There is absolutely no simple answer to this question but I can give you some guidelines. ANYONE who tells you they can give you a firm valuation without obtaining medical information, policy information and trust information if it is held in a trust is simply lying to you. You can get a rough idea but pricing a life settlement involves many variables. That said you can get a ballpark and understanding the basics will help you evaluate whether your chosen broker knows his knee from his elbow.

The basic valuation equation

An investor’s return on a life settlement is the death benefit (DB), a clearly defined number. This is one of the things that is unusual and attractive about life settlements to investors…they know how much they will get paid. Obviously the investor, in order to make money has to pay less than the death benefit. His costs are the annual premium (P) to “maturity” (the politically correct term referring to the death of the insured) and of course how much he has to pay the owner of the policy to acquire it (A). The annual premium (P) is another defined number, the life insurance carrier will provide an illustration of how much premium is needed every year to keep the policy in-force. The unknown in the valuation equation is life expectancy (LE) of the insured. To get an estimate of this an investor will need a life expectancy report from a medical underwriter, several companies specialize in this area. So an investor is able to calculate the likely total cost of premiums on his investment. By subtracting that from the death benefit he knows how much absolute profit ($) he potentially has in the deal and can decide how much he can afford to pay the owner to acquire the policy.

$ = DB – ((P*LE) + A)

Determining how much he can afford to pay the seller means the investor must calculate the Net Present Value of the investment. That is how much is he willing to pay today to acquire (A) to receive his profit ($) in the future. To do this the investor must decide on a rate of return or yield he expects to get on his capital to buy an asset like a life settlement. E.g If an investor hopes to earn $1 on an asset in 10 years he might pay you 15c for it today. Typically investors in this space expect to make quite high yields (15% annualized rate of return is not uncommon). That may seem quite high but the investor has substantial risk of having to pay much more in premium expense as life expectancies are quite inaccurate.

The Use of Statistics, Probabilistic valuation

Life expectancies are very inaccurate at predicting an actual point in time. In fact life expectancies are actually not a date but a bell curve based on the mortality rate of a large number of people. The life expectancy report basically tries to answer the question. If you had 1000 people who looked like the insured how many are likely to have died in the first year, the second year, and so on to create a bell curve that may spread out over decades. The LE investors use is typically the 50^th percentile or the year in which the bell curve indicates 500 deaths will have occurred.

Investors use a statistical technique that essentially combines the probabilities of death in each year over the whole curve to value a policy. The most common tool for doing this is a software program from Model Actuarial Pricing Systems or MAPS. This is often wrongly called “Milliman valuation software” after the consulting company who originally wrote the software. This software combines the life expectancy curves, calculates premium expenses and allows the investor to enter their desired rate of return to calculate the net present value of the policy.

Non-Financial Valuation factors

As with all investments the pure numbers are only one part of determining the market value of a policy. Investors will consider many other variables some intrinsic to the policy such as the kind of policy it is (Universal life, second to die, whole life) or even the State it was issued in or credit rating of the carrier. Other factors may be completely unrelated to the policy, such as an investor may need your specific type of policy to meet the diversity criteria he has for his pool of policies. Many variables will have an impact on an investor’s evaluation of risk on the policy and each investor creates their own unique profile of policies they are interested in and those they are less interested in. Some investors may want to buy only small face policies others don’t want to buy policies with less than $1M face.

Getting the best Price for Your Settlement

While there is science to valuing a life settlement, your ultimate price will come down to the skill and experience of the broker at negotiating with as many interested investors as possible. As with all negotiations knowledge is power, so make sure that your broker has experience and the valuation tools like MAPS software (often called Milliman life settlement software, incorrectly).

We helped this client reduce annual life insurance expenses by over 60%, keep their coverage…all at no cost to them.

We have a long term client who purchased a $1M survivorship life insurance policy in 2000 from a highly rated carrier. Several years later they took out a loan for $75,000 to help with college tuition for their 3 children.

The annual premiums are currently $6,088 and loan interest payments are $5,900 totaling an annual payment of $11,988. The loan has grown to $80,000 reducing the death benefit to $920,000. This policy had become overly expensive and a life settlement was an idea but we had a much better solution for them.

Both insured have maintained their preferred health status so we proposed a replacement not a life settlement via a 1035-tax free exchange to an alternate highly rated carrier with these results. This would not only allow them to keep life insurance protection but eliminate the $80,000 loan.

We rolled the cash surrender values net of the loan balance to a new $1M Survivorship policy with annual premiums of $3,912. The family is out from under the growing loan, restored their full $1M benefit and reduced the annual outlay from $11,988 to $3,912 for a policy that will carry to well beyond the youngest insured’s age 100.

The surrendering carrier will send a 1099-R to the insured’s for the value released above the cost basis which in this case is approximately $10,000 of ordinary income. But considering all, the client is very happy and will still save a ton of money beginning in year 1.
The moral of this story is regularly review your life insurance situation a far better deal may well be out there.

In working with investors we are regularly asked to review portfolios. Buying life settlements requires extensive due diligence but often when you are first presented with a portfolio you can spot some red flags. Now these red flags don’t mean that you have a bad portfolio or that you should go running for the hills. Quite the contrary in my opinion if you are expert enough in your ability to do the due diligence required this might be exactly where you will find the best deals. But this is definitely an area of life settlement investing to keep your wits about you.

We were asked to help a client recently and as normal the first look at this $500M portfolio was a spreadsheet.

Red Flag 1: Who owns the portfolio? And more importantly are you talking to them directly? The fact is that spreadsheets are passed around this industry like dinner rolls. Long broker chains will kill any chance of a deal.

Red Flag 2: All policies are 2-3 years old. That means this is likely a BI portfolio or financed, so buyer beware of STOLI.

Red Flag 3: These recently issued at Preferred rates and new LE’s are now all short. Sure declines in health happen but if you are looking at a few dozen policies with that fact pattern in the same portfolio statistics would say something is awry.

Red Flag 4: Lots of insurance on single lives. It goes without saying that concentrating in relatively few lives is a risky proposition. But also when one portfolio has been assembled this way it should call into question the sellers motives and caliber of origination.

Red Flag 5: The Brooklyn specials. The simple fact is that there has been a good deal of questionable inventory originated in the NE area and a concentration from there is cause to increase scrutiny.

There are plenty of life settlement portfolios that have one or all of these flags. If you have the ability to do the due diligence necessary it could be a great opportunity to pick up some very discounted life settlement inventory.

Red Flag 4: