How much will Investors pay for life insurance?
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 50th 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).
