Peaceful Wealth: Death Play - the truth about Life Settlements
Saturday, May 23rd, 2009
R. Scott Maxwell, MBA
How did we arrive here?
I am constantly amazed by the number of bad ideas that become sterilized “financial products” and sold by whatever means necessary to anyone who will buy them.
It really is a neat marketing trick. Products are neither good nor bad. Products are immune from ethical or philosophical scrutiny. You either buy a product for its intended use or you do not buy it because you do not need it.
This philosophy works great when you are kicking tires for a new automobile or trying on a new suit. It fails to hold water when the safety and security of your retirement is at stake, or when you have an opportunity to profit at someone else’s expense.
No, investments are not products. They are ideas and their implementation has consequences. Understanding the real risks, costs, potential benefits and ethics behind an investment idea should be the goal of every investor.
A relatively recent idea to hit the “financial products” marketing machine are life settlements. Defined by Investopedia as “the selling of one’s life insurance policy to a third party for a one time cash payment”, life settlements allow an investor to buy a life insurance policy (or a fraction of a policy) from an elderly man or woman at a discount and then receive the policy payout when the insured dies.
The purchaser of the policy becomes the beneficiary of the policy. In addition to paying the insured a lump sum for the right to become the beneficiary, the investor also must assume responsibility for making all policy premium payments. A life settlement investor profits on the difference between the lump sum payment to the insured man or woman along with any premiums they pay and the ultimate payout of the policy once the insured dies.
How’s that for an idea jam packed with financial, ethical and moral questions begging further scrutiny?
Life settlements are heavily marketed these days because they are a goldmine for the sales agents pitching them. I met with a life settlement salesman last summer who told me he had pocketed over $500,000 in sales commissions during the first half of the year and wanted to know if I wanted to be part of his team by offering them to our clients here at Talis Advisors.
I declined, for the reasons I will list in a moment. His reaction was telling. I asked if his clients put all their money in life settlements. He told me no, and that he would be interested in referring clients to us for their broader investment needs. I showed him our approach and our historical performance. Everything came to a halt when he looked up at me and said he could not, and would not, refer prospects to us because our client portfolio returns were much better than anything his clients have achieved and he was afraid they would not buy any of his life settlements if they saw our results.
That tells you everything about his character and his focus – forget about the client’s best interests. Its all about self-promotion and self-interest.
Here is a breakdown of why I do not like life settlements:
1) They are unregulated. There are no oversight, regulation or sales standards for the “products”. Many life settlement providers use a multi-level marketing approach. They can say almost anything and make outrageous claims with limited, if any, accountability. Don’t be fooled by the pitch life settlements are offered using an insurance agent model. Insurance has oversight, standards, licensing requirements, client protection advocates and accountability standards. Life settlement products are the wild-wild west and buyers need to be aware of the risks and the potential for misdeeds.
2) They have significant risks. You cannot be sure when the person whose policy you hold (or partially hold) will die, and you only profit once the insured dies and you receive the policy payout. Your money is tied up and time is not on your side. You must also pay the policy premiums or lose your initial investment if the person continues to live. The Texas Attorney General has numerous complaints from people who bought life settlement contracts and now must fork over additional cash or lose everything. Yes, everyone eventually dies. But your profit declines the longer the insured lives. And don’t be fooled by a projected rate of return based on longevity tables. Life settlement marketing companies have a much better chance of selling their “product” when they claim a high potential for return.
3) Real returns are less than advertised. I spoke to an industry expert earlier this year and she told me the marketplace for life settlement products is maturing and returns should average 7% to 8% going forward. She believed demand, capacity and longevity are driving down returns. The only way to make more money is to pay the elderly man or woman whose policy you are buying less money and hope they die quicker. Yes, 7% to 8% sounds good when the markets are down, but that leads me to the next problem.
4) They are illiquid. Your money is tied up until the person dies. As I said, you benefit when they die sooner. Your returns diminish as they live longer. You are stuck until the person dies. Sure, the pitch men will tell you there is an aftermarket for your policy, but the longer you hold it the less it is worth. And where is the aftermarket? Who regulates or oversees it? How do you really know if there is a viable aftermarket willing to pay you any reasonable price? Every timeshare owner wishes there was a viable aftermarket for their expensive timeshare.
5) You profit from the death of someone else. You also profit more when they die sooner. You also profit more if they are taken advantage of and offered less for their policy than it is worth elsewhere. You also risk buying policies that were sold to an elderly person with the sole intent of buying it back from them within a short period of time – an illegal practice. Not a game I want anything to do with.
Life settlements are an investment idea that has captured the fancy of many, especially during recent market declines. Sure, there are those who will rebut many, if not all, of the points I’ve made. High commissions and non-existent regulation are powerful incentives to say anything to make the sale.
The bottom line is I believe they are a bad investment on multiple levels.
Life settlements offer me no peace on the journey to wealth.
R. Scott Maxwell, MBA is a Vice President and a wealth and income solutions expert at Talis Advisors, a wealth management firm headquartered in Plano, Texas. He is committed to teaching investors the truth about the stock market and how they can achieve Peaceful Wealth throughout their lives. Scott can be reached at 972-378-1794 or 866-608-2547 or via his web site at http://www.talisadvisors.com