Life Settlement Investment – Scam or Legit?

by Darwin on March 28, 2011

Life Settlement Investment – Scam or Legit? A friend of mine sent me an interesting “investment opportunity” today which entailed what seemed to be some sort of sales pitch, wining and dining with an investment advisor who has access to life settlement products.  What was purported in the PDF invite letter immediately raised a red flag for me.  He promised “guaranteed 7% returns or more with no risk of loss“.

No Risk of Loss?

To me, no risk of loss means one of two things.  Either an FDIC insured account under the present limit of $250,000 or a US government issued bond.  Ironically, even the latter is being questioned by a substantial portion of Americans these days.  But let’s face it, the government can always issue more debt, so at least in terms of our US fiat currency system, Treasuries should be considered “safe”, hence they are usually used as a benchmark as a “risk-free rate of return”.  Nonetheless, what I wanted to point out was that given your best Savings Rates, CD Rates [listings of best available in your area] and long-duration Treasury yields, you can’t even get 4%.  So, how could someone offer a 7% yield risk-free?

That was red flag number 1.

Ever since the market crash in 2008-2009, something that financial advisors and marketers have latched onto is the mantra like “Why gamble in the stock market?”, “Stocks have gone nowhere in 10 years!” and basically use the prior decade’s lackluster market performance to induce fear and push you into alternative investments.  Sometimes, these alternative investments benefit them and not you given their commissions earned.  You take the risk, they take home the commissions.  Nice arrangement – for them.

What is a Life Settlement?

Basically, let’s start with an individual policy.  You’ve got a guy who has some terminal illness.  He’s burned through all his cash and his doctor assures him he only has a year to live.  He has a $1Million insurance policy that is tantalizingly attractive and cash-rich but he can’t touch it until he dies.  OK, then he can’t touch it either – but his heirs can.  Well, in comes the “financial innovation”.  An investor can come in and offer this poor lad $500,000 for his policy so he can remain in his home, pay for his medical bills and have some semblance of dignity in his final months rather than dying a vagrant as he depletes his assets and loses his home.  In this scenario where there’s no alternative, selling his life insurance policy may well be a better option than just waiting around do die.  Surely, his heirs lose out, but is that really priority #1 to make your kids rich when you die?

Now, that first example sounds rather morbid and one might wonder if investors are “profiting from death”.  Another common scenario though is a simple case where a person just wants the money or perhaps can’t afford to pay the premiums anymore.  Rather than letting the policy lapse and get nothing, they figure, they’ll sell it for cash now.  The investors continue to pay the premiums to keep the policy going and the seller gets up-front cash.  Of course, there’s a profit in there for the investors, but isn’t that only reasonable given the risk they’re taking?

So, you can see where this vehicle has some value to people on either side of the equation.  What’s a little more murky is the tangential issues, which we’ll get to.

Why Invest in Life Settlements?

As an investor seeking the benefits of diversification, a high investment return, non-market correlated returns and simple portfolio diversification, at face value, this “investment” seems like a winner.  After all, if all pans out as planned, it’s the equivalent of a 7% or higher CD.  Sure, your money’s locked up for some period of time, but where else can you earn 7% without any volatility?  To further blunt risk of individual policy expectations not being met, firms securitize (remember that word from the mortgage mess?) many policies into a single fund and then allow investors entrance to the fund through shares or a transaction similar in nature.  These days, many pension plans are modeled to return about 7% per year while trying to minimize volatility.  If high-paid pension plan managers are satisfied with 7% returns, shouldn’t you be as an individual investor?  If things worked out that way, sounds like a decent investment.

How to Invest in Life Settlements

Apparently, the market is pretty robust these days.  Once relegated to life insurance companies, hedge funds and pension fund managers, now retail investors are being enticed with the prospect of high yields and low volatility.  While I haven’t gone to see the financial professional advertising the life settlement investments, I checked in with a friend of mine who’s a CPA, Financial Advisor, etc.  He said the premium over risk-free rates IS warranted and real because it’s a rather illiquid market and your money is tied up for a while.  Of course, scams could abound, so it would behoove you to know and trust the entity selling the policies.  In my case, I don’t know this guy at all so I’d need to research further before taking it seriously.

Where Can Life Settlement Fraud Occur?

Everywhere.  That’s what gives me pause.  Here are a few examples of where things could go south and as an investor, you don’t get nearly the return you anticipated:

  • The fund doesn’t actually use your money to buy the life insurance policies, but just spends it on something else – like their own salaries, real estate or some other asset
  • The insured end up living longer than anticipated.  This happened a few decades ago when the industry relied on AIDS patients for income and rather than dying on the projected timeline, those darned pharmaceutical companies developed life-saving drugs that extended their lives, so many of those AIDS patients have now even outlived the initial investors themselves!  Talk about poetic justice?  So, in this vein, as medical advances continue, life expectancy in your pool may increase beyond the actuarial assumptions.Congress could eventually act to start taxing these premiums as income instead of treating them as non-taxable payouts to beneficiaries (since let’s face it, these are investments).
  • The investment fund could end up being a Ponzi scheme.  There are dozens of articles out there over the years highlighting those situations.
  • The seller of the initial policies may have overemphasized the health risk of the insured, thus boosting the “assumed yield” with predictions of a near-term death, while they end up expiring much later.

If you put aside the notion that this is a rather morbid way to make money at face value – there are benefits and risks.  I could envision some unexpected scenarios where I might end up either in court or out of luck altogether in trying to recover the returns I was initially promised.  However, since I have virtually all my investable net worth tied up in equities globally, I could use some diversification and the prospect of a non-correlated 7% return is very appealling.

I’m not sure if I’ll pursue this opportunity any further, but as usual, about once a day, some new financial topic pops into my head or enters my personal life and I feel compelled to write about it.  So, there you have it.  Life Settlements.

Would You Invest in Life Settlements?

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