One of the great success stories to come about from progress in medical research and technology is that life expectancies have increased dramatically. As a result, many clients have come to the realization that the insurance they own as well as the insurance they need, is not suitable or they no longer qualify.
The reality is that life insurance has long been priced on the belief that a sizeable share of policies would be allowed to lapse because the customer could no longer afford the premiums or no longer needed the coverage. However, until recently, if it was determined that a policy was no longer needed or wanted for whatever reason, there were two choices: surrender it back to the existing insurance company for the policy’s underlying cash surrender value (CSV) or let the policy lapse for nothing. The CSV option is equivalent to selling a home back to the original builder at a pre-determined below market price or selling a stock to someone without checking what the current price quote is on the NYSE. No one would ever approach a real estate or securities transaction in that manner and now you don’t have to with life insurance.
As a result of these changing consumer needs, and seeing the opportunity to fill a void, entrepreneurs entered the space creating ‘secondary market’ for life insurance called Life Settlements. This market consists of major institutions who are interested in buying these existing life insurance policies. Quite simply, for those who own an unwanted or unneeded life insurance policy the appeal is that they will receive a one-time, lump-sum cash payment that’s usually much more than the cash surrender value of the policy, and they will be relieved of making all future premium payments on the policy. Life Settlements are being used for many reasons such as providing the necessary funding required to obtain a more contemporary policy, funding dependant care/immediate needs and to achieve other complex financial planning goals.
The market for Life Settlements is divided into two camps: the funding companies and the brokers. Similar to the mortgage market, the funder is equivalent to a ‘bank’ and one can go directly to them, while the broker deals with many funders and tries to find the best deal amongst all the funding companies in its universe. In either case, the service is typically free of charge to the customer.
Life Settlements are often confused with the old Viatical marketplace. While they are similar in that the insured is selling their policy to an outside ‘investor’, there are two very substantial differences. Viaticals typically refer to someone who is terminally ill with a maximum life expectancy of 2 years and the policy was almost always sold to an individual or group of individuals. The inherent problem is obvious; the buyer knows who the insured is and has a financial interest in their death. This has some serious potential risks. Life Settlements, however, refer to those with changing needs and greater than 3 years of life expectancy and the policies are almost always packaged in blind trusts and sold as securities to institutional investors such as AIG, Merrill Lynch, Morgan Stanley and Berkshire Hathaway. As a result of the blind trust, the insured’s information is never known to the end investor. As a result of the maturing of this marketplace, the National Association of Insurance Commissioners recognizes Life Settlements as a viable solution and the AICPA as well as the American Bar Association both recognize an advisor’s fiduciary duty to discuss settlement options with their clients.
The market has come far since its viatical days with examples being that A.M. Best, the insurance rating agency, has recently come out with best-practices guidelines for packaging life insurance policies into bonds and brokerage Sanford C. Bernstein & Co. estimating that $160 billion worth of insurance policies will be bought by institutional investors via life settlement transactions over the next few years.
How does the Process Work? 
