A Risky and Wild Investment
Posted by Brent Everett on Fri, Jul 30, 2010 @ 02:14 PM
According to a Dow Jones report, no less than the Government Accountability Office (GAO) has warned consumers about participating in life settlement transactions "due to a lack of clear, consistent state oversight." The Securities and Exchange Commission (SEC) and the Financial Regulatory Authority (FINRA) have issued similar warnings in the past. The SEC has long maintained that life settlements should be regulated as securities.
Despite all this, salesmen continue to push life settlements as low risk investments. We have always disagreed. While it is true that life settlements are not correlated with the stock market, that does not make them riskless or even low-risk investments.
Investors in life settlements are making a bet that the insured party will die within the time frame used in calculating the touted return. If that happens, it's a money maker. But, it certainly does not always happen that way. And, if the insured lives significantly longer than expected, the investor may realize a very low rate of return - or even lose money. It is entirely possible that this can happen due to medical advances or changes in lifestyle.
It's also quite possible that the underwriters have underestimated the the life expectancy of the insured. This can also lead to a lower than anticipated return or a loss. According to Stephan Leimberg, editor of Tools and Techniques of Life Settlement Planning, "Life expectancy tables have not been accurate - particularly for small face-value policies."
There is also legal risk associated with fraud or lack of insurable interest. In such cases, insurers will not pay the death benefit and the premiums may or may not be returned.
Finally, there is significant liquidity risk. The investor will have no access to funds invested in a life settlement and, if for any reason the insured lives longer than expected and the investor is unable to maintain the policy premium payments, all of the investment may be lost. The market for resale of the policies is thin and illiquid.
The Dow Jones article calls life settlements a "wild investment" and comes to the conclusion that "the risks of life settlements are greater than the potential rewards." We agree.
