Be careful investing in life policies

An increasingly popular alternative investment is investing in the life insurance of an elderly person.  In an article entitled Grim Risks of Investing in Death's Rewards, the Wall Street Journal discusses the mechanics:

Called "life settlements," these arrangements allow senior citizens to sell their policies at a discount to face value. As a buyer, you claim the benefits when the seller dies. In the meantime, you pay the policy premiums. Investment earnings hinge on how long the insured person lives. The ghoulish facts of such investing: The sooner the original policyholder dies, the better for the investor.

Say you purchase a $1 million policy held by an 82-year-old woman. Actuarial tables say she has five years to live. If you do the deal via Life Partners Holdings Inc., a major life-settlements firm, you must pony up $540,000. The woman gets $200,000 of that; the remainder goes toward future premiums and transaction fees.

Should she obligingly die on time, you net a 13% annual return. Yet if she doesn't shuffle off this mortal coil for 10 years and you end up forking over much more in premiums, the return sinks to 3%. Every extra year she soldiers on, your take shrinks.

As the article details, these investments are fraught with risk and are only suitable for wealthy and sophisticated investors.

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J. Michael Young3 Comments