Chapter 5
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What's My Policy Worth?
The average policy sale in the industry results in a cash settlement of 20% of the policy's death benefit*. For example, if you had a $1,000,000 policy and you were a candidate for policy sale, you could receive on average $200,000. That said, each offer received is completely case specific. You can get an initial estimate of your policy value, but many more factors are needed for a licensed provider to make an offer. Below we will provide a specific example of how a life settlement offer estimate can be calculated. In general, the following factors will determine your offer:
Policy Size
The larger the policy benefit, the more valuable the life settlement will be. In general, the minimum policy size eligible for a life settlement is $100,000. As the life settlement industry continues to develop, smaller policies may become eligible to sell.
Age & Life Expectancy
The older the insured is, the more valuable the life settlement will be. Similarly, the lower the life expectancy, the more valuable the settlement will be. The reason for this is because the buyer will be able to realize the death benefit sooner and will be required to pay out fewer premium payments.
Premium Amount
The lower the annual premium cost, the more valuable the life settlement will be. This is because the cost to maintain the policy and keep it in-force is lower for the investor.
Market Rate of Return
The rate at which the investor can raise capital affects their targeted investment returns, which affects what they can pay for policies. All else equal, in a low interest rate environment, investors would be willing to pay more than normal for a policy because they can tolerate lower returns.
Cash Value
See below. This is more complicated than the other factors so we have devoted a full section to discussing it.
Sample Valuation Calculation
The calculation of the value of a life settlement transaction is a discounted cash flow analysis. Let's consider an example of an individual who has a life expectancy of 10 years. The individual owns a whole life insurance policy with an annual premium of $4,000 and a death benefit is $100,000. Let's also assume that the discount rate used is 8%. We can create a discounted cash flow analysis to establish the value of the policy.
This shows that the expected value is $19,479. In this example, the present value of the death benefit exceeded the present value of the premium payments - i.e., the sum total of each year's discounted cash inflows/outflows is positive - and so the policy is sellable. This is not always the case. For instance, let's change the example such that the individual has a life expectancy of 15 years.
A greater life expectancy results in both additional premium payments as well as reducing the NPV of the death benefit. In this case, the policy would not be sellable because the present value of premium payments exceed the present value of the death benefit.
Click here to download the Excel spreadsheet used for the sample calculations above.Life Expectancy
It's clear by the previous example how big of a difference life expectancy can make. Just an additional 3 years turned what was a highly positive transaction into a negative one. Therefore, it's important to note how life expectancy is determined.
The primary factors of life expectancy are age and health. Life settlement buyers often utilize a life expectancy underwriter to provide this estimate. The two well-known underwriters are AVS Underwriting and 21st Services. Using various mortality tables and the insured's medical records, these underwriters will produce a life expectancy for investors. Although their models are not available for public use, here are a few free online tools you can use to estimate life expectancy:
• Social Security Longevity Calculator
What About My Cash Value?
You may have noticed by the examples above that we implicitly assumed zero cash value. For most policies, cash value can be used to pay premiums. Therefore, an investor will use the cash value to pay off premiums in the early years, where the discount factor is high. This means cash value can increase your policy's worth, but not one-to-one, and furthermore, the rate of increase decreases with higher cash value.
It's worth noting that policies with very high cash value (excess of 25% of death benefit) can be less attractive to buyers. The reason is because investors do not want to "buy cash" - especially if it is illiquid cash that can't be used for many years. High cash value presents them with additional risks, such as interest rate risk. As a result, investors could discount the cash value more aggressively or forgo the policy altogether.
Furthermore, the cash value is a hurdle. If you can get more money by surrendering the policy, then there is no reason to go through a life settlement. This means that a life settlement on a high cash value policy will create much less value.
In some rare cases where a policy has a high cash value, the policy owner could take out a withdrawal of the cash value before undergoing a life settlement. This will decrease the death benefit, but potentially make the policy sellable. However, this is a complex transaction and you should engage with a life settlement broker to help you analyze this option.