Tuesday, October 6, 2009

Let's Kill Grandma

"Life settlements generally involve long-standing 'permanent' universal life and variable universal life insurance. These are the sorts of policies that were sold, not bought. ... As a dejected policy owner, you have three choices: You can pocket the meager cash-out value offered by the insurer. You can keep pouring money into the policy, maintaining the death benefit for your heirs. Or you can sell the policy to a stranger. ... The stranger buying you out is hoping you get flattened by a train, preferably the day after the deal closes. ... Downsides: Life settlements are labor-intensive, multimonth processes from which sellers usually emerge with a lot less than they would get in an efficient, transparent market. Sometimes they get hit with hefty tax bills. ... The process of receiving a life settlement is so complex and perilous, and it's so easy for policyholders to leave a lot of money on the table, that it's best to hire competent help. Bypass the legions of agents trolling the Internet and find an expert through a trusted attorney or other estate planning specialist. ... It's best to pay your helper a flat or hourly fee. Compensate him purely for doing a deal and you'll increase the chance it will be a bad one. ... Investors in life settlements are typically seeking 14% to 20% annual returns. To help them investors have traditionally followed the ghoulish practice of cherry-picking sellers with short life expectancies", William Barrett at Forbes, 5 October 2009.

No problem for the investor. To assure good life settlement returns, kill grandma. This looks like a wonderful opportunity for the mob.


Jr Deputy Accountant said...

if this doesn't kill Grandma, not being able to eat will. a 1% return on her CDs will do that, you know.

Anonymous said...

The pity is that grandma has no one to protect her...

Just out there alone... vulnerable to the mob and other predators like insurance salesman.

A Fellow CPA said...

I have been involved with the valuation of these life settlements, and believe me, they are quite the ball of wax.

Hedge funds and investment banks especially are becoming big players in this market. Modern portfolio theory has driven uncorrelated returns to be a big selling point. But, I think it's a little sick the way the current practice is.

From the investor's standpoint it is a viable investment vehicle considering the returns are tied to a guaranteed life event (after all, the only things in life that are certain are death and taxes!).

I think as a society to protect our elderly we really need to make sure that they know what they're getting into.

In the long run, this will probably become a mature investment vehicle, just as MBS/ABS have (not that they're perfect either). But as more money chases these uncorrelated returns the expected IRR will diminish to its expected risk level, which is fairly low. In addition, money will stop chasing exclusively those who were previously restricted to viatical type settlements. Maybe in 5 years people will be willing to accept an 8% return and the cash-out from these will be a wonderful alternative to what currently exists. But for now, it is definitely the wild west both of investment vehicles and of selling your policy.

I enjoy your blog. And hello from a fellow CPA!

Industry participant said...

Dr, Skeptical CPA,

Isn't it possible that honest, hard-working professionals believe this is a reasonable asset class that provides seniors/heirs with much needed funds that drastically exceeds either $0 (lapse value) or cash value (varies) or the continuing cost of premiums for insurance they may not need?

Is it also possible that these same hard working professionals have no murderous tendencies and no connections to this 'mob' that you seem to believe still exist?

You can enjoy your cheap shots and perhaps there is a morbid element to the industry for the uninformed, but seriously, murder grandma? We are all just regular people, many of us with Grandmothers, and/or elderly parents, that take deep offense to such casual insults.

The industry has existed for nearly 20 years and no one has ever been 'harmed' by a life settlement investor, and never well. But has anyone ever been murdered for their life insurance policy? Yup - it has happened multiple times (in life and on TV. Except it’s the wife, or husband, brother, kids etc that have been the perpetrators.

Be responsible – your advice to seek professional trusted advice was wise, but why mix it with tabloid like behavior. You lose credibility and actually do harm.

To any senior - consider the life settlement, seek 'valuation' of your policy and most importantly, find out what your broker/agent is receiving from your proceeds. You have the right and should only deal with life settlement providers who disclose their commission.

stuart egrin invescor said...

You are correct that life settlements generally involve a universal life insurance chassis. This is because the policy offers flexibility in premium payments, transparency as to what the cost of insurance is to maintain the contract, and the mispricing that the insurance companies have used for many a year, lapsed-based pricing. Investors are simply taking advantage of an arbitrage opportunity that is available. It is quite possible that the life insurance agents have not done as good a job as they could in selling these policies to consumers. You are also correct in stating that the options to get out of the policy are 1) to let it lapse for no value, 2) surrender it for the policies cash surrender value, or 3) see if it makes sense to capture the current economic value of the policy given prevailing market conditions in a settlement transaction. The third option is one that was recognized by the US Supreme Court back in 1911. A policy owner has the right to transfer for value their in-force policy to a 3rd party. It is true that the investor in the policy will experience a higher return if the insured dies sooner rather than later. It is also true that the investor will experience a small return or loss if the insured lives too long or they paid too much for the policy. That is called investment risk which is why institutions such as Credit Suisse and CALPERS buy a large number of policies to diversify the risk. They use life settlements as part of an overall portfolio diversification strategy. Life settlements are not for everyone, are complex, and take a while to complete. That is because over 70% of the states have regulations in place which require among other things 1) transaction disclosures, 2) commission disclosures, 3) disclosure of all offers, declinations, rejections, and counter-offers, and 4) filing of all documents that are used by the buyers with the state prior to use. Those representing the policy owner/seller also must take on fiduciary responsibilities to act in their best interest and follow their instructions. Since the transaction typically takes several months to complete, the policy owner/seller has ample time to see if the numbers make sense for them to proceed and to seek professional advisor assistance. I can only imagine what the flat or hourly fee would be for their service. Please note that it is not the case that all those seeking to sell their policies will be given offers, or will receive offers worth taking. There must be a reason why lawyers often work on a contingent fee basis. So please do not paint the industry with such a broad brush. Life settlements offer policy owners true value when other options are not available or not as economically sound.