Guest Contributor: The Life Insurance Secondary Market, An Emerging Class in Alternative Investments
By Bill Acheson, Chief Financial Officer of GWG Holdings, Inc. (NASDAQ: GWGH)
This past summer, S&P Dow Jones Indices and MSCI moved stock exchange-listed equity REITs and other listed real estate companies from the financials sector of their Global Industry Classification Standard (GICS) to a new real estate sector. In late September, BlackRock and Artivest announced a partnership to provide better access to alternatives.
These are just two examples of the validation of the importance of alternative investments by market participants and investors alike. “Alts” have arrived on Main Street and are here to stay. One alternative investment that tends to be little understood among advisors, agents and the consumers they serve is one that invests in the life insurance secondary market (LISM).
Here’s a primer on the secondary market for life insurance policies and how they can be used to supplement retirement income for seniors.
What is the Life Insurance Secondary Market?
Although the life insurance secondary market as we know it has been around since the 1980s, it is still relatively unknown, even within the alternative investment community.
In the life insurance secondary market, firms buy life insurance policies from people (usually seniors aged 65 years or older) who no longer want, need, or can afford them. Many policy owners — as well as their advisors — don’t realize that a life insurance policy is an asset with property rights, and, just like a house, or car, can be sold for fair market value.
In these transactions, generally known as life settlements, LISM companies typically offer policy owners five-to-eight times more than the cash surrender value (CSV) of the insurance policy. The firms (and not the policyholder) continue to pay the premiums and ultimately collect the death benefit. Policy owners can also elect to accept less or no cash up front and retain a portion of the policy benefit, without future premium payment obligation. This is known as a retained death benefit option. Policy owners can sometimes get a combination of cash and retained death benefit – both without paying additional insurance premiums.
In one example of a combination settlement, a man in his 80s was able to sell his $1 million face amount policy for $115,000 and keep $250,000 of the policy’s benefits, with no further premium obligation. His CSV at the time of the transaction was $14,000.
Why would a policy owner sell their policy?
There are many reasons why someone may wish to sell their policy. It’s usually one of three reasons: the policy owner no longer wants, needs or can afford the policy. Selling a life insurance policy can be an attractive option for seniors looking to fund retirement and pay for medical expenses. Financially secure seniors with grown children in well-established careers, may opt to reinvest the funds or use them to enhance their post-retirement lifestyles.
Why would a firm buy a life insurance policy?
Private companies are able to pay policy owners more for their policies than the insurance companies cash surrender value for two reasons: 1) the high lapse rate built into the premiums of the insurance, and 2) health changes of the insured since the policy was originally issued. These and other factors can create a situation where the market value is significantly higher than the CSV.
According to the Life Insurance Settlement Association, approximately 88 percent of universal life policies lapse or surrender before a claim, meaning the issuing insurance company never pays the death benefit. In 2014 alone, $602 billion in insurance benefits were surrendered or allowed to lapse.
During the past decade, our firm has purchased more than $2 billion in life insurance policy benefits and paid seniors nearly $353 million more than the surrender value of those policies.
The future looks bright for the Life Insurance Secondary Market
According to Conning Research, there is approximately $12 trillion of individual life insurance in force. This large — and still growing — market will continue to create opportunities for policy owners to realize significant value for their policies. It will also drive the growth of the secondary market for life insurance. As consumer awareness increases, so will the size and velocity of the secondary market and those companies that are well positioned within it.
The life insurance secondary market also benefits from a high level of regulation, with 42 states having regulations in place that cover more than 90 percent of the US population. It is a market that serves policy owners and their families well. According to the National Association of Insurance Regulators, there has been only one consumer complaint about this industry since 2013.
Approximately 10,000 people turn 65 every day. For those who own life insurance policies that no longer fit their original purpose, the life insurance secondary market may be a valid alternative.
The opinions in the preceding commentary are those of the author alone and do not necessarily reflect the views of The DI Wire.