Turkey Day 2017

I Did It. I Invested In Death!

In Investing by Gen Y Finance Guy16 Comments

Reading Time: 6 minutes

It’s official: the Grim Reaper and I are now partners. However – let me be clear – we have agreed upon a firewall between our respective functions. The Grim Reaper himself will continue to fulfill his duties in transitioning people from life to death (I’m not into the whole blood and guts scene), and I also stay out of the realm of deciding whether someone’s time has expired or not. Additionally, I made him promise that he can’t take anyone earlier then they were naturally going to go or I just wouldn’t be able to participate in this arrangement with a clear conscience. It’s a matter of morals and ethics.

My role in this arrangement is solely financial. I agreed to put up the capital to buy fractional shares of life insurance policies (i.e. life settlements) for those that are likely on their last stretch of life. Now hold on just a second before you jump to any morbid conclusions. In agreeing to this arrangement, I am providing a new source of liquidity for the insured. If you read my post from a few weeks ago (you may want to go back and read this before reading this post), there are three main reasons why someone may choose to sell their life insurance policy:

  1. The policyholder can no longer afford the insurance premiums to keep the policy active.
  2. The policyholder no longer needs or wants the life insurance policy.
  3. The policyholder may need the money now to pay for medical bills or to maintain their standard of living during the remaining years of their life.

And the reason that investors like YOU and me can even get a piece of the action is that the insured can get more money from private investors than what the insurance company will give them in the form of the cash surrender value. In many cases, the insured can get 3-4X more this way than via the cash surrender value offered by the insurance company.

So I look at it as a win/win. The insured gets a lot more money while they live out the rest of their life and the investor gets rewarded for providing that benefit up front at the end of the insured’s life.

Before you decide whether this is for you or not, we should dive a little deeper into the risks associated with this investment product. Then, at the end, I will provide in-depth detail on my first $30,000 investment into life settlements.

Key Risk Considerations

As with any investment, there is always risk lurking on the horizon. Anytime someone tries pitching you a riskless investment, turn around and run the other direction as fast as you can because no such investment exists. There are two primary risks when it comes to investing in life settlements:

(1) Liquidity Risk – The issue of liquidity is fundamental in deciding how much to commit to any investment. Purchasing a fractional interest in a life settlement policy means that your funds are committed until the policy matures (i.e. the insured passes away). So, you should not invest any funds you can’t afford to have locked for multiple years (I would plan for two to seven years depending on the specifics of the insured).

(2) Life Extension Risk – The estimated life expectancy of the insured plays a vital role in determining the ultimate returns you will earn. The life expectancy estimates are determined through medical evaluations and actuarial analyses of similar population groups. Because we are dealing with estimates, we are almost guaranteed that any one individual may live longer or shorter than the estimated life expectancy derived from the analysis.

Although most reading this may find the illiquid nature of this investment product as a risk, I have increasingly grown fond of investments that lack liquidity. The reason for this is that it forces my hand to remain disciplined and patient, something that is harder for me (and many others) to do when you can buy and sell with the click of a button. So, I look at illiquidity as a feature, rather than a risk (but not everyone is going to have this same perspective). We all know that “time in the market” is more important than “timing the market” when it comes to compounding our money.

For me, that leaves life extension risk as the primary risk to analyze. I realize that we live in a time where advancements in medicine are happening more rapidly than in any other time in history.  The question then actually becomes “when will these advancements in science become a real threat to this asset class?” One of the primary reasons I chose Reliant as the company through which I am investing in these vehicles is the filter they use to screen the policies they decide to purchase and then fractionalize to investors.

Reliant’s policy acquisition team reviews $300 million worth of policies each month, with only a small fraction of that making it through their funnel. To give you further context, they have been in business since 2012 and have only made 30 life insurance policies available for investments, out of a selection of hundreds and maybe even thousands.

Their sweet spot checks all of the following boxes:

  • Universal life policy with a face value of $2.5M or higher.
  • Age of the insured is 80+ years old.
  • Insured also typically has some form of medical impairment and possibly a sub-standard family history.
  • Targeted life expectancy of insured is two to five years.

Reliant goes the extra mile by providing multiple life expectancy reports from other licensed third-party underwriters for each policy they market. In addition to these third-party determinations, Reliant also discloses the Social Security Administration life expectancy estimate relevant to the insured.

With these extra reports and the rigorous and disciplined filter process, I feel comfortable with the life extension risk. However, I do plan to diversify this risk over multiple policies, with three now and a plan to acquire ten total over the next six to twelve months.

What About Taxes?

The good news is that there are no taxes due on these investments until the policy pays out. To me this is another great benefit to the “illiquidity feature” I described above. I’m a big proponent of delaying taxes for as long as possible, and this product offers this as a built-in feature (FREE of charge 🙂 ).

When the person insured by the life insurance contract dies, this triggers the insurance company to pay the death benefit. Because the investors of life settlement policies have no other relationship with the insured, and would not otherwise see any detriment to their finances upon the insured’s death, the normal tax-exempt status of death benefits doesn’t apply. The IRS treats gains from life settlements as ordinary income, rather than capital gains. Yes, this is a negative for high-income individuals (like the GYFG household), who will be taxed at rates much higher than capital gains rates.

Our current marginal tax rate is sitting around 40%, so if we do earn say a compounded 12%, our after-tax return is only going to be approximately 7.2%. Based on my income aspirations, one of these days we could be closer to a 50% marginal rate, leaving us with only a 6% after-tax return. Let’s hope that tax reform lowers the tax brackets favorably before we realize any gains from these investments.

(An investor could alternatively choose to mitigate this tax consequence by investing in life settlements through a self-directed IRA.)

Just keep in mind that a 6-7% after-tax return is still very respectable. For comparison, if you’re in the 40-50% marginal tax bracket and you get 8% from investing in the stock market (the oft-quoted historical average), you are only looking at 4-5% after-tax returns. This gives me further comfort and removes FOMO (fear of missing out) by choosing this investment as a component of my portfolio vs. investing in more stocks.

Details Behind My $30,000 Investment

The minimum investment to get started in this asset class was $30,000 with a minimum of $10,000 per policy. So, I started off my position with the minimum spread across the following three policies:

 

Life Settlement Investments R2

Originally I had planned to share the specific details of each policy but found out after receiving all of the documentation that it’s confidential and prohibited under California Law (except for dissemination of which is necessary to effect the sale of the policy). So instead, I thought I would give you an idea of the medical condition of the people that fit Reliant’s criteria listed above.

 

Here is a rundown of the medical wrap sheet that will be common (or worse):

  • 83-year-old male
  • Former smoker
  • 5′ 9″ weighing 230 lbs with a medical history of obesity
  • Adhesive capsulitis of the shoulder
  • Osteoarthritis of left leg
  • Rotator cuff tear of right shoulder
  • Dislocation of right shoulder due to fall
  • Mumps and measles as a child
  • Suffers borderline hypothyroidism
  • Umbilical hernia
  • Dermatophytosis
  • Osteoarthritis of lower legs
  • Varicose veins
  • Possible signs of neurological problems
  • Sleep apnea.
  • History of falls
  • Medical records indicate insured is non-compliant and uncooperative with doctors [you go, old guy]

The overall goal is to build a $100,000 position over ten policies to achieve diversification of the life expectancy risk. As policies mature and pay out I will have to decide whether to reinvest for another cycle or take the money and redeploy elsewhere. Let’s cross that bridge when we get there!

– Gen Y Finance Guy



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Comments

  1. This is a very interesting investment to get into and am looking forward to reading updates in 2-5 years from now (or tomorrow).

    So that I understand, the life extension risk is that the insured individual lives past the maturity date and triggers a call from the investors to fund the policy premiums for that year and every year after until “maturity”?

    Again, thanks for sharing your investments with the community.

    1. Author

      Hey Church – I think you hit the nail on the head as I am not going to have much to update on this investment on a regular basis. However, stay tuned for a special mini update in my monthly financial reports, with respect to how I plan to value them in net worth.

      Regarding your question about life extension risk…Yes, the risk is that the insured lives past the life expectancy. For example, if the life expectancy was 4 years, the escrow account would be pre-funded with 4 years worth of premiums but if the insured lives to year 5 there will be a premium call to investors based on their pro-rata share of ownership in that policy.

      Cheers

  2. Interesting stuff. While the net return is tempered for those in higher tax brackets, I like the low (or no) correlation to the stock market. Even if stocks and related securities are down, the returns on this investment should be stable. Thinking it through, though, another risk is the risk of inflation. If inflation shoots up while waiting for the investment to mature, the returns could be much less than expected. Still, I like the outside-the-box thinking for this alternative investment. Thanks for sharing!

  3. Absolutely fascinating. It sounds like a slam dunk. Interesting that the risk is them living forever. I imagine it could make early retirement drawdown strategies a bit more difficult due to timing so I think specifying that this is only one aspect of your portfolio is important. Keep us posted!

    1. Author

      Hey Kristine – Thanks for stopping by. I don’t know if I would call it a slam dunk, but I like the fact that it has zero correlation to the stock, bond, or real estate markets. Absolutely, this is only one piece of the overall portfolio allocation (that makes up less than 5%). Additionally, I have no plans for early retirement anytime soon, my target is 48 (today I am 31).

      Cheers

  4. Very interesting post. The tax benefit sounds like a major selling point. If an investor is comfortable with the liquidity of this type of investment, there seems to be major benefits. It will be interesting to see how this pays off as time goes by.

    1. Author

      Dave – You definitely have to be okay with the illiquidity of this type of investment. As I mentioned in the post, this has become a “feature” I seek in my investments lately.

  5. Very interesting. I have always avoided this asset class, as it has had a bit of a sleazy veneer and they have a tendency to re-mark the mortality model which impacts the value. There also seems to be a huge number of middle-men involved in sourcing policies and there are regulatory risks around these instruments. I would definitely diversify the number of lives as much as you can. 10 policies sounds like quite a small number, any chance you can get smaller slices and aim for 100+ lives?

    1. Author

      AoF – You bring up some valid points.

      (1) There are a lot of sleazy companies just trying to make a quick buck, which is why I spent several months researching before I found a company that I was comfortable placing my money with. I also like the fact that Reliant keeps skin in every policy (typically ~20%).

      (2) To your point about regulation, one of the reasons I chose Reliant is that it operates in California, which has the most stringent regulation for this investment class. Reliant only works with California residents.

      (3) With respect to concentration with only 10 policies, unfortunately, the minimum investment is $10,000/policy. This is another reason I was attracted to Reliant was due to their investment filter process. However, another reader did point me to a podcast that mentions another way to gain access to this investment class, which allows for greater diversification across 100’s of policies.

      Given your comment name, it sounds like you are in the business. I would love to hear you expand on what you mean by “they have a tendency to re-mark the mortality model which impacts the value.”

      Cheers,

      Dom

  6. Great title and post! Fascinating information about this investment vehicle. However, I’m still reeling over your marginal tax rate. Ouch! You need a llama farm.

    1. Author

      Hi CashFlowKat – Nice name! Glad you like the post and title (I felt the title appropriate). Yes, our marginal tax rate is high, but it’s not the worst problem to have 😉

      I will have to check into the llama farms and what…LOL!

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