The sale in the USA of a life insurance policy to a 3rd party

• Legal
• Highly regulated
• Both buyer and seller profit

Imagine having the ability to benefit from the diligent financial habits of middle America.

Like most residents of advanced countries, Americans have a tradition of establishing a life insurance policy as they start a family, take on a mortgage or build their own business. Over a period of responsible financial discipline, the children become independent, and debt is paid off. The need for insurance cover diminished.

Some policyholders realise that their life policy is a financial asset and would seek to cash in its value. Unfortunately, there is a low level of understanding of the options available to cash in life insurance policies. This resulted in over 90% of life policies being terminated in the US without paying a death benefit in 2018.

To provide a better outcome, the life settlements market was formed to match policyholders wishing to sell their unwanted cover to investors looking for a non-correlated asset class with the potential for stable returns. A life settlement market will give policyholders additional options in obtaining a higher value of their policies.

A life settlement transaction starts with a policyholder selling their life insurance policies to an investor (usually a fund). The life settlement investor buys the life insurance policy from the policyholder and commits to paying future insurance premiums until the insured person dies. The investor then collects the death benefit payout from the insurance company as the concluding repayment of the life settlement transaction. The path of an illustrative policy is shown below.
           

Illustrative example - assume a life settlement transaction backed by a policy with a death benefit of $100k

Hence, a life settlement transaction is clearly win-win transaction for the seller and for the investor. The returns to the investor are embedded in the benefit payout collected upon the maturity of the policy. Most market observers estimate a long-term range of 6-12% p.a. as potential returns going forward as long as the portfolio is managed properly.

Funds operated by this manager: 

Premium Asia Fund, Premium Asia Income Fund, Premium China Fund

Alignment with ESG principles is becoming imperative in investment management. A majority of Australians expect their super or other investments to be invested responsibly and ethically. In addition to the expectation of returns not being compromised, investors also expect these investments to have a real environmental, societal or governance impact, not just "ethics washing."

Due to slow-changing legacies, popular investments such as equity and bonds, funds usually start their ESG journey through implementing negative screening to exclude investments whose activities are considered harmful. However, it is still difficult to directly link the remaining assets to having actual positive ESG impact. These assets might just be less harmful.

Positive ESG impact assets are not immediately obvious because most investors are not used to the idea that assets that service a societal need can be profitable. The opportunity in life settlements shows how helping others can be profitable too.

How can an investment in life settlements, where returns are made when the insured dies, be a social good?

The positive impact that can arise from an investment in life settlements is improved physical and financial wellbeing of senior citizens in the US (where the most active life settlements transactions market operates). An investment in a life settlements fund can help vulnerable retirees and tackle three ESG-related issues in the US:

There is a shortfall of retirement savings in the US

The National Institute of Retirement Security estimates that approximately 44% of people born between 1944 and 1979 are at risk of having insufficient income to meet basic day-to-day expenses in retirement.

Due to the savings shortfall, seniors cannot access long-term care

The average middle-class senior citizen does not have sufficient savings to cover the cost of long-term care. When accounting for long-term care costs, 69% of households are at risk of being unable to maintain their standard of living in retirement.

Instead of helping to ease this shortfall, life insurance policies add to the burden with regular ongoing demands for insurance premiums while the senior is alive.

Every year since 2009, over 33 million life insurance policies terminate prematurely which means the policyholder does not realise a benefit from the policy despite paying premiums for decades. The American Council of Life Insurer reported over 90% of life policies terminate without paying a death benefit in 2018.

Life settlements provide a solution to these issues by providing a cash payout to the seniors and by shifting the burden of the insurance premium to life settlements investors. By investing in this asset class there is potential for:

• Retirees to use life settlement proceeds to replace pre-retirement income and help maintain a dignified standard of living.
• Frail and disabled persons to use life settlement proceeds to pay for long-term skilled nursing, subsequently reducing the burden on the shoulders of family or government programs.
• The benefit of decades of premiums paid on a policy to be realised by an individual in need rather than forfeited to insurance companies.

Researchers from London Business School estimated in 2013 that the value unlocked by the life settlement market is on average about four times greater than that of the surrender value offered by insurance companies.

While life settlements might not look like a candidate as a force for ESG- aligned investing, its fundamental raison d'etre is to address a societal need for better retirement provision. In return for such social good, life settlement investors can obtain stable, uncorrelated returns which has historically been in the teens.

Tomorrow, we continue this release with a follow-up article 'What is a Life Settlements Investment?".