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Sudden change in health? New solution to help pay for healthcare (Part 3 of 11)
Sunday December 02, 2007 12:00AM | Click here to visit original article.
So the viaticals mess left a multi-billion dollar business with relatively few real victims of disease to buy policies from. But one of the great things about America is the ingenuity of our capital markets, and their ability to not just let money sit around but to put it to work. It was just about when the viaticals markets were starting to fall apart that some very bright person looked at the situation and said, "Hey, what about people who aren't terminally ill, but whose health has gone down since they originally bought their policy? Since the insurance companies are prohibited from lowering benefits to reflect their poor health, their policies are worth a lot more than their surrender value." Thus was born the concept of investing in the life insurance policies of the elderly, or what is known as "life settlements". Assume that you have an old codger who is 65 and had a significant decline in health, such as a stroke or major heart attack (their medical records include physician's comments to the effect of "one foot in the grave" or "quite surprised to see him again"), but who once upon a time bought a $1 million life insurance policy. The old codger has since raided all the cash value out of the policy to fund his medical treatments and early retirement. Indeed, because of his age the cost of insurance is now rapidly increasing meaning that the old codger will either have to put more money into the policy or it will expire anyway. His problem is that he doesn't have any more money to put into the policy unless he borrows against the equity in his home or something, which he really doesn't want to do. Keep in mind that by this time the old codger has forgotten what he bought the life insurance for initially, which was both for tax-free growth and to leave something for his kids. Because it no longer has cash value for him to access, and because he has forgotten that it will pay out a large amount of money to his kids if he keeps it up, it to him is a wasting asset that he would love to get rid of. The life insurance has basically become a "What have you done for me lately" sort of investment, and thus emotionally the old codger is much more willing to hold it than, say, stock in IBM which hasn't paid him much in the way of dividends but still has dramatically appreciated in value. A quick glance at your handy pocket guide to Actuarial Tables & Life Expectancies reveals that the old codger is supposed to die, on average, within five years. So, you go to the old codger and say, "Hey, I'm willing to buy your life insurance policy from you for $500,000 paid immediately." From your viewpoint, this is a good investment. If he cashes it in by 70 as predicted, then you get paid $1 million on the policy, meaning that you've made $500,000 over 5 years (less any premiums you have to pay to keep the policy up). In round numbers, this is a $100,000 per year pre-tax profit on your original $500,000 investment. That 20% annual pretax return doesn't look too shabby against current interest rates, and the insurance company is arguably much more solvent than any bank. Gosh, even if the old codger lives to 75, it's still not a bad investment, since then you're still making 10% per year. And the odds of the old codger living past 75 (and giving your corporate bond like rates) are somewhat offset by your hope that he will cash it in before 70 meaning that you made a wonderfully nice profit. As an aside, most of the investors in life settlements are large financial firms and hedge funds who are looking for something that has at least the safety of high-grade corporate bonds, but with a high return (since bond yields are still intolerably low). These firms buy many, many life settlements and pool them together. While these firms can not, of course, predict when a particular old codger will finally kick the bucket, they can employ the Law of Large Numbers to get a pretty good actuarial feel for when most of the policies will pay, thus allowing them to calculate their expected yield for the pool - and sell slices of the pool to investors looking for safe, higher yielding investments. ---Source: http://www.quatloos.com/life_settlement-life_settlements.htm |
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