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On Life Settlements

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I wrote this on the 8th of September, 2009:


Well, thank you Rolfe Winkler and Reuters.  I go off-line on Sundays because it is the Sabbath, so I don’t review the web or catch e-mail, but when Rolfe e-mailed me and I saw it on Monday morning, I felt I had to give him a response.

Now, my response was a brief one, for me.  There was more to say, some of it of a personal nature, but I was busy this weekend.  We moved six of our children into different rooms, repainted two of them, and simplified our lives — I have more trash sitting outside than I have ever seen in my life.  The house is simpler and prettier than ever before, and our two oldest now both have their own rooms.

So, what I wrote was significant, but limited.  Let me fill in some gaps.

First, the efforts on life settlements have been going on for a long time.  This is not new, but has been happening for a little less than 20 years.  Over the last ten years I have been personally invited to be a part of three (maybe more) of these enterprises, and I have turned them all down early because of the ethical issues involved.  I genuinely believe in the concept of insurable interest.

Second, life insurance is for the most part sold, not bought.  I used to have trouble with that, but there are many people who will not save or seek protection unless someone goads them to do so.  Those who will not actively look out for themselves pay a price relative to those who seek coverage unbidden.

Surrender charges exist on life insurance policies to allow insurers to recover the cost of the commission that they have not amortized.  As GAAP accounting would suggest, all revenues and expenses are spread over the life of the policies.  The significant cost of acquiring a life insurance policygets recovered over the life of the policy.  If a policy owner wants to surrender early, the insurance company has a surrender value or cash value that reflects no loss to the insurer on average.

Pretend for a moment that you are a life insurer.  You want to make a profit, or if a mutual, break even.  You test/underwrite potential insured lives before the policy is issued to assign policies to the proper rating class for them.  The more accurate you are, the more polices you will write, and the fewer surrenders you will have.  But over time, people change.  After issue, insureds tend to get more sloppy in their lives, on average.  Also, things that could never have been caught in underwriting emerge.

Those doing life settlements aim at the policies where there have been negative health events since issue.  Death is considerably more likely, and so the value of the policy is worth more.

Think about it: you as the insurance company did your best job to estimate the risk involved. You did it assuming that policies could not be sold, whether really or synthetically.  You already knew that those who were healthy in the future would surrender and seek another carrier, but thought the those who were less healthy would persist to some degree.  Well, with life settlements, the unhealthy persist at a much higher level, which bites into profits.

This is the box that life insurers are in.  They can’t lock in policyholders, but policyholders can hang on, refinance (so to speak), or sell off their obligations.  That is a tough equation for life insurers to work through, and to the degree that life settlements are allowed, premiums will have to rise to compensate for the loss of profitability.


Back to the present.  If you didn’t read Rolfe Winkler’s post, it is worth looking at to see what else I said on this.  In general, most complexity in investing works against average people.  If you are tempted to do a life settlement, you could see if the insurance company would be willing to match or beat it.  That would be a cleaner transaction than a life settlement.  Try to explain how the insured doesn’t have much longer to live.  Just remember, death benefits are tax-advantaged.

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David Merkel

David Merkel

2010-present, David is working on setting up his own equity asset management shop, tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities. He did many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, he was a leading commentator at the investment website His background as a life actuary has given him a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that he deals with in this blog. All of these goals rely on the help of Jesus Christ and his readers.
David Merkel

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