Although the secondary and tertiary markets for life insurance policies are relatively new, these markets were more than 100 years in the making. The life settlement market would not have originated without a number of events, judicial rulings, and key individuals.

The U.S. Supreme Court case of Grigsby v Russell, 222 U.S. 149 (1911),  established a life insurance policy as private property  which may be assigned at the will of the owner. Justice Oliver Wendell Holmes noted in his opinion that life insurance possessed all the ordinary characteristics of property, and therefore represented an asset that a policy owner may transfer without limitation. Wrote Holmes, “Life insurance has become in our days one of the best recognized forms of investment and self-compelled saving.” This opinion placed the ownership rights in a life insurance policy on the same legal footing as more traditional investment property, such as stocks and bonds. As with these other types of property, a life insurance policy could be transferred to another person at the discretion of the policy owner.

This decision established a life insurance policy as transferable property that contains specific legal rights, including the right to:

In the 1980s, the U.S. faced an AIDS epidemic. AIDS patients faced short life expectancies, and they often owned life insurance policies that they no longer needed or could afford. As a result, the viatical settlement industry emerged. A viatical settlement involves a terminally or chronically ill person (generally with less than two years life expectancy) who sells his or her existing life insurance policy to a third party for a lump sum of money. After the viatical settlement transaction, the third party becomes the new owner of the life insurance policy, pays the premiums, and receives the full death benefit when the insured dies. Because of medical advancements, people with AIDS started living longer, and, therefore, viatical settlements became less profitable. As a result, the life settlement industry arose.

A life settlement is similar to a viatical settlement, but in a life settlement transaction, the insured is typically at least 65 years old and is not chronically or terminally ill.

In 2001 the National Association of Insurance Commissioners (“NAIC”) released the Viatical Settlements Model Act, which set forth guidelines for avoiding fraud and ensuring sound business practices. Around this time, many of the life settlement providers that are prominent today began purchasing policies for their investment portfolio using institutional capital. The arrival of well-funded corporate entities transformed the settlement concept into a regulated wealth management tool for high-net-worth policy owners who no longer needed their policies.

On April 29, 2009, the United States Senate Special Committee on Aging conducted a study and came to the conclusion that life settlements, on average, yield 8x more than the cash surrender value offered by life insurance companies.

Life Settlement Providers

Life settlement providers serve as the purchaser in a life settlement transaction and are responsible for paying the seller of the life insurance policy a cash sum greater than the life insurance policy’s cash surrender value but less than the death benefit. The top life settlement providers in the industry fund many life settlement transactions each year and either hold the seller’s policy as a portfolio asset or sell it to a financing entity. These life settlement providers are experienced in the analysis and valuation of life insurance policies with high death benefits and work to locate sellers of life insurance policies that meet a financing entity’s requirements. Life settlement providers often have in-house compliance departments that carefully review transactions and, most importantly, typically are backed by institutional funds.

Approximately 43 states regulate, to some extent, the sale of life insurance policies to third parties.  In the states that regulate viatical and/or life settlement transactions, life settlement providers must obtain a license from the appropriate state agency.

Brokers

Generally, a life settlement broker is a person who represents a seller of a life insurance policy and, for compensation, solicits, negotiates, or offers to solicit or negotiate a life settlement contract. As with life settlement providers, in the states that regulate life settlements, a person must be licensed to act as a life settlement broker and often must take continuing education courses. 

A life settlement broker, in exchange for a fee, will shop a life insurance policy to multiple life settlement providers similar to how a real estate broker solicits multiple offers for one’s home.  Compensation arrangements for life settlement brokers may vary significantly and should be fully disclosed to and understood by the seller to determine whether engaging a life settlement broker will benefit the seller. 

In states that regulate life settlements, there are laws pertaining to procedure, privacy, licensing, disclosure, and reporting, which if violated, may subject the life settlement broker to penalties.     

Investors

Life settlement investors often are known as financing entities because they are providing the capital or financing to purchase life settled life insurance policies from life settlement providers. Life settlement investors may use their own capital to purchase the policies or may raise the capital from a wide range of investors through a variety of structures. The life settlement provider is the entity that enters into the transaction with the policy owner and pays the seller of the life insurance policy when the life settlement transaction closes. Often, the life settlement provider has a written agreement with a financing entity to provide the life settlement provider with the funds needed to acquire the life insurance policy and transfer the life insurance policy to the financing entity or its designee. In such a scenario, the life settlement investor effectively is the ultimate funder for both secondary and tertiary life settlement market transactions. However, in some life settlement transactions, the life settlement provider uses its own capital to purchase the life insurance policy for its own investment portfolio.   

Life Expectancy Providers

Life Expectancy Providers (LEPs) are specialized independent companies that issue life expectancy reports (LERs) that estimate the life expectancy (LE) of an individual whose life is insured under a life insurance policy.  LEs are not a prediction of how long an individual will live, but rather are the average survival time amongst a particular risk cohort.  Risk cohorts are typically grouped by age, gender, smoking and relative health/morbidity. A LE is a key component in the pricing of a life insurance policy for purchase of a life insurance policy both in the secondary and tertiary markets.

LEPs are typically made up of actuaries and medical underwriters who utilize actuarial models based on published or proprietary mortality (life) tables and medical underwriting based on various debits/credits for various morbidity characteristics similar to the medical underwriting performed by life insurance company underwriters and reinsurance underwriters. Until recently, the most commonly used mortality table was the 2001 Valuation Basic Table (VBT) published by the Society of Actuaries based on data supplied by contributing life insurance carriers. In 2008 the Society of Actuaries published a new table, the 2008 VBT that is based on 695,000 lives representing $7.4 Trillion in death benefits which is almost 3 times more lives than the former 2001 VBT. Included with 2008 VBT are relative risk tables (RR Tables) that separate insured lives into various underwriting categories based on the health/morbidity of the insured at the time the policy was issued. Note that no impaired lives are included in any of the RR tables, but rather were designed for companies that subdivide their standard policies into more than one sub-class. Most LEP’s have factored in the experience data underlying the 2008 VBT, as well as their own experience data and other factors, as a basis for their mortality tables. This resulted in a significant lengthening of average LEs in the fourth quarter of 2008 for some LEPs. All major LEPs have continued the practice of developing and using proprietary and confidential mortality tables based on extensive medical research and mortality experience. One new LEP has adopted the use of the 2008 VBT RR Tables as a replacement for proprietary multipliers, despite the fact that Relative Risk Factors are in their infancy and not designed for impaired life nor life settlement underwriting.

Regulation

As previously stated, most states regulate life settlement transactions and, in most instances, restrict the sale of a life insurance policy until two or more years after the life insurance policy’s issue date.  However, as of January 2018, the states of Michigan and New Mexico only regulate viatical settlements and not life settlements, while the states of Alabama, Hawaii, Missouri, South Carolina, South Dakota and Wyoming do not regulate viatical settlements or life settlements at all.

Major Study Findings

An academic study that showed some of the potential of the life settlement market was conducted in 2002 by the University of Pennsylvania business school, the Wharton School. The research papers, credited to Neil Doherty and Hal Singer, were released under the title “The Benefits of a Secondary Market For Life Insurance.” This study found, among other things, that life settlement providers paid approximately $340 million to consumers for their under performing life insurance policies, an opportunity that was not available to them just a few years before. It also has been stated by Neil A Doherty, the professor at Wharton, that this practice drives up the cost of insurance to all other consumers purchasing life insurance.

“We estimate that life settlements, alone, generate surplus benefits in excess of $240 million annually for life insurance policy holders who have exercised their option to sell their policies at a competitive rate.” – Wharton Study, pg. 6

Another study by Conning & co. Research, “Life Settlements: Additional Pressure on Life Profits.”   This study found that senior citizens owned approximately $500 billion worth of life insurance in 2003, of which $100 billion was owned by seniors eligible for life settlements.

A life insurance industry sponsored study by Deloitte Consulting and the University of Connecticut came to negative conclusions regarding the life settlement market.

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