Trend towards smaller policies in life settlements

The average life settlement is for a life insurance policy with a face value between $1.5 million to $2 million. However the average face amount of a life insurance policy is $320,000. So why the disconnect? Why is the average face value of a life insurance policy sold in a life settlement so much higher than the average face amount of an in force life insurance policy?

For a long time, selling life insurance in a life settlement was reserved for insureds that were terminally ill. This was particularly true in the late 1980's up until the late 1990's. During this time, life settlements for terminally ill people, also known as viatical settlements, were a popular strategy for AIDS patients who needed money for medical treatment and living expenses.

As AIDS patients began to live longer with improved medical treatments, investors began to look elsewhere for life insurance policies. At the same time, more and more investors were looking to buy existing life insurance policies. The buyers turned their attention to healthy seniors.

In the late 1990's, healthy seniors were embraced by financial institutions interested in buying their existing life insurance policies. Since a life settlement is really the sale of an asset for cash, it was wealthy seniors that first participated in life settlements of healthy insureds. It makes perfect sense. The wealthy are more often insured, because they are more proactive with estate planning and simply have more to insure. In addition, a wealthy senior will have the expertise of financial planners, estate planners or estate attorneys at their disposal. That means an expert may be the one to identify, suggest and assist in life settlement transaction. Rather than the senior having to figure out that they can sell their life insurance policy for cash. In addition, wealthy seniors may be more likely to adjust their insurance to reflect the changing size of an estate.

Conversely, financial institutions are attracted to higher face value policies (higher meaning in the low millions, not the hundreds of thousands of dollars). The same amount of administration and underwriting go into a $5 million policy as that of a $50,000 policy. The difference is that the return in real dollars is much higher with higher face value policies.

So why the trend in smaller policies? The amount of life settlement providers has increased significantly since the late 1990's. Life settlements were seen as a very exotic, almost edgy investment. However, they return a very attractive 8-12% on average for the investors that buy policies. Those are great, uncorrelated returns that any Wall Street firm can be proud of. So other financial institutions took notice and the club of buyers has grown. Now big name banks from Main Street, hedge funds, investment funds, investment banks and even high net worth private investors are competing for policies to buy in a life settlement. With increased competition they have to look for new sources of deals if they want to be able to buy policies...i.e. smaller policy sizes.

So the policy size that life settlement providers (buyers) are willing to consider for purchase has decreased. The most common lower limit of a policy face value that a life settlement provider will consider is $250,000 or $100,000. However, a select few life settlement providers will consider policies with a face value of just $50,000.

There is a problem with smaller face value policies. It is much more challenging to absorb all of the life settlement provider expenses, offer the policy seller an attractive price and still make a profit. So the smaller policy sizes are a growing area of interest for buyers, but they have a smaller margin of error in their purchase. It is inevitable that the average face value of a life insurance policy selling in a life settlement will much more closely match the average face amount of an in force life insurance policy sooner rather than later.