Life Settlements: A Socially Responsible Investment
Updated: November 2021
Introduction
In exchange for a life insurance policy that an elderly individual may no longer want or need, the immediate lump-sum of cash from a life settlement transaction may be used to maintain a comfortable standard of living in retirement or retain ongoing medical services. Because of this, investments in the market for life settlements can potentially make a significant, positive impact on the social welfare of the senior citizens of the United States.
In this post, we present three social issues faced by U.S. senior citizens: 1. the enormous and growing retirement deficit, 2. the lack of insurance coverage and increasing need for long-term healthcare, and 3. the unknowing forfeiture of billions of dollars in assets in the form of lapsed or surrendered life insurance policies. We propose that life settlements are a form of sustainable, responsible, and impact (“SRI”) investing because the existence of a life settlements market provides seniors with a potential solution to all three of these issues.
Over 45% of Americans have zero retirement savings .
Demand for sustainable, responsible, and impact (“SRI”) investing continues to rise. A recent survey revealed that seventy-nine percent of investors want their financial decisions to make a positive impact on society.(1) Seeking alpha is no longer enough. People want portfolio performance that aligns with their personal values.
To their credit, professional portfolio managers have responded to investors’ appetite for social impact investment opportunities. As of December 2020, approximately 33% of private capital firms worldwide had SRI policies in place, and 80% of investment managers to make a moderate to significant increase in their SRI policies by 2025.(2) Investment managers have architected new securities products using negative screening strategies and “best in class” methodologies. These portfolios only invest in companies that steer clear of ethical breaches and demonstrate best practices with respect to environmental pollution.
For better or worse, 77% of investors report feeling significantly more engaged with current events than they did even five years ago.(3) This is in an age of social media activism, hashtag campaigns, and click-bait articles. Climate change, social justice, and corporate scandals are hot topics that generate page views. As a result, the existing SRI investing landscape primarily focuses upon environmental, social, and corporate governance issues that have reached the level of public consciousness. But what about SRI issues that haven’t quite entered the zeitgeist of the early 21st century; issues that don’t make headlines; issues that don’t spark immediate, emotional outbursts? Although some social issues may manifest as a rising tide rather than a tidal wave, the resulting societal impact can be equally catastrophic. The following problems facing senior citizens in the United States may not make national headlines, but if left unresolved, they will have long-term negative repercussions on our society, economic and sociological, tangible and intangible.
Issue 1: U.S. Retirement Deficit
Most Americans have insufficient retirement savings. Fidelity Investments recommends a minimum of 10x salary in retirement saving by age 67.(4) However, over 45% of Americans have zero retirement savings. Altogether, approximately 80% of Americans fall short of conservative retirement savings targets. Moreover, 78% of the bottom half of the income distribution have no retirement savings assets at all.(5)
For a retiree to maintain their standard of living, they will need to replace about 85% of their annual pre-retirement income. Currently, about 81% of Americans have retirement savings of less than their annual salary. By that measure, most seniors will be unable to maintain their standard of living for even two years into retirement. When combined with rapidly increasing medical costs, the situation can become hopeless. Approximately 70% of people born between 1954 and 1963 are below the 25% lower savings goal for retirement assets.(5)
Social Security and employee sponsored retirement plans remain the most significant replacement for pre-retirement income. However, changes to Social Security implemented in 1983 have forced Americans to reduce their reliance on entitlement benefits. Once the changes are fully phased in, Americans born after 1960 that choose to retire before the age of 62 will receive 30% less in benefits than those that retire at age 67. Even with these substantial cuts, the entire Social Security program is projected to have insufficient funding to pay anyone more than 79% of entitled benefits after the year 2034.(6)
With the aforementioned reductions in social security benefits, the burden of providing sufficient retirement income has fallen squarely on retirement planning while in the workplace to fill the deficit with savings. The main sources for these savings come from employer-sponsored retirement plans and/or the individual’s defined contribution plans.
At one point in history, Americans could rely on an employer sponsored defined benefit pension plan to supplement their Social Security income during retirement. A defined benefit plan, which is controlled by the employer, has the advantage pooled resources, economy of scale, and a professional management structure, which can lead to significantly higher returns on investment. Unfortunately, a significant portion of the U.S. workforce lacks access to any employer-sponsored retirement plan whatsoever. Since the introduction of the defined contribution plan in 1979 we have witnessed the rapid decline of employer-sponsored plans, and by 2014 only 51% of private sector employees ages 21-64 had access to a retirement plan, the lowest rate since 1979.(5)
Defined contribution plans were originally designed to supplement, rather than replace, the defined benefit pension plan. These plans (often referred to as 401(k)s or IRA’s) place all of investment and contribution risk upon the individual employee. However, some individuals lack the financial literacy to identify the risks and merits of investments, and many are unable to sacrifice 10-15% of each paycheck, the recommend rate of contribution.(7) Defined contribution plans are especially vulnerable to significant downturns in the marketplace, as evidenced by the face that during the Great Recession from 2007 to 2011, adults aged 55-64 had lost a median net worth of $72,380.(8) In addition, the number of seniors filing for bankruptcy since 2007 has almost doubled to a record high of 12.2%.(9) Historically, medical debt is the most common cause of bankruptcy amongst older Americans.
There is a positive correlation between economic health and physical well-being. Older people in uncertain financial circumstances tend to put off doctor visits, cut back on medications, and experience greater stress as a result. These changes in behavior in turn lead to increased stress on the U.S. healthcare infrastructure, which is currently ill-prepared to fulfill the idiosyncratic needs of the nation’s elderly population.
Issue 2: Long-Term Care Gap
Approximately 96% of all people age 65 and over in the United States are covered by the Medicare program.(10) The Medicare program was explicitly designed to cover the major costs associated with episodes of acute illness or the acute manifestations of chronic illness, such as surgery. As the population ages, seniors are increasingly considering surgeries that were once deemed to be too dangerous. People over age 65 represent roughly 16% of the U.S. population but account for 40% of patients undergoing surgery.(11) Unfortunately, elderly patients that undergo major surgeries are substantially more likely to become too frail or disabled to live independently afterward. As a result, they will require long-term care such as skilled nursing or assisted living. Medicare was not designed to pay for long-term care services. That leaves many elderly Americans financially vulnerable.
About 52% of people who are retirement age or older will experience a need for long-term care in the future, while 68% of people reaching retirement age will need some form of long-term care during their lifetime.(12) Long-term care includes a broad continuum of services that address the needs of people who require help with the basic activities of everyday living. The services can vary from informal care de- livered by family and friends to the formal services of home care, assisted living, or nursing homes. Spending on long-term care is expected to more than double from 1.3% of GDP to 3% by 2050 as demand increases alongside an aging populace. The average annual cost of a shared room in a skilled nursing facility is about $90,000, an enormous amount to pay out of pocket on a limited income.(13)
Due to the retirement deficit in the U.S., the average, middle-class senior citizen doesn’t have sufficient savings to cover the cost of long-term care that is uncovered by Medicare. When accounting for long-term care costs, 69% of households are at risk for being unable to maintain their standard of living in retirement. Often, they are forced to seek assistance from government programs. Medicaid, originally intended to be a safeguard for the poor and disabled, is now the default payer for 68% of all senior nursing home residents.(14) If they aren’t poor enough to qualify for Medicaid, many turn to their families for help. Adult children, when forced to contribute to caring for an aging parent, spend an average of $7,000 to $14,000 per year.15 On top of that, adult-child caregivers in the U.S have an average of $283,716 in total income lost for men and $324,044 for women due to caregiving (including pension, wages, and Social Security).(16)
The average annual cost of a shared room in a skilled nursing facility is $80,000.
Many senior citizens have no retirement savings, no social support network, and increased medical expenses. For them, the only option may be to eliminate non-essential expenses and begin liquidating their hard-earned assets. Some might stop paying premiums on a life insurance policy in order to save money, particularly if the death benefit is no longer needed. Unfortunately, most people with life insurance policies are unaware that an active policy is an asset that holds intrinsic financial value. A policy that has been allowed to lapse becomes worthless.
Issue 3: Sunk Cost of Life Insurance
Every year since 2008, over 33 million life insurance policies have been terminated prematurely. This amounts to a combined face value of approximately $2.5 trillion dollars.(17) According to a joint study by the Society of Actuaries and Life Insurance and Market Research Association (LIMRA), 4.5% of American life insurance policyholders over 65 lapse their policy each year. They never realize a benefit from the policy, even after paying decades of accumulated premiums to the insurance carrier.
Often, insurance premiums become a significant financial burden for retirees on a fixed income, especially for those in need of longterm care. With insurance rates rising by up to 200% per year, many policy holders can no longer afford to pay the premiums.(18) Furthermore, when a policy holder’s children have grown and their spouse has passed, the life insurance policy may no longer serve a purpose. When a life insurance policy is no longer wanted or needed, the insurance provider offers two options: (i) allow the policy to lapse and become worthless, or (ii) surrender the life insurance policy back to the carrier for the cash surrender value. The surrender value is calculated by taking the accrued value of the policy and deducting the surrender charge. The surrender charge is a contractual penalty that dissuades holders from surrendering their policy before it is to the carrier’s financial advantage. Both options allow insurance carriers to pocket billions of dollars in pure profits at the expense of the elderly, disabled, and chronically or terminally ill. However, there is a third option, the life-settlement. On average, a life settlement will pay out 7-8x the cash surrender value of the policy.(19)
Potential Solution: Life Settlements
A life settlement allows insured persons to realize the value inherent in their life insurance policy through sale to investors in the secondary market. The top life settlement providers of 2018 combined to pay out $640,480,000 in cash in 2,587 transactions.(17) That means that the average senior insured person received $247,576 to reduce their retirement savings deficit, maintain a dignified standard of living in retirement, and ease the financial burden on families and government programs..
The market for life settlements also has enormous untapped potential to finance the healthcare needs of the elderly in the United States. To put things into perspective, in 2017, the combined cost of U.S. drug invoicing, long-term care, and home healthcare was $20.6 billion.(14) In comparison, over the same period, people over the age of 65 allowed policies with $148 billion in face value to lapse or surrender.(17) If we assume a transaction price to face value ratio of about 18%, then that means that ~$26.6 billion each year could be going back into the pockets of seniors, retirees, and the disabled elderly. Thus, if the secondary market for life settlements reached 100% capitalization, the amount of investment would meet and exceed the amount needed to bridge the Medicare's gaps in outpatient coverage and long-term care.
Conclusion
The proceeds from life settlements may be used to improve the lives of the elderly and ease the burden upon families and taxpayer funded entitlement programs such as Medicare and Medicaid. Therefore, we believe an investment in life settlements is an investment in the physical and financial wellbeing of senior citizens in the United States. This is especially true for people with relatively small-face value policies, which are more likely to be held by individuals in need of financial liquidity for retirement or healthcare expenses.
To summarize, we believe that investment in life settlements is sustainable, responsible, impact investing. With increased capitalization of the secondary market for life insurance, there is potential for:
I. Retirees to use life settlement proceeds to replace pre-retirement income and help maintain a dignified standard of living.
II. Frail and disabled persons to use life settlement proceeds to pay for long-term skilled nursing, subsequently reducing the burden on the shoulders of family or government programs.
III. The benefit of decades of premiums paid on a policy to be realized by an individual in need rather than forfeited to insurance companies.
In the current SRI environment, negative selection against board-room scandals, fraud, and pollution carry the day for portfolio managers. Perhaps rightfully so. Yet, equally severe issues face senior citizens in the United States. Although these issues tend to remain outside the spotlight, we can help ensure that they are not ignored.
Hypothetical Practical Examples
Below are practical examples that reflect real-life circumstances in which life settlement investments can make a positive impact on people in need.
Example #1: Term Conversion
Elizabeth, a 68-year-old woman, had a convertible term policy and was battling lung cancer. Paying expensive premiums was not what she wanted to do at this stage in her life. She needed money to pay for quality healthcare and to wanted to enjoy her limited time with her family. Elizabeth was able to sell her life insurance policy for $490,000.
Example #2: Unplanned Health Change
Bill, a 70-year-old man, had just suffered a heart attack, which left him permanently disabled. Neither Bill nor his family was financially prepared. Staff at the care facility found out about Bill’s $500,000 life insurance policy and educated Bill and his family about the life settlement option. Bill sold the policy for a $250,000 settlement and no longer had to pay the premium. The life settlement funds covered Bill’s expenses until his passing three years later.
Example #3: Unaffordable Policy
Arthur, a 59-year-old entrepreneur, had fallen on hard times during the economic crisis. As a result, he was forced to file bankruptcy to discharge business loans for which he was personally responsible. Arthur had a $1 million term policy that needed to be converted within the next several months. However, he could not afford to pay the premium for a permanent policy. After consulting with his advisor, Arthur decided to sell $750,000 of the term policy and retain $250,000 of term coverage. His advisor worked with multiple providers to negotiate settlement offers resulting in a total gross offer of $295,000 plus reimbursement of the first quarter’s premium. The gross offer was 39% of the total death benefit.
Example #4: Cash to Pay Premiums
Oliver, a 67-year-old small business owner, was diagnosed with colon cancer. The need for cash outweighed the need for a future death benefit. Oliver owned a $250,000 universal life policy that was originally obtained for income protection, which he no longer needed since he had retired. The policy had a small loan on it and Oliver no longer wanted to pay the premium and interest due on the loan. A life settlement was recommended to create additional capital to pay the premiums on a larger policy. Oliver’s advisor worked with multiple providers to negotiate a gross offer of $113,000.
ENDNOTES
1) Fifth Annual Responsible Investing Survey. Nuveen, 2020.
2) The Future of Alternatives. Preqin, 2018.
3) Fourth Annual Responsible Investing Survey. Nuveen, 2020.
4) Fidelity: How much do I need to retire? Fidelity Investments, 2021.
5) Estimates of retirement adequacy in different cohorts of the population from Brown, Saad-Lessler, and Oakley (2018), Retirement in America: Out of Reach for Working Americans? National Institute on Retirement Security.
6) Retirement Insecurity. National Institute of Retirement Security. Oakley and others, 2019.
7) The Retirement Savings Crisis. National Institute on Retirement Security. Rhee and others 2013.
8) 10 Years Later: How the Financial Crisis Affected Seniors. Investopedia. Probasco, 2018.
9) Seniors are still struggling to recover after the financial crisis. Minnesota Public Radio. Beras, 2018.
10) The Financing of Health Care Services for the Elderly - The Aging Population in the Twenty-First Century. NCBI Bookshelf. Gilford, 1988.
11) The Elderly Are Getting Complex Surgeries. Often It Doesn’t End Well. New York Times. Span, 2019.
12) U.S. Department of Health and Human Services, Administration for Community Living, How Much Care Will You Need?, 2020
13) Long-term Care Providers and Services Users in the United States from 2015–2016, 2019.
14) National Investment Center for Seniors Housing & Care, Skilled Nursing Data Report Key Occupancy & Revenue Trends, 2019.
15) Family Caregiving and Out-of-Pocket Costs: 2016 Report. AARP. Rainville and others, 2016.
16) The MetLife Study of Caregiving Costs to Working Caregivers, Double Jeopardy for Baby Boomers Caring for Their Parents, 2011
17) Saving Face: A Solution to the Hidden Crisis for Life Insurance Policyholders. Braun and others, 2018.
18) Life Insurance Settlements: A Way to Give Back $8.8 Billion Annually to Seniors and the Economy. Mason Finance, 2018.
19) The Deal.com League Tables. Top life Settlement Providers for 2018.
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RISK OVERVIEW
Management of Operational Risk- In the normal course of business, AIRAM life-settlement funds may be exposed to a variety of operational risks, including position pricing and Net Asset Value calculation procedures, client reporting procedures, compliance controls, and policy acquisition sources. Our managers seek to manage these risks by employing experienced service providers and management who report and manage in accordance with the investment objectives of each fund as outlined in its prospectus. Our approach is to hire the most experienced professionals and firms to add value and protection to our investors.
Longevity Risk- When evaluating the value of life settlements, each policy must be reviewed for multiple quantitative aspects of the insured and their health to get a firm handle on the probability of death over a given timeframe. Understanding the broader implications of these small details within a life settlement transaction is important. One of the key pieces of data used during the underwriting process is the medical underwriting report, which is performed by an independent medical underwriter. Utilizing the latest mortality information, premium data, mortality tables, and verification of coverage, an asset profile is developed and a valuation is produced by an independent valuation agent. A thorough review should then be conducted by a number of parties to create redundancy, and a detailed checklist utilized to ensure uniformity such that all criteria and regulatory requirements correspond to accurate underwriting and quality standards.
Liquidity Risk- Liquidity risk is the risk that a fund may not be able to settle or meet its obligations on time. Investment vehicles are traditionally exposed to quarterly and annual cash redemptions of units at specified amounts. Liquidity risk is managed by investing the majority of the Fund’s assets in investments that can be readily disposed of through various life settlement firms and exchanges. The Fund utilizes marked-to-market accounting practices within its assets that provide quotations to its fund managers on a regular basis ensuring proper valuations are maintained. Longevity risk is the biggest quantitative risk factor in the valuing of life settlements. In general, investment managers focus on reducing the economic impact of unexpectedly increased policyholder longevity. In order to ensure this, a fund must review actual versus expected results and stress test different scenarios of mortality expectations in order to determine the impact that these stressed scenarios have on the value of the life settlement. This stress testing is typically performed on the current portfolio as well as on policies available in the market that are being evaluated for purchase. The primary driver of a policy’s sensitivity to longevity risk is the cost of insurance (“COI”). COI increases every year until a mortality event because premiums must be paid to maintain the policy. A policy’s sensitivity to longevity can be found by reviewing how probable it is that mortality will occur when the COI would produce an unacceptable return.
Credit Risks- Credit risk is the risk that the counterparty to a financial instrument will fail to discharge an obligation or commitment that has entered into with a fund. Where the fund invests in only U.S. life insurance policies these represent the main concentration of credit risk. The fair value of life settlement policies include consideration of the creditworthiness of the life insurance issuer, and accordingly, represents the maximum credit risk exposure of the fund. Management considers a fund to have marginal credit risk to the U.S. life issuers as each insurer is required by law to maintain stringent reserve requirements. In addition, no U.S. life insurance carrier has ever failed to pay a legitimate death claim. The risk of default is considered minimal.
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