How is a Life Settlement Priced? 

Rebecca Parson
Rebecca Parson

Rebecca Parson

Author

Rebecca Parson is a financial and tech writer with 10 years of experience writing about topics such as life insurance, commodities investing, and the SaaS industry. She has a master’s degree from Johns Hopkins University and a bachelor’s degree from the University of Mary Washington. Her writing has appeared at money.com, sacbee.com, cart.com, herodevs.com, blanchardgold.com, and more.

Brian OConnel
Brian OConnel

Brian O'Connel

Contributor

Brian O’Connell has been a contributing writer for U.S News & World Report since 2016. A former Wall Street bond trader and the author of two best-selling books; “The 401k Millionaire” and “CNBC’s Creating Wealth”, he has 20 years experience covering business news and trends, particularly in the business and financial sectors. He believes education is the best gift a financial consumer can receive – and brings that philosophy to every story he writes. His byline has appeared in dozens of top-tier national business publications, including CBS News, Bloomberg, Time, MSN Money, The Wall Street Journal, CNBC, TheStreet.com, Yahoo Finance, CBS Marketwatch, and many more.

By Rebecca Parson, Brian O'Connel
Author, Contributor, Life Insurance

Several key factors determine the price of a life insurance policy, including the policy’s death benefit, cash surrender value, age and health of the insured, and future premium obligations. Life settlement providers use these factors to calculate a fair and accurate offer for the policy.

Policy Death Benefit: The death benefit is the amount the insurance company will pay upon the insured’s death. The higher the death benefit, the higher the offer.

Cash Surrender Value: The dollar amount an insurance company will pay if a policy is surrendered or canceled before its maturity date. 

Premiums: The premiums are the policy owner’s ongoing payments to keep the policy active. Before purchasing a policy, a life settlement buyer will calculate the minimum premiums they must pay to keep the policy in force until maturity. This is known as “premium optimization”. 

Insured’s Age: The insured’s age impacts life expectancy and premiums. The older the insured, the lower the life expectancy, leading to a higher policy offer. This effect is somewhat counterbalanced by the fact that policy on an older individual will have higher premiums. Generally, the impact of the lower life expectancy will outweigh the effect of the higher premiums. In most cases, a life settlement for an older individual will command a higher price.

Discount Rate: Life settlement providers also consider current interest rates when pricing a policy. Since the death benefit is a fixed amount of money in the future, the buyer will discount that amount using an internal rate. The higher the market interest rates are, the higher the buyer’s internal rate will be, leading to lower offers.

Health of the Insured: The price a life insurance policy commands as a life settlement is closely related to the insured’s life expectancy. A buyer will review the medical records and third-party “Life expectancy reports” to assess the insured’s life expectancy.

In addition, buyers may consider other factors, such as the insurance company’s rating, the state’s regulatory environment in which the policy owner resides, and the likelihood of future medical advances impacting the insured’s life expectancy.

What is a Life Expectancy?

A life expectancy certificate, otherwise known as an LE, is an estimate by a third-party underwriter as to the mean life expectancy of an individual. The LE is one of the most important variables regarding the price a life settlement will command: the insured’s life expectancy. Buyers will generally use one or more LEs to determine how much they are willing to offer on a particular policy. 

An LE estimates how long the insured individual is expected to live based on various factors such as age, health status, and lifestyle. When a policy owner contracts with a broker to sell his life insurance policy, the broker will first obtain medical records on the insured. Once the broker has sufficient medical records, he will forward them to one or more third-party underwriters, who will use the information to calculate an LE estimate. The broker will forward the estimate to potential buyers with the details of the policy as well as any other pertinent information.

Why don’t the buyers review the medical records themselves?

Reviewing medical records is time-consuming. Having every buyer review medical records individually may lead to a delay in the settlement process. Furthermore, not all buyers may have the expertise or resources to accurately analyze medical records and make an informed decision on the LE estimate. Third-party underwriters specialize in analyzing medical data and providing accurate LE estimates, making them essential to the life settlement.

In addition, using third-party underwriters ensures consistency and fairness in the LE estimation process. Each underwriter uses a standardized methodology to calculate LE, eliminating potential bias or discrepancies. This also makes it easier for buyers to compare policies and make informed decisions.

Finally, using third-party underwriters protects all parties involved in the life settlement transaction. If the underwriter provides an inaccurate LE estimate, they may be held liable for any losses incurred by the buyer. This protects the policy owner from receiving a lower offer than they deserve and the buyer from overpaying for a policy with an underestimated LE.

Who are Some of the Most Trusted Life Expectancy Providers? 

Some of the biggest and most reputable life expectancy providers include Fasano Associates, AVS Underwriting LLC, 21st Services, EMSI Health, and ExamOne. These companies have established themselves as leaders in providing accurate and reliable LE estimates.

Premium Optimization

To correctly price a policy, investors will do their best to optimize premiums where they will pay the lowest possible premium to keep the policy in force. In the life settlement industry, this is called “premium optimization.” It’s important to note that this approach varies from the typical level premium approach, which aims to accumulate account value over time. 

Premium optimization can benefit all policy owners and not just buyers of life insurance policies. As a policy owner who wishes to retain their insurance policy but is contending with affordability constraints, understanding the concept of “Optimized Premiums” can be crucial. 

Insurance companies provide an illustration document outlining the minimum fixed payments necessary to keep your policy active. This information can help you calculate future premiums, but you may need an actuary to run the numbers. These calculations can be complex, and the insurance company does not usually provide the minimum premiums you will owe to keep the policy in force. 

Often, a policy owner may not need to pay the total level premium to keep the policy in force in the short term. Level premiums include the amount necessary to keep the policy in force for the current year and a contribution to the account value. While building account value in the early policy years prevents high premiums in the later years, paying the minimum premium reduces the amount needed to maintain your policy. 

By understanding these factors, you can navigate the complexities of your insurance policy and find a viable solution to keep your insurance active. Please remember that this approach requires a deeper understanding of your policy’s cost of insurance charges and interest rates. It is advisable to consult with a financial advisor or insurance professional to help you fully comprehend these details and make an informed decision.

Why Are Insurance Company Ratings Important?

One often overlooked component of the price of a life insurance policy on the secondary market is the life insurance company’s credit rating. A high credit rating not only indicates a solid financial standing of the company but also positively impacts the perceived risk associated with purchasing an existing policy from that company. This can result in a higher price for the policy on the secondary market.

Life Insurance Company Ratings:

A credit rating for a life insurance company serves as a benchmark of the insurer’s financial strength and stability. It provides insight into the company’s ability to meet its financial obligations, specifically the claims and benefits payments. The credit rating is evaluated by independent rating agencies such as Standard & Poor’s, Moody’s, and A.M. Best, using a variety of metrics, including financial performance, asset quality, business profile, and management strategies. A high credit rating signifies a lower risk of default, thus instilling confidence amongst policyholders and potential investors in the secondary market.

Who are the Rating Agencies, and What does their Rating Mean?

Several rating agencies assess the creditworthiness of life insurance companies. These include Standard & Poor’s, Moody’s, and A.M. Best. Each agency uses a different rating scale to evaluate insurers’ financial stability and strength.

Standard & Poor’s – assigns ratings ranging from AAA (extremely strong) to D (in default) based on the company’s ability to meet its financial obligations. The ratings also come with a plus or minus sign, indicating a slightly higher or lower position within the rating category.

Moody’s – uses ratings ranging from Aaa (exceptional) to C (highly speculative) to evaluate the creditworthiness of insurers. Similarly, the agency may use “+” and “-” signs to show slight variations within each rating category. 

A.M. Best – uses a scale from A++ (superior) to D (poor) to rate the financial strength of life insurance companies. The agency also includes a modifier in its ratings, indicating any changes or potential risks that may impact the insurer’s creditworthiness.

How Important Is A Life Insurance Company’s Creditworthiness To Life Settlement Pricing?

As a practical matter, the creditworthiness of a life insurance company has minimal impact on the pricing of a life settlement. Most life insurance companies maintain strong credit, which most pricing models already consider. On occasion, a life insurance company will have a poor credit rating. In this case, the life insurance company’s negative rating can significantly affect the price its policies will command as a life settlement.

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