Many retirees, already struggling with rising health care bills, have been hit recently with the unexpected news that they will soon be facing an increase in their life insurance premiums. This can be especially painful for those seniors who were already unprepared for retirement.
On the other hand, the opportunities have never been better for seniors who can no longer afford their life insurance premiums to sell them through what is known as a life settlement: the sale by the owner of a life insurance policy to a third party for an amount greater than its cash surrender value and less than the death benefit. The seller of the policy gets a cash payment. The buyer of the policy assumes all future premium payments and receives the death benefit upon the passing of the insured.
Opportunities for seniors to receive better offers on their life insurance policies continue to increase as the asset class becomes more attractive to institutional investors. One of the key reasons we are seeing more interest from institutional investors in purchasing these policies is because of a changing financial environment with respect to – of all things – bond yields.
The Wall Street Journal reported last week that, for the first time in history, three-month U.S. Treasury bonds were sold with a yield of zero. In other words, investors had such high demand for these government bonds, they were willing to purchase them without receiving any return at all. The yield has been zero in such auctions several times in the past month, and the one-month treasury has recently had a negative return – investors who purchased these bonds lost principal!
The article suggests that these yields are so low because investors now believe that the Fed will not raise interest rates this year, driving stocks higher and less risky assets lower.
This situation illustrates a number of qualities inherent in life settlements that could be attractive to institutional investors. Obviously, non-correlation is one such advantage. While bonds can be driven literally below zero due to policy moves, or lack thereof, by the Federal Reserve, performance in life settlements is driven by mortality. It thus does not rise and fall with the broader markets, and thereby provides a unique ability to diversify a portfolio.
In addition, life settlements offer a similar risk profile to bonds in that credit risk plays a large role in both assets. The more likely an issuer is to be able to make good on the bond obligation, the lower the yield. For very good credit risks, like the US Government, that yield is very close to zero. For highly rated corporate bonds, which are slightly more risky, the yield is still well below 5%.
Life settlements that are backed by A-rated insurance carriers similarly carry very little credit risk. In fact, no US life insurance carrier has ever defaulted on a death benefit, regardless of carrier rating, in the history of the insurance industry. What’s more, insurers are highly regulated, with reserve requirements and strict rules on investment. Many insurance companies pay into state funds to provide a back stop in the event of a default.
Despite this compelling credit risk profile, life settlements continue to trade with yields in the low to mid-teens. While the zero bond yield is on shorter term assets that do not present longevity risk, it is hard to argue that these factors justify more than a 1000 basis point gap in yield. Life settlements thus offer a premium to fixed income on a risk-adjusted basis. Particularly in a low interest rate environment (and it can’t get much lower than zero), life settlements provide investors with a welcome opportunity for yield.
About the Author:
Dan Young, CLU, ChFC, CASL, is the President of Magna Life Settlements, Inc., a well-established life settlement provider focused on maintaining transparency, risk management and rigorous process control in the purchase of life settlements. Magna is owned by Vida Capital, a vertically integrated asset management company providing longevity contingent investment solutions to institutional and individual investors. Dan is the Vice President, Asset Management and General Counsel of Vida.
In addition to his role at Vida, Mr. Young is an adjunct professor of regulatory law at the University of Texas Law School, Board Member and Chair of the Legal Committee of the Institutional Longevity Markets Association (ILMA), Board Member of the Life Insurance Settlements Association (LISA), and a frequent speaker at life settlement industry conferences. Prior to joining Vida Capital, Mr. Young was the President and CEO of New York Life Insurance Company’s Broker-dealer and Registered Investment Advisor. Mr. Young graduated from Stanford University with Honors and Distinction and from the University of Chicago Law School with Honors.