Life Settlement
Also known as: Traded life policy, Senior settlement, Viatical settlement
Buying someone's life insurance policy, paying its premiums, and collecting when they die. Genuinely uncorrelated, and the asset class where the modelling error has a name and a face.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A policyholder no longer wants or can no longer afford a life insurance policy. Their options are to let it lapse for nothing, surrender it for a modest cash value, or sell it. A life settlement is the third: an investor buys the policy, takes over the premiums, and receives the death benefit when the insured dies.
The economics are straightforward and the framing is uncomfortable, so it is worth stating both plainly:
- For the seller, the market usually pays several times the surrender value the insurer would offer. That is a genuine improvement, and it exists because the insurer's surrender value is deliberately low.
- For the investor, the return depends on how long premiums must be paid before the benefit arrives. Live longer than modelled and the return falls; considerably longer and it goes negative.
The asset is uncorrelated with markets in the strongest sense available — mortality has essentially nothing to do with interest rates or equities. It is also the asset class where an actuarial estimate is the entire investment case.
a paymentsomething deliveredonly if a condition is met
This page describes a market that exists and is regulated in several jurisdictions. It takes no view on whether anyone should take part in it.
At the sale
- The buyer → The policyholder The insurer's own surrender value is usually lower, which is the gap that creates the market.
- The policyholder → The buyer Ownership and the beneficiary designation transfer to the buyer.
Every year afterwards
- The buyer → The insurer The buyer must keep paying to keep the policy alive. A longer life than expected means more premiums and a later claim — the return falls as the insured lives on.
When the insured dies
- The insurer → The buyer Paid to the buyer as the policy's owner. The uncomfortable arithmetic of this instrument is that its return improves the sooner that happens, which is why conduct rules around the sale are strict.
- Asset class
- Alternatives (insurance-linked)
- Instrument type
- Purchased life insurance policy
- Traded
- Private secondary market, mostly US
- Typical users
- Specialist funds, some institutional investors
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketbarely applies
- Creditmatters
- Liquiditydecides it
- Fundingmatters
- Operationaldecides it
What decides it here. The buyer must keep paying premiums to keep the policy alive, so a longer life than expected costs money twice. There is no market to sell into if the estimate proves wrong.
3 · IntermediateHow it works in practice
The arithmetic
What the symbols mean
- Pa price, or a present value
- ta point in time
- Tmaturity, in years
- rthe interest rate, per year
- Ean expected value
- Every input is knowable except T. The death benefit is contractual, the premium schedule is contractual, the purchase price is negotiated.
- Life expectancy estimates come from medical underwriters who review records and apply mortality tables with impairment multipliers. Two underwriters routinely disagree by years on the same file.
- The sensitivity is brutal: an extra two years of life on an eight-year expectancy means two more years of premiums and two more years of discounting, hitting the return from both directions.
What determines a policy's value
| Factor | Effect on price |
|---|---|
| Shorter life expectancy | Higher price — benefit arrives sooner |
| Lower premium load | Higher price — less to carry |
| Insurer credit quality | The benefit is only as good as the insurer |
| Policy type | Universal life dominates; term policies rarely qualify |
4 · AdvancedPricing & valuation
The systematic error, and why it happened twice
The industry's defining problem has been persistent underestimation of life expectancy. In the late 2000s a major medical underwriter revised its methodology, lengthening estimated life expectancies materially across existing portfolios. Funds holding those policies had to write down values sharply, and several closed.
- The error was systematic, not random. It applied in the same direction to every policy in every portfolio at once, so diversification across hundreds of lives provided no protection at all.
- This is the cleanest available example of model risk as distinct from market risk: the assets performed exactly as contracted, and the assumption about them was wrong.
- Medical progress makes the error directionally likely to recur. Any treatment that extends life in the insured population reduces the value of every policy simultaneously — an unhedgeable, one-directional exposure.
The practical risks
- Premium optimisation is mandatory. Universal life policies allow flexible premiums; paying the minimum to keep the policy in force, rather than the scheduled amount, materially changes returns. Getting this wrong — or missing a payment — lapses the policy and loses everything.
- Insurer credit risk is real over a twenty-year horizon and rarely priced by buyers focused on mortality.
- Contestability and insurable interest. Policies originated purely to be sold — "stranger-originated life insurance" — have been voided by courts. Provenance diligence is not optional.
- Illiquidity is absolute. The secondary market for a fund's portfolio is thin, and forced sellers have historically realised deep discounts.
The ethical question, stated fairly
The objection is obvious: an investor benefits financially from a person's earlier death. The counter-argument is also real: the alternative for most sellers is lapsing a policy for nothing or surrendering it far below market value, and a functioning secondary market demonstrably pays more. Both propositions are true at once. Regulation in most US states now requires disclosure, licensing and cooling-off periods for sellers, which addresses the transaction's fairness without resolving the discomfort — and the discomfort is a reasonable thing for an investor to weigh alongside the return.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Life Settlement in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Life Settlement beside any other instrument →
Where this instrument shows up elsewhere
- MediumInsurance UnderwritingIndustryPricing a risk somebody else does not want to carry, and finding out years later whether the price was right