreed amount in the form of a single lump sum. As the buyer of the policy, a life settlement company is making an educated guess on the rate of return they will realize when the insured dies and they can collect the death benefit.
The rate of return on life settlement investments can be affected by a number of different variables. You should understand each of those risks before you make the decision to invest in life settlements.
The insured lives longer than expected
Calculating the life expectancy of any person is not an exact science. Despite the meticulous efforts that go into reviewing medical records, analyzing them, and translating the findings into a number representing how long a person has left to live, life expectancy is still only an estimate.
A chronically ill person could surprise everyone and live for 5 years more than predicted. He or she could be killed in a car accident and die sooner than predicted. A person with a bad heart could qualify for a life settlement and then, two years later, get a heart transplant and live for twenty more years. You just never know for sure how long someone will live.
When a person lives longer than they are supposed to live, that will lower the rate of return on a life settlement investment. Principal and interest are not returned to the investor until the insured dies and the death benefit is paid.
Death benefits held up in court
Although life settlements are carefully drawn up to prevent any disputes over the full payment of the death benefit, there is always the risk of litigation when it comes time for an insurance company to pay out the death benefit. Payment can be delayed. Legal costs to obtain the full death benefit can reduce the rate of return on this type of investment.
Higher premiums
One of the calculations that goes into the valuation of a policy is the amount of the number and dollar amount of the premiums the new owner will have to pay to keep the policy in force. In a non-guaranteed universal life policy, the life insurance company reserves the right to increase the premium up to the maximum amount shown in the policy. In practice, cost-of-insurance risks are very small.
Coping with the risk factors of life settlement investments
Performance of your investment can be affected by all of the above risk factors and many more. To help guard against those risks an investor should look for:
- An experienced manager with a history of delivering a solid ROI.
- Low expenses – High expenses can eat-away at your ROI.
- A portfolio of different types of policies issued by different insurance companies.
- A portfolio of policies diversified by face value and life expectancy.
- Periodic reports that show the fund’s performance and outlook.
- Expected returns based on reasonable assumptions and not on a best-case scenario. Be wary of someone who promises 100 percent returns in just two
years.