How much will Investors pay for life insurance?
Posted in: alternative investing, Life Settlement Info, life settlement, life insurance settlement, Life Settlement Info, life settlement | Comments (0)
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).
admin @ July 19, 2010
Risk vs. Ignorance
Posted in: alternative investing | Comments (0)
Every day see people engage in what I consider insanely risky activities. For starters millions of us jump into a 5000 LB hunk of metal that kills and disables millions of people every year. And yet most of us also would not consider driving a car a recklessly risky decision. Why is that? Is it because the odds of a fatal accident are low, that may be part of it but we humans are not rational calculation machines. The reason is that we have acquired the knowledge to control our destiny and drive safely. We know how to drive, we’ve learned the rules of the road and how to keep a safe distance. We all know though that there is real risk, things we can’t control no matter how much we learn. Accidents happen we can’t control, so we put on a seat belt, buy a car with airbags, keep our distance from the car in front.
I have noticed that its exactly the same with alternative investing. Investors often have a knee jerk response to an alternative strategy that it must be much more risky than investments they know and are familiar with. If the last couple of years with the stock market doesn’t illustrate the extreme real risk in equities I am not sure what will. But sometimes people start to confuse familiarity with knowledge. Like the driver who, starts drifting to close to the truck in front on his daily commute. Just because equities and bonds are what every body does and talks about does not mean they are less risky than other alternatives.
Of course, I am not suggesting alternatives may not be risky but just because investment strategies are less widely known has nothing to do with the real risk involved. The only way you can know the real risk is to do some homework and gain some knowledge about the investment strategy. Also in regard to your portfolio you must consider what drives the real risk in the asset class or strategy. Because even if you have two different asset classes, if they are impacted by the same risk factors your portfolio is exposed to more risk. For example, corporate earnings drive stocks and corporate bonds. Know the risks in your portfolio, not to eliminate them because you cant, but when you have the knowledge of what the risks are you can manage them.
Some alternative strategies are very risky and you should only consider with the help of an expert. To torture my transport analogy a little further, I like a professional pilot to fly my planes rather than being thrown the keys to a jet liner. The fact is this is how fortunes are made on what finance professionals call asymmetric information. When you have information or knowledge about an asset you can profit where others fear to tread. Professional asset managers know this and bank on it all the time. I am not referring to anything nefarious or immoral. Simply the advantage that knowledge of how something works allows you to see opportunity where others see risk.
admin @ July 13, 2010
When You Avoid Taxes, Returns Can Explode
Posted in: General | Comments (2)
There are many proven strategies employed by the country’s wealthiest families and corporations to reduce taxes. And yet most people still don’t use them. The fact is probably the single most powerful way to explode your investment returns is to stop giving half of what you make away. We have been very busy this year helping clients set up platforms that allow them to defer and in some cases avoid paying taxes on their income or corporate profits. These are not questionable strategies that when the IRS comes looking will collapse and have you owing huge back
taxes. These strategies use specific sections of the tax code expressly written to provide these tax benefits. One of the strategies I’ll mention today is used by the majority of Fortune 500 companies and could be used by any profitable business. When you find out about this strategy you will wonder why on earth everyone doesn’t do it. For a business owner who is generating strong annual profits they can easily have to pay over 50% in taxes. This strategy allows the owner to dramatically reduce corporate taxes. Everyone is familiar with insurance and that premiums are a deductable expense. However did you know that there are specific sections of the Internal Revenue Code written that allow you to create your own captive reinsurance company that can sell insurance coverage to your primary business. Obviously there are well defined rules and laws that need to be followed. But imagine if you could take a substantial portion of your company earnings and pay a premium to another company you own to get valuable insurance. You can insure against risks that traditional companies wont cover such as the loss of revenue from a major referral source. Not only do you substantially reduce your taxes but you benefit from profits in the captive company you own. There are over 5000 captive insurance companies in existence. Fortune 500 companies and very wealthy families have accumulated millions in reserves and saved taxes. These savings and benefits could easily be enjoyed by small and medium sized businesses. There are many other strategies that can benefit individuals and companies in saving taxes. Like all financial strategies they are not a panacea, they work well given the right situation but all have pros and cons. But if you are not at least asking your advisors for ways that you can save or defer taxes you are leaving a lot of money on the table or more accurately allowing the IRS to take your money off the table when you don’t have to.
By Simon Leach
Mickelson Capital Consulting
admin @ July 2, 2010
