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.
- Asset class
- Alternatives (insurance-linked)
- Instrument type
- Purchased life insurance policy
- Traded
- Private secondary market, mostly US
- Typical users
- Specialist funds, some institutional investors
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.
3 · IntermediateHow it works in practice
The arithmetic
- 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.