Life settlements: Known knowns

'There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns — the ones we don't know we don't know'

- Donald Rumsfeld

Why are life settlements not mainstream?

Perhaps it is because notwithstanding the universal acceptance of life insurance, and even though a life settlement does not change the nature of the life insurance contract other than assigning a new owner and beneficiary, the institutional purchaser in a life settlement transaction is disparagingly seen as ‘betting on death’? That focus is somewhat distinguished from that of a life insurer which, at least empirically, is betting on lapse. All finance though involves some measure of calculated risk. Insofar as life settlements are concerned, for the insurer the risk is to their lapse-based pricing model, for the institutional investor the risk is that their portfolio does not offer proper diversification, and for a senior that owns a life insurance policy the risk is not knowing that life settlements exist.

The negative repercussions of selling a life insurance policy that is ‘unwanted and/or unneeded’ is akin to the conundrum of having to pay taxes on ‘found money'. Finding a couple hundred thousand under the mattress may be a taxable event, may affect eligibility for public assistance or other government benefits or entitlements, or may be subject to garnishment by creditors…much like a lottery ticket.

Also, selling a life insurance policy obviously means the senior is forfeiting other rights or benefits including accelerated benefit options, policy loans, conversion rights and waiver of premium benefits that they may have under the policy or certificate of a group policy. Much like when you sell your home, you do not get to live in it anymore.

A life settlement resembles a real estate transaction. The document slate, the time for consummation, and the dollar value returned to an owner are analogous.

In real estate a seller provides detailed information as to the nature of the property, in life settlements the owner provides detailed information as to the nature of the policy. Both processes are initiated with a term sheet or an offer delineating property description, purchase price, estimated inspection period and anticipated closing date.

The purchase and sale agreement and legal disclosures include numerous covenants, warranties, and conditions of closing. In real estate a seller and/or seller’s representative promises to deliver all applicable information regarding the property, warrants that the property is free from hazardous substances and complies with all laws, and confirms the continuing accuracy of representations made. In life settlements a seller and/or seller’s representative promises to deliver all applicable information regarding the policy, warrants that the policy is not fraudulent and complies with all laws, and confirms the continuing accuracy of representations made.

Having a signed term sheet or offer in either real estate or life settlements does not make the contract execution a perfunctory event. Contracts are documents that are prepared specifically for each idiosyncratic transaction. Due diligence is performed, an inspection is necessitated for real estate and a confirmation of insurable interest and ‘perfected’ ownership is conducted for life settlements.

An inspection is commonplace for real estate much like an actuarial determination is mandatory with life settlements.

In both scenarios, the asset is either ‘unwanted and/or unneeded.’ The owner, in conjunction with either legal or financial advisers, makes a determination whether a sale is in his/her best interest.

There is however one particular dissymmetry between real estate and life settlements. In real estate when the owner of a property fails to make mortgage payments and defaults and fails to cure said default, the mortgage company can foreclose. The foreclosure process is an industry unto itself, an amalgamation of servicers, public and private foreclosure relief programs, and legal advocates with the potential detritus of ongoing delinquency. At minimum the mortgage company does not desire that the end result of entering into a contract is foreclosure.

In contrast the life insurer desires that the ‘final destination’ of entering into a contract is a policy lapse. As a result, life settlements are a clear and present danger to the ‘windfall profits’ of the life insurance industry.

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