Most people know that when it comes to stock market investing, broad portfolio diversification is key. A lucky few investors get rich by investing early in a stock that later brings them astronomical returns — think Apple, Home Depot or Starbucks. Their impressive wins sometimes lead others to believe that going all-in on a promising company is the answer.
In reality, even many of the investors who benefited from a standout stock still held diversified portfolios, with that winner representing just one part of a broader strategy. For the small number who concentrated everything in a single company and succeeded, the outcome was the exception, not the rule.
Picking the next breakout stock is difficult, even for professionals, which is why many investors rely on diversification and exposure across multiple asset classes to manage risk.
This golden rule of stock market investing — portfolio diversification — also holds when investing in life settlements. Here’s a deep dive into why and how to diversify your life settlement portfolio.
LIFE SETTLEMENTS AS A PORTFOLIO-BASED ASSET CLASS
Having more than one life settlement in your portfolio can help smooth out your returns by spreading risk across many insureds. When you pool policies with different structures and insureds of various ages and health profiles, it reduces the impact of any one policy maturing later than expected.
Owning multiple life settlements with staggered life expectancy estimates may also help provide a more predictable cash flow. Death benefit payouts are distributed over time, with policies maturing over multiple years instead of all at once.
Approaching life settlements as a portfolio-based asset mirrors how investors typically evaluate other alternative assets, such as private credit, real estate and insurance-linked securities. Here, long-term results are generally driven by the portfolio’s construction, diversification and scale rather than the performance of a single asset.
WHY ONE POLICY IS THE WRONG WAY TO EVALUATE LIFE SETTLEMENTS
Life settlements can have returns of 1,000% or more when a policy matures much earlier than expected, or negative returns of 10% or more when it matures much later than initial estimates. Outcomes vary widely because maturity dates can differ from life expectancy estimates.
Judging life settlement performance based on a single policy is similar to evaluating the stock market by looking at one company’s short-term results. Even strong, established businesses can have off years, just as individual life settlement policies can deviate from projections.
When a policy matures later than expected, it doesn’t mean that underwriting was flawed or the investment approach was problematic. It simply reflects the inherent uncertainty in estimating individual life expectancies.
Technology like smarter AI is making life expectancy estimates increasingly accurate. Still, no one and no tool can predict with absolute certainty when an insured will pass away, a fact that’s just as frustrating to life settlement investors as it is to life insurance companies.
WHY LIFE SETTLEMENT PORTFOLIO CONSTRUCTION DRIVES RETURNS MORE THAN ANY SINGLE POLICY
Typical annual returns of life settlements are 11% to 13%, and a well-constructed portfolio with carefully selected policies is more poised to deliver these results than owning only one or two policies because it reduces your risk if any one policy underperforms.
Whether purchasing one or 10 policies, a thorough selection process is also essential to ensure that you’re paying fair prices and your decision is informed by high-quality underwriting. Evaluating policies against conservative life expectancy assumptions can also help with life settlement risk management by adding a margin of safety when projecting cash flows.
Ongoing portfolio management and monitoring are also crucial in helping portfolios achieve average annual returns.
A life settlement advisor can help build a portfolio based on your budget, time horizon, and risk tolerance. Look for someone with years of experience and a strong track record of successfully sourcing, evaluating, and managing life settlement investments.
A diversified portfolio better protects you because risks are spread across many polices. Some policies may mature before their life expectancy, and others may live beyond it. The early policy maturities will offset the policies that may live beyond their life expectancy.
DIVERSIFICATION IN LIFE SETTLEMENTS
One way to diversify your portfolio is through life settlement fund investing. A fund pools hundreds of policies together to spread out risk across a variety of insureds.
However, many investors prefer to manage their own life settlement portfolio to avoid management fees and have more control over policy selection. The three aspects to focus on for a diverse life settlement portfolio are the insured, the policy structure and the life expectancy estimates.
- Policy-level diversification: You want to ensure your portfolio has policies with a good mix of insurance carriers, insured ages and health profiles, and death benefit amounts.
- Structural diversification: Your portfolio should include a mix of policy types and premium costs, as well as a variety of insured genders, ages, life expectancies, and medical conditions.
- Timing diversification: To help with cash flow and reduce reliance on any single expectancy outcome, policies should have a range of estimated maturity dates.
TAKING A PORTFOLIO-FIRST APPROACH TO LIFE SETTLEMENTS
Life settlements are often misunderstood because only a single policy is evaluated. That leads investors to focus too heavily on what-ifs, such as a policy reaching maturity much later than initially estimated.
However, whether you’re investing in traditional options like stocks and bonds or in alternative asset classes like life settlements, a diversified portfolio helps manage risk, smooth outcomes and increase the likelihood of better returns. Thorough and accurate underwriting can also ensure you better understand a policy’s risks.
Reach out to an i2 advisor today if you’re interested in learning more about a portfolio-based approach to life settlement investing. We can help you evaluate life settlements within a broader portfolio context and build a diversified portfolio.