Life settlements are a leading non-correlated asset and an appealing option for investors. These investments aren’t directly affected by stock market swings, political changes or investor sentiment, so their value holds steady even when other asset classes go for a ride.
When investing in life settlements, you purchase existing life insurance policies at a discount from seniors who no longer need or want them. You pay more than the surrender value but less than the death benefit. Then, you take over the premium payments and receive the full payout when the insured passes away.
With 10,000 baby boomers hitting retirement age each day, the market for life insurance policies is growing fast. If you want to get started but aren’t sure how to invest in life settlements, follow this step-by-step guide.
STEP 1: UNDERSTAND WHAT YOU’RE INVESTING IN
Investing in life settlements is fundamentally different from investing in stocks or bonds. Your returns aren’t based on market performance, interest rates or company earnings. Instead, they’re based on actuarial data and the timing of a policyholder’s passing. That makes life settlements largely immune to economic disruptions, including from recessions, pandemics and market downturns. This stability is one reason investors are turning to life settlements to diversify their portfolios.
…And Who You’re Investing In
A life settlement investment is a big win for the insured. Many can no longer afford their premiums when living on a fixed retirement income and don’t even need the policy’s financial protection now that the kids are grown. But if seniors surrender the policy, they lose much of what they’ve paid into it, sometimes over decades. If they can’t meet payments and the policy lapses, they get nothing back at all. These options are like surrendering a car they can’t drive anymore to a junk yard or giving it away to a passerby. Seniors would make much more money if they sold the car for its fair market value.
Similarly, selling a life insurance policy is a solution that gives insureds the largest return on their investment while alive. The lump sum payout can significantly improve their quality of life by helping to cover medical bills, supplement retirement income or even fund a long-awaited dream vacation.
STEP 2: KNOW THE INVESTMENT STRUCTURE
You have two main ways to invest in life settlements: going direct or through funds.
Direct Investments
Direct life insurance policy investments mean you’re buying individual policies. You’ll work with licensed brokers or providers, analyze specific policies and make offers. This gives you complete control but takes more know-how and capital. You’ll have to manage the policy and premium payments yourself, unless you work with life settlement advisory companies that provide full-service support, including paying premiums, tracking the insured, processing claims and life settlement consulting.
The biggest benefit of direct investments is that you participate in the upside of this investment. This means if the insured’s life expectancy is six years and the return to life expectancy is 12%, your returns could be 800% or more if the insured passes away in one year.
You can also build an individual pool of policies to help spread out the risk of an insured living longer than their life expectancy. Most investors don’t put all they have into one stock and hope they see returns. Instead, they diversify their risk by purchasing several stocks, often adding other asset classes to the mix for a well-rounded portfolio. Depending on your risk tolerance and goals, you can have as few as two policies in your pool to 50 or more.
Life Settlement Funds
Life settlement funds have the advantage of built-in diversity. These funds pool multiple policies together, spreading risk across hundreds of insureds and limiting the impact of a single insured far outliving the life expectancy estimate. However, you don’t participate in the upside of those returns if a policy matures (the insured passes away) earlier than estimated. Using the previous example, if a policy with a life expectancy of six years matured in one year, that 800% annualized return stays with the fund. You receive only the stated return.
STEP 3: KNOW IF YOU QUALIFY
Most life settlement fund opportunities are only available to accredited investors because of their complexity and illiquidity. To qualify, you need a net worth exceeding $1 million (excluding your primary residence) or an income over $200,000 each year for the last two years. You’re also expected to maintain that income level.
SEC rules govern who can be solicited for private securities offerings. Some platforms are starting to offer access at lower minimums. However, the best opportunities can still require $100,000 or more as an initial investment.
Direct policy purchases are regulated at the state level, and requirements vary. Many states limit participation to accredited investors or have other eligibility criteria. Before investing directly, talk with a licensed life settlement broker or attorney familiar with your state’s laws.
STEP 4: EVALUATE THE POTENTIAL RETURNS
Life settlements typically target returns in the 8% to 12% range, though some policies may pay more. Your actual returns depend on three factors:
- 1. What you pay for the policy
- 2. How much you spend on premiums and ongoing costs
- 3. When the payout occurs
Even with promising potential returns, investing in life insurance has its pros and cons. While a policy’s death benefit doesn’t fluctuate with market conditions, you might face challenges financing premiums during market crashes. It’s also not as easy to find buyers if you need to exit early. The policy’s value stays the same, but your ability to access that value can be affected.
STEP 5: UNDERSTAND THE RISKS OF INVESTING IN LIFE SETTLEMENTS
The main risk with life settlement investments is longevity. If the insured lives longer than expected, you’ll pay more in premiums and costs and wait longer for your payout. This can negatively affect your returns.
Other risks include:
- Premium risk: You must keep paying premiums for the policy to stay active and for you to receive the death benefit.
- Liquidity risk: There’s no easy secondary market to resell the policy. You should see this investment as a long-term strategy.
- Regulatory risk: Rules vary by state and can change.
- Insurance company risk: State guarantee funds offer limited protection if the insurance provider goes bankrupt.
Smart investors address these risks through diversification and conservative underwriting. A well-diversified portfolio of policies helps lower the impact of any one policy underperforming.
STEP 6: CHOOSE HOW TO PARTICIPATE
For most investors, the choice comes down to their expertise and available capital.
Direct Investments
Direct purchases may work best if you have significant capital, typically $100,000 or more, to cover both the policy purchase price and a reserve to pay premiums with. You’ll also need relationships with brokers and time to analyze individual opportunities.
Alternatively, you can work with an experienced life settlement advisory company that offers a turnkey process. Advisors can give you a clear path forward without the burden of managing every investment detail alone. All you do is remit the payment, and they will manage the policy’s ongoing obligations, including:
- Paying premiums
- Checking on the insured’s health status
- Tax reporting and compliance
- Acting as a second addressee for policy-related communications to help prevent missed notices and lapses
I2 Advisors can educate you on the risks of this unique asset class and help you create custom investment strategies.
Life Settlement Funds
Funds are probably better for other types of investors. Look for established managers with strong track records. You’ll also want to make sure they have transparent fee structures and diversified portfolios. Some funds specialize in certain policy types or insured demographics. Others require a substantial upfront investment, such as $250,000.
STEP 7: DO YOUR DUE DILIGENCE
Before investing a dime, do your homework. For funds, check:
- The manager’s track record and experience
- How policies are sourced and underwritten
- Fee structures (both upfront and ongoing)
- Historical performance data
- The quality-of-life expectancy providers used
- Any lawsuits, regulatory enforcement actions, allegations and investigations against the company
It’s critical to research funds thoroughly to make sure you aren’t being misled about products or services. In recent years, a handful of companies have been involved in legal proceedings for unscrupulous behavior, such as fraud or manufacturing fake revenue.
For direct investments, you’ll want to gather further details about the policy and the insured, such as:
- The insured’s medical records
- Policy illustrations (projected costs and performance over time)
- Life insurance carrier ratings
- What company is providing life expectancy estimates
Instead of going at it alone, consider partnering with a licensed life settlement advisor. They can source policies, specialized attorneys who understand the regulatory landscape, and independent life expectancy underwriters for unbiased assessments.
STEP 8: UNDERSTAND THE REGULATORY LANDSCAPE
Forty-three states are regulated by life settlement laws. These regulations protect both sellers and buyers, requiring licensing, disclosures and proper procedures. Most states require clear information for consumers, licensing of brokers and providers and anti-fraud measures.
Make sure any provider or fund manager you work with follows all compliance protocols. Look for proper licensing, escrowed transactions and transparent documentation. Be sure to work with another provider or fund manager if they aren’t compliant.
A UNIQUE ASSET FOR THE RIGHT INVESTOR
Investing in life settlements isn’t for everyone. It requires patience, capital and comfort with illiquidity. But for investors seeking true diversification and stable, non-correlated returns, life settlements are a strong investment option with special features.
Ready to explore life settlements? Contact i2 Advisors to learn how these unique investments might fit your financial strategy. We have 25 years of experience and can provide the guidance you need to get started. You’ll tap into this growing market while helping seniors unlock the value of their underutilized assets.