Senior Settlements -- Pricing
Although the life insurance policies involved in senior settlements are generally larger than those in viatical settlements (typical senior settlements involve policies with a face amount of $1 million or more, while the average viatical policy is about $100,000) the percentage of the policy’s face amount paid in senior settlements is considerably lower. The reason for this difference lies almost entirely in the disparity between the life expectancy of the insureds involved.
While life expectancy is generally two years or less for viatical settlements, it is much longer for senior settlement—often as long as 13 or more years. And, from the buyers’ viewpoint, the insured’s longer life expectancy means that death benefits are likely to be far longer in coming, and buyers are more likely to insist on greater discounts from the policy face amount. The simplistic standards set in the NAIC’s Model Law do not work well in situations with longer life expectancies. Investors in senior settlements are more likely to rely on present value calculations for more realistic pricings.
The concept of “present values” is based on that old adage: a bird in the hand is worth two in the bush. A dollar in hand today is worth more than the possibility of a dollar received in the future. How much more? That’s the investor’s rate of return -- and it depends on the amount of risk the investor feels he is taking by waiting for those future dollars. In valuing a lifetime settlement, the investor applies a rate of return to the expected life expectancy to obtain a “present value” of those future death benefits. There is a “simple” mathematical formula to calculate a present value:
policy's face value
present value =
life expectancy in years
(1 + annual rate of return)
Luckily, there are tables of "present value intererst factors" to assist investors calculate the present value of a viaticated policy. The twotables below list present values for annual rates of return at 16% and 20%. By multiplying face value of the policy by the interest factor for the appropriate rate of return for the estimated life expectancy, the purchaser can determine the present value of the policy.
Assume a $1 million dollar policy is offered for sale and the insured has a life expectancy of 2 years. Also assume an investor is looking for a 20% pretax rate of return, based on the risk she perceives she is taking. The present value factor from the 20% table for 2 years is 0.6944. In other words, she should be willing to pay 69.44% (0.6944) of the policy‘s face value or $694,400($1,000,000 x 0.6944). If the insured’s life expectancy is 10 years, the same investor would be willing to pay only 16.15% (0.1615) of the face value, or $161,500 ($1,000,000 × 0.1615 = $161,500). The present value tables illustrate a common sense concept -- investors are willing to pay more for situation with faster payoffs, and will apply deeper discounts for longer waits.
As we can see, the effect of a longer life expectancy on the amount of a settlement is enormous. In this case, the viator with a two-year life expectancy might receive almost four times the settlement than the insured with a ten-year life expectancy.
Generally speaking, the life expectancy of the insured is the primary factor in setting the value of a lifetime settlement. Keep in mind, a projected life expectancy is an “educated best guess” -- there are no guarantees. The insured could die tomorrow or far outlive the projected life expectancy. This is a risk the investor takes -- and the rates of return sought by the investor reflect that uncertainty. One last point about anticipated rates of return: if the insured's life ends exactly at the projected life expectancy, the investor will actually earn the rate of return he or she sought. If the insured dies earlier, the investor's actual return on the investment will exceed the rate stated he or she anticipated; if the insured outlives the projected life expectancy, the investors actual rate of return will be less. This uncertainty has led to accusations of misrepresentations when terms such as "guaranteed" are used advertisements aimed at potential investors -- these misrepresentations and other ethical abuses are discussed later in the program.
While life expectancies are the primary determinant of settlement proceeds, there are other factors that affect the amount a policyowner might receive. These include:
size of policy and accumulated cash value;
premium payments needed to sustain coverage;
additional policy features that could affect death benefits;
the rating of the life insurance company that underwrites the coverage; and
the prevailing discount rates in the viatical settlement market.
As mentioned earlier, senior settlements are sometimes called “high net worth” transactions because the market is geared to the purchase of larger policies. The industry-wide minimum is $250,000, and sale of multi-million dollar policies is common. Larger policies are more marketable; smaller policies sell at a deeper discount. Sellers of policies with substantial cash values will command higher prices that those with little or no accumulated cash values -- and those higher prices make policies with large cash values less desirable to purchasers. Purchasers, in effect, are looking to buy the "pure insurance coverage", not the cash value.
The purchaser of a viaticated policy must pay all future required premiums to keep the policy in force. Traditional whole life policies require an annual premium payment as long as the insured is alive. Limited pay policies have a shorter premium payment periods, e.g. “20-year limited pay“, “paid up at age 75“, etc. In limited pay policies, the purchaser will face fewer possible premium payments and can therefore be more generous in the amount he is willing to pay for the policy when negotiating a purchase price. Likewise, if the policy has a waiver of premium rider and the insured is disabled, future premium payments are eliminated (for the duration of the disability). This, too, is advantageous to the purchaser -- and will result in a higher purchase price. Universal life policies allow for more flexible premium payments -- and purchasers of viaticated policies prefer universal policies for that fact.
Policies with "extra" possible death benefits are worth more to purchasers of viaticated policies. Accidental death riders, commonly referred to as “double indemnity“ plans, will double the death benefits paid in the event the insured dies of accidental causes. While accidental deaths are a statistically rare, the possibility of greater death benefits will appeal to investors -- and consequently result in slightly higher prices. A policy with a cost of living adjustment (COLA) rider will adjust death benefits upwards for inflation. These types of riders are more valuable to an investor than policies without such provisions.
Two other policy provisions that affect the marketability of the policy are the contestability and suicide clauses. The former allows insurers to contest possible claims in the early years of the coverage -- typically the first two years. Thereafter, the insurer will find it difficult to deny payment of the death claims (except in rare cases such as impersonation or when the beneficiary intentionally murders the insured). Similarly, life policies will allow insurers to deny claims for death by suicide in the early years of the policy. Most insurers impose a one- or two-year suicide clause in their policies. Generally speaking, most purchasers will only buy “aged” policies, those in which these limiting clauses have elapsed. Although, under the right circumstances, some investors may be willing to assume the greater risk that “younger” policies pose, if the potential returns are sufficient.
As with viatical settlements, investors will discount the value of the policy based on the quality of the insurer. Sellers of lower-rated policies will receive less than those offering higher-rated policies. Or put another way, investors will require a higher rate of return -- that is, apply a deeper discount -- on riskier policies.
As with any free market, rates of return will vary based on changing economic times. The rate of return investors expect from an investment in viatical policies depends, in part, on what types of return are available on alternative investments -- which, in turn, are dependent on general economic conditions. Referring back to the present value tables, if the investor’s expected rate of return were to drop from 20% to 16%, the value of viaticated policies will rise significantly. Using the previous example, a viator with a two-year life expectancy would receive $743,200 instead of $694,400, and the policy with a ten-year life expectancy would receive $226,700 instead of $161,500.
As you can see, a number of factors influence the “settlement value” of a life insurance policy. Different investors will attach varying degrees of significance to these factors. A rate of return that one investor is willing to accept, will be insufficient for another. One investor may rely on very conservative estimates of the insured's life expectancy, another will be more liberal. Determining a “value” for an existing policy is more of an art, than a science. For that reason, viators looking to sell their policies should “shop around” to find the best deal.