What about the big policies?

Life settlement broker commissions are often a hot topic in the life settlement industry. A common question that comes up is “doesn’t it take the same amount of work to sell a large policy as it does a small policy?” Which inevitably leads to the question, “well then shouldn’t the broker’s commissions be reduced for the larger policies?” First, a shameless plug for Amrita Financial - All of our commissions are essentially reduced with our direct to consumer model since we refund half of the commission amount to policy sellers. That not withstanding, lets apply the question to traditional bricks and mortar, life settlement brokers.

This line of reasoning about the commissions involved with selling a large policy vs. a small or medium sized policy seems logical. However, the logic is predicated on the idea that selling policies of different sizes (or buying policies of different sizes from a life settlement provider’s perspective) entails the same amount of work, which I will argue is not true for the average bricks and mortar life settlement broker. The reason is that the market for jumbo policies, life insurance policies with a death benefit exceeding $10 million, is much less liquid than the market for smaller policies. Therefore selling a large policy, say over $10 million in face value, is not as easy as selling a policy that is in the range of $1 to $2 million dollars in face value. First, most life settlement providers have buying parameters that have a maximum face value limit of $5 million dollars or less. Meaning they will not consider policies with a face value in excess of $5 million dollars. Some have an upward limit of approximately $2 million. Secondly, the ultimate buyers of the policies (Those entities that the life settlement providers are buying on behalf of) try to minimize risk wherever possible.

Imagine for example, a life settlement buyer wants $20 million dollars worth of life insurance policy face value in their investment portfolio. They can theoretically buy a $20 million dollar policy or they can buy four $5 million policies. The transactional and underwriting costs involved in buying 4 policies are in aggregate, which include the aforementioned life settlement broker commissions, obviously more expensive than buying just one policy. In addition, the servicing costs are higher with multiple policies, even though there is an economy of scale. However, the longevity risk is greatly reduced when holding 4 policies vs. one. With life settlements and the longevity markets nothing is certain. There aren’t any set in stone maturity dates to these types of investments. Therefore if someone far outlives the life expectancy estimates with a $20 million dollar policy, the investment can easily lose money….and lots of it. However, the law of numbers works for investors by holding several smaller policies. That is because outlying cases are less of a risk since their impact is minimized by the others and the overall portfolio of life insurance investments should fall in line with averages. The more policies a portfolio has, the more risk is spread out.

With that in mind, one can understand why life settlement investors prefer not to buy large policies. When buyers do purchase jumbo policies or even large policies that don't quite reach the jumbo threshold, they usually discount the offers. A higher IRR is used which essentially lowers the settlement amount offered to the policy seller.

At the same time, life settlements have the highest transactional cost of any asset class, so buying small policies can really adversely impact profit margins. So, most life settlement providers target policies in between $500,000 to $5,000,000. Current market activity suggests that range provides the most attractive balance between transactional costs and portfolio risk to investors.

If we take that logic one step further, we can see why selling a large or "jumbo" death benefit policy is somewhat more difficult to do. In the end, their lower demand and less liquid market can present more challenges for a traditional life settlement broker.

Post new comment

The content of this field is kept private and will not be shown publicly.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Allowed HTML tags: <a> <em> <strong> <cite> <code> <ul> <ol> <li> <dl> <dt> <dd>
  • Lines and paragraphs break automatically.
This question is for testing whether you are a human visitor and to prevent automated spam submissions.