If you think investments only happen in the stock or real estate markets, think again. There’s a type of investment utilized by big banks, businesses, and hedge and pension funds that can offer impressive returns with less risk. Even Warren Buffet and Bill Gates rely on it.
Called life settlement investing, people have been using life insurance for investment purposes for over 100 years, often outperforming the S&P 500. In fact, it can help diversify your financial portfolio and protect you from market volatility, as it isn’t correlated with stocks, bonds, interest rates or the economy.
But before you think about investing with life insurance policies, there are several things you need to know. In this article, we’ll explain how life settlement investing works. Plus, we’ll outline the pros, cons and alternatives for diversifying and securing your financial future.
HOW LIFE SETTLEMENT INVESTING WORKS
Life settlements are transactions where a life insurance policyholder sells their policy to a third party in exchange for a lump sum of cash. There are three main reasons why policyholders choose to sell their policies:
- They no longer need insurance coverage, like if their children are grown, they’re divorced, or they have lost a spouse.
- Their policy is underperforming and a lump sum payout would allow them to invest in other opportunities with more upside potential.
- Their financial situation changes to where they can no longer afford insurance premiums.
When a life insurance policy is sold as a life settlement, the policyholder receives a payout greater than the cash value of the policy—typically between 10% and 25% more. This is one reason why individuals strapped for cash, interested in other financial products, or no longer needing life insurance may find selling their policy so appealing. The alternative is to surrender their policy to their insurance company, where they will only receive the policy’s cash value (sometimes less), or to let the policy lapse, in which case all premiums paid are lost.
Individuals who don’t own a cash value insurance policy typically aren’t eligible for a life settlement. Therefore, term life insurance policyholders do not qualify. Individuals must own permanent life insurance like whole life or universal life with a cash value component in order for their policy to be appealing to potential third-party buyers. They also must be at least 65 years old or have certain qualifying health issues to sell their policy.
Once a policy is sold, the buyer is responsible for paying all the policy premiums until the insured passes away. At that time, the death benefit of the policy is paid out to the buyer. Essentially, the buyer is the owner and the beneficiary of the policy, and the seller is the insured.
Here’s an example of how a life settlement works:
Jay is a 40-year-old male who buys a $5 million insurance policy with annual premiums of $80,000. At age 70, Jay decides he no longer wants to keep his policy in force and would rather sell it for a cash sum. The current cash value of the policy is $3 million.
A life settlement investor offers Jay $3.5 million for his policy—16% more than the cash value. The investor continues to pay premiums for 10 years until Jay passes away, totaling an additional $800,000. All in, the investor has paid $4.3 million. The insurance company pays the investor the $5 million death benefit, a 16% return for the investor before taxes and broker fees.
Life settlement investing is interesting in that one typically is required to have insurable interest on the insured in order to take out a policy in their name. For example, spouses, parents, and children all have insurable interest because they would be negatively affected financially if one were to pass away. Similarly, business partners may also take out insurance policies on one another. But with a life settlement, the third-party owner need not have any financial relationship to the insured other than the contractual obligation outlined in the life settlement.
THE HISTORY & FUTURE OF LIFE SETTLEMENTS
In 1911, Justice Oliver Wendall Holmes Jr. opined in the case of Grigsby v Russel that policyholders have the right to sell their insurance policies to third parties, and the U.S. Supreme Court ruled that insurance policies are indeed considered assets which can be sold. But it wasn’t until several decades later that life insurance investing became a wealth strategy utilized by big banks and accredited investors.
During the late 1980s and early 1990s, at the height of the HIV/AIDS epidemic, those diagnosed with terminal illness sought to sell their insurance policies as viatical settlements, which are essentially life settlements for the terminally ill. The need for immediate funds for medical treatment or better quality of life, given their short life expectancy, outweighed the benefit of keeping the policy in force.
Then, with the Great Recession in the early aughts, many more turned to life settlements to replace retirement savings lost during the market crash. Most recently, selling life insurance policies has been a way to avoid loss for those whose employment was affected by COVID-19.
The life settlement industry is still growing. Conservative estimates project it at $50 billion with potential to reach upwards of $200 billion in the next 10 years. An aging population with little retirement savings plays a major driving factor in the growth of the industry, as do rising medical costs that create immediate cash needs for some policyholders.
PROS & CONS OF INVESTING IN LIFE SETTLEMENTS
With such impressive projected growth, life settlements may seem like a great wealth strategy, but you should be aware of the pros and cons associated with this type of investment.
- The insurance industry is heavily regulated and there is little risk of an insurer not paying out a death benefit on a life settlement.
- Life settlements typically provide a high rate of return, averaging anywhere from 8% to over 12%.
- Life settlements aren’t tied to the stock market or interest rates, and are therefore protected from market and economic volatility, and diversify an investment portfolio.
- Life settlements are usually positive for both the seller and the buyer, as the seller receives significantly more for their policy than they would selling it back to their insurance company, and the buyer typically makes a healthy profit.
- Life settlements are generally mid- to long-term investments, not to be relied on for a quick return.
- Significant upfront capital is required to purchase someone else’s life insurance policy.
- Life settlement investing is usually limited to high-net-worth, accredited investors, creating barriers to entry for some individuals.
- Policy premiums must be paid for the duration of the policy to keep it from lapsing, which would void any investment opportunity.
- If the insured outlives their projected life expectancy, returns go down, as the investor must pay more in premiums to keep the policy in force.
- Investors do not receive the tax benefits associated with owning life insurance and will owe taxes on the death benefit, minus purchase price and premiums paid.
- Life settlements can be complicated to manage and typically require management or brokerage fees that reduce profits.
INVESTING: GETTING STARTED
Due to the credentials required to invest in life settlements, directly purchasing one isn’t an option for the majority of investors. In addition to being highly regulated, federally and by state, individuals must earn a minimum of $200,000/year or have a net worth of at least $1 million to be considered accredited.
Assuming you meet this criteria, the first step in investing is working with a qualified broker to participate in life settlement investment auctions, where you bid on a life insurance policy and the seller will transfer ownership to the highest bidder. In addition to paying the seller for their policy, you’ll also owe fees to the broker, usually around 30% of the settlement price plus a settlement fee.
Once the policy is purchased, you are responsible for paying premiums until the insured passes away, at which point you will receive the death benefit payout.
Non-accredited investors may purchase a fraction, or share, of a life settlement as part of a pension plan or trust. Life settlement shares may also be purchased through private equity funds. Investment funds have the added benefit of being more diverse. Fees are significantly less than purchasing a stand-alone policy directly; you’ll likely pay a management fee up to 2%.
With investment funds, you’ll receive regular quarterly payments. Because these funds hold hundreds of policies, the flow of policies maturing and new policies being purchased sees a more consistent cash flow.
LIFE SETTLEMENT INVESTING ALTERNATIVES
Life settlement investing is a growing market, but its barriers to entry make it a niche financial strategy for most individuals. Fortunately, there is an alternative option that features some of the same benefits—the Perpetual Wealth Strategy™.
With the Perpetual Wealth Strategy, you use your own life insurance policy to grow wealth via a guaranteed rate of return, tax advantages, and potential dividends. The key is properly structured whole life insurance via a mutually owned, highly rated insurance company. Unlike typical whole life insurance, notorious for its slow growth and lackluster returns, the Perpetual Wealth Strategy utilizes insurance in a Wealth Maximization Account™ that is structured for rapid growth and optimized to function at the maximum-allowed, tax-advantaged level outlined by the IRS tax code.
These uniquely structured policies, like life settlement investments, are not tied to typical markets like stocks, bonds, or real estate and are protected from market volatility. They can act as buffers for retirement and even provide tax-free retirement income. In addition to a guaranteed rate of return, mutually owned whole life insurance also earns non-guaranteed dividends, which increases overall growth. The top-rated mutual insurance companies we work with at Paradigm Life have historically paid out dividends for over 100 years.
With properly structured whole life insurance in a Wealth Maximization Account, you pay annual insurance premiums—a portion of which goes toward the policy’s death benefit and administrative fees. The rest is reflected in the policy’s cash value account, which you can access at any time. Cash value can be withdrawn or it can be borrowed in the form of a tax-free policy loan. To supercharge growth, you can also contribute funds above your premium in the form of paid-up additions — essentially allowing you to overfund your policy.
Wealth Maximization Account policies can be purchased by individuals or they can be purchased in a trust. The benefit of the latter is additional tax protection, particularly from estate, gift, or inheritance taxes. In an irrevocable life insurance trust (ILIT), policies are ideally situated to create generational wealth.
If you already have a permanent life insurance policy that isn’t performing the way you want it to, you may have the option of transferring it to a Wealth Maximization Account. This is done through a 1035 exchange and allows you to keep as much of your existing cash value as possible without tax implications.
Paradigm Life is not a life settlement broker, but if you’re looking for financial tools that help diversify your portfolio and provide protection from market volatility, a Wealth Maximization Account is ideal. We work with the nation’s top-rated mutual insurance companies to help you find a policy that fits your financial goals.
In addition to a paid-up additions rider to supercharge your policy’s growth, we can also customize your policy with riders that allow you to access your policy’s death benefit in qualifying situations, like for long-term care, if you become disabled, or if you are diagnosed with certain illnesses. In today’s environment of rising healthcare costs, these riders can provide you and your family with critical funds and can even be structured in such a way that you no longer have to pay insurance premiums.
At Paradigm Life we can customize a policy to fit your financial situation. Our expert Wealth Strategists are available to answer your questions and show you customized illustrations, outlining an individual plan of action to help you achieve your goals.
At Paradigm Life, we know that millions of people follow out-of-date financial advice that prohibits the future they deserve. Perpetual Wealth 101 consists of a series of free videos that teach you The Perpetual Wealth Strategy™ and guide you to a secure financial future.