WHAT IS THE ASSET?

An investment in an individual life insurance policy or a fund that purchases multiple policies in exchange for potential returns after a stated period. Investors can begin with one investment and later add to their portfolios with more funds, fractional policies, or individual policies when they have reached a certain level of competence in the asset class.

Where a high-equity cash value policy is more of a high-yielding cash flow management account, a life insurance settlement has a more traditional risk vs. reward profile.

I was initially attracted to this asset class because of its low correlation to the stock market. While I’m hesitant to say that this asset class has zero correlation—because if the stock market collapsed to unimaginable levels, there would be negative effects on the financial longevity of any insurance company—it still has a significantly lower correlation to the market than other more well-known assets. Ultimately, whether or not the market is in a bear or bull mode, it’s a fact of life that people eventually die. And I think that’s a much safer investment philosophy than trying to guess the short-term direction of the market.

As an investor in this space, you have three ways to participate:

Option 1 — Purchase a policy directly through a broker. This is not an ideal starting point since there will be a significant learning curve with broker relationships and understanding the variables. More importantly, brokers might not take you seriously without a significant cash outlay. Brokers need to know you are serious, and this takes time. Direct purchase should be reserved for experienced investors only.

Option 2 — Make a direct fractional purchase. This takes place when a larger settlement gets broken into smaller pieces for investors to divide amongst themselves. This is a better option for new investors, but only if you know the other investors in the deal and find trustworthy underwriting. When new to this space, it might be better to buy a portfolio of a few different fractionalized deals than burn all of your investment capital on one deal.

Option 3 — Invest in a fund. This makes the most sense for a new investor in this space. Just like a fractional purchase, you pool your money with other investors and allow a fund manager to assemble a portfolio of life insurance settlements. This option is better because it gives you instant diversification, and your only major responsibility is vetting the fund manager. While not an easy task, it’s only done once, as opposed to vetting every new settlement that comes your way. The only negative is that with most fund models, the investor needs to be accredited and wouldn’t be able to participate in the fund without having a third party or accounting/legal professional certify their accredited status. After you do this process once, it usually becomes second nature, but it is a hurdle every time I speak to a new investor. The other nuances are that you would be considered a partner in the fund, which requires a partnership tax return known as a Schedule K. This is done on your behalf by the fund’s accountant but it’s not unusual for these returns to be filed late, creating a need for filing extensions on your own personal tax returns.

In the case of investing in a fund, you’ll find that they often purchase a consistent type of policy held by individuals with a similar age profile (for example, a minimum age of 91). This way, the fund can establish a model for returns based on the average life expectancy remaining of the underwritten group.

PRO TIP: If you see a fund that invests in various population segments instead of focusing on one specific group, that’s probably a red flag that the fund isn’t being selective enough.

When your fund experiences a capital event, the disbursements that follow are guaranteed by insurance companies that are highly rated by agencies like AM Best, S&P, Moody’s, and Fitch Ratings. While the agencies all use slightly different metrics to develop those ratings, the most common are:

• How safe is the company’s balance sheet?
• What is the risk/reward profile of the investments made by the company?
• How solvent is the company?
• How much leverage is the company taking on?
• What actions are in place to mitigate risks?

In order to be able to compare the ratings among different rating agencies, a composite score was created called the Comdex ranking, which is based on the combined rankings. Where individual agencies have a letter system with different variations for quality (such as A+ vs. A++, or A1 vs. Aa3), the Comdex ranking has a simple numerical assignment of value from 1–100. As of January 2020, a few companies, like Northwestern Mutual and New York Life, had perfect scores, and at least 25 other companies had a rating of at least 90 or above. For context, as of this writing, Disney currently has a BBB+ S&P rating, which is lower than all 25 life insurance companies. To be fair, Disney did suffer a COVID-related debt downgrade, but even with its previous A rating, this would be lower than the 25 insurance companies.

The Pros and Cons of Life Insurance Policy Investing

PROS

• This is a relatively unknown niche within a robust industry
• Offers attractive expected returns
• High credit quality of insurance companies
• Low correlation to other assets
• Investing in a guaranteed life event: death

CONS

• Expected returns can take years to trickle in
• Policy needs to be kept up to date
• Underestimated premiums may cause a capital call—payment of a portion of funds promised by investors
• Negative ethical connotations
• Potentially high investing fees
• Actuary’s determination of how long the fund’s insured pool will live could be inaccurate, leading to significant investment losses

If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways. 

Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.