The essence of a life insurance policy’s attractiveness to the life settlement industry lies in its pricing, which takes into account multiple factors, including the value of the policy, expected future premiums to keep the policy in force, the age and sex of the insured, and their life expectancy (driven largely by types and severity of health impairments).
That’s partly why universal life insurance policies are the most common policy type purchased on the secondary market (and, therefore, on the tertiary market).
Universal life policies can accumulate a cash value, which earns credited interest, and policyholders can adjust their premiums to paying only the minimum cost of insurance charge, a key benefit in terms of cash flow for an asset manager. A universal life insurance policy ‘prices’ well for a life settlement investor.
Whilst universal life is the most common type seen in the market, others can price favourably as well. Whole life, where the premiums are fixed amounts, are not commonplace, however.
Whilst not yet robust in life settlement transactions, variable life insurance policies also make their way into the market on some level. These policies are considered to be securities because the investment risk of the amounts credited to be invested in the policy’s account is borne by the policyholder.
For a life settlement asset manager to buy these, they must go through a broker dealer (life settlement brokers are licensed entities, but not usually also as securities brokers). Additionally, if a fund invests a significant amount (40% or more) in variable life insurance policies compared to the rest of its non-securities assets, then the fund will be an “investment company” regulated under the US Securities Exchange Act of 1934, which adds a layer of regulatory scrutiny (and cost), so variable life is seen less frequently.
Another type of life insurance that is seen in the life settlement market is term life. According to life insurance industry trade group the American Council of Life Insurers (ACLI), in 2022, 39.3% of all new life insurance policy sales were term life.
However, despite being almost 40% of the US life insurance industry overall, term life policies don’t make up nearly as much of a corresponding percentage of the life settlement space.
There’s a simple reason as to why.
“The vast majority of term life policies are not an attractive asset because these policies insure the life of the insured for a finite “term” which cannot be extended,” says Michael Freedman, CEO of Lighthouse Life.
“Most managers are unable or unwilling to invest in the purchase and maintenance of a term policy due to the risk of losing the entire investment if an insured lives beyond the finite term,” Freedman continued.
Term life policies that can be converted to a permanent life policy (typically a universal life policy) eliminate that risk and can become an asset that many funds will acquire. For a fund to accept a term policy, it must contain the conversion feature, which must be exercised by the policyowner before the conversion feature expires, and the permanent policy that it is converted into must be acceptable for a life settlement. Most commonly, eligible term policies are converted by the original owner prior to a life settlement.
It’s these convertible term policies that can be interesting to the life settlement market. A recent court case filed by an insurance company, however, has brought renewed attention to whether a new owner can first purchase a convertible term policy and subsequently convert the policy after it was the subject of a life settlement.
Ameritas Life Insurance Company v. Wilmington Trust, N.A., filed on 25th March in California, has raised the topic of whether a secondary market policyholder must have an ‘insurable interest’ in the life of an insured when a term policy is converted. Essentially, the case is asking whether, by converting a life insurance policy owned by a third party, a situation of an illegal wager on human life will be created.
The life settlement industry will be watching this case with interest. But, regardless of the outcome, universal life will still remain the preferred type of life insurance for the market.
“Historically, and going forward, universal life insurance policies will remain the dominant type of policy for life settlement investors because universal life has the most attractive combination of cost, flexibility and benefit,” says Freedman.
“We will continue to see the strongest demand from fund managers for this type of policy than term or whole life policies.”
