Once people know you're an “investing guy” you get to hear about all kinds of interesting opportunities. So when I walked into my shift recently, one of my partners handed me a book titled, “Smartest Doctor In The Room: How Doctors and Dentists Are Outwitting Wall Street” written by a local guy who happened to be a friend of the partner. The book was a short, self-published, rarely bought/sold/reviewed paperback that seemed to be primarily used to hand to prospective clients to explain the investment being sold. As you might imagine, the investment being sold wasn't index funds, the way most doctor and dentists ought to be outwitting Wall Street. The investment was life settlements, or viaticals, where you pay someone more for their life insurance than their life insurance company is willing to pay, make the premiums until they die, and then get the death benefit. Morbid? Of course. But that didn't bother me. What bothered me was the way the investment was being sold.
I didn't like the book all that much for a few reasons, although I think the investment is well worth talking about. Here are the reasons I didn't like the book:
Appeals to Physician Egos- From the title to the tone of the book, it was designed to make doctors feel like smart investors. The angle of the book is that because doctors are more familiar with the medicalese in these contract owner's medical files that they can evaluate this investment better than anyone else. I don't buy it. I might be able to understand a medical file, but that doesn't make me any better at predicting when someone is going to die (the basis of this investment) than anybody else, especially an actuary. So why isn't this book titled “The Smartest Actuary In The Room: How Actuaries Are Outwitting Wall Street”? Well, actuaries don't have any money to invest, nor do they usually qualify as an accredited investor. A good general rule is that if the only other investors in any given investment are doctors, you probably ought to avoid it.- The investment can be easily explained on one page. Yet the book is 138 pages. It is filled with a bunch of stories about why someone might want to sell their insurance policy or want to buy somebody else's policy.
- No Lose Investment- The investment is portrayed as a “no lose” situation. The author likes to point out that you're going to get your money, it's just a matter of when. However, there is only one short paragraph in the entire book where he actually admits that you may have to come up with some additional cash if the insured person lives “too long.” All of the charts in the book only go out to about 6 years. I don't know about you, but I get surprised all the time by how long some patients with reportedly terrible diseases live.
- Not Enough Emphasis on Investment Ethics- The book justifies the investment by simply pointing out that the insured is getting more money than they would from the insurance company. Yet the primary profit from investing in life settlements comes from buying the policy for less than it is really worth. I guess you're helping out an old guy in a tough spot, but it sure feels a lot like those “Zero Down” real estate schemes that rely on stealing old peoples' houses at below market prices to be successful.
- Doesn't Explain How He Is Paid- The book emphasizes the “low fees” of the investment, and even goes so far as to quote Jack Bogle extensively about the importance of low fees. But he never does explain how he is paid for putting the investment together. I assure you he isn't working for free.
- Bashes Stock Investing- Like most alternative investment books, he seems to go out of his way to point out all the downsides of investing in stocks, while never pointing out that their benefits (high historical returns, high liquidity, easily diversified, very inexpensive etc.)
How It Works
So how does this investment work? Well, it starts with someone who owns a life insurance policy, usually a permanent one such as whole life or universal life. For some reason, he no longer wants to own this life insurance policy. This might be for several reasons:
- Can't or doesn't want to continue to pay premiums
- No longer has a need for the insurance. This may be due to a change in estate tax laws or because the beneficiary preceded the insured in death.
- Wants to disinherit his heirs.
- Has a need for cash such as for living expenses or long term care
So he goes to the insurance company, where he may be presented with a few options.
- Surrender the policy and take the cash value
- Borrow from the policy
- Sell the policy to the insurance company
- Accelerated death benefits (begun in response to viatical companies)
Then he hears about something else, getting a “life settlement” which will pay him much more than the insurance company will. Plus, unlike borrowing from the policy he won't have to continue to make the premiums. So he goes to a broker, who shops his policy around to a few firms willing to purchase it in exchange for a commission. He finds the firm willing to pay the most (the viator) and closes the deal. He gets his commission, the insured gets the cash, and the viator now owns the policy. So where does the viator get the money to pay the insured? That's where you come in Doctor.
The Investor's Perspective
Some type of analyst working for the viator has looked at the policy and estimates that the insured will die in four years. Let's say there is $200K in cash value in the policy. Premiums are $25K a year. The face value of the insurance is $1 Million. So the viator pays $500K to insured. His broker takes his 20% cut (I have no idea how large these commissions are; could be more, could be less) and pockets $100K. The insured is very happy to now have $400K. The viator now rounds up a bunch of investors. He plans to put 8 years worth of premiums (twice the life expectancy) into an escrow fund, so he needs a total of $700K. So he rounds up 28 doctors willing to put in $25K a piece. That buys 3.57% of the death benefit ($25K/700K). So when the insured keels over, the doc gets $35,700. If he dies after one year, the doc has a return of 43%. If he dies after 2 years, the return is 20%. If he dies at his life expectancy of four years, the return is 9%. If he dies at 8 years, the return is 5%. However, here is where it gets interesting (and isn't mentioned in the book.) The escrow account is now depleted. The doctor is now on the hook for 3.57% of the premiums for the rest of this guy's life. $25K*3.57%= $893 per year. So if the guy miraculously lives a total of 16 years, your return is 0.8%. The return turns negative at year 20. Does that seem unlikely that a guy with a life expectancy of four years would live 20? Of course. But to say there is NO risk of loss seems unwise.
The wise investor will notice that something was left out of my explanation. It was left out of the book too. That's the answer to the question, “How does the viator make any money?” The author vaguely alludes to the idea that he doesn't get paid until the policy matures (the old, sick guy keels over.) So presumably he is being paid with some “free” shares (you are paying for them, just like you're paying the broker's commission and the insured's settlement.) That doesn't mean it is a bad deal for you, but it would be nice if it were a little more clearly disclosed. Certainly whatever he is paid comes out of your return. In investing, you get what you don't pay for.
What I Like About Life Settlements
Now, I might sound negative about this investment based on what I've written above. That's not entirely true. There are several things I really like about this idea.
- Sticking it to the insurance companies-Under this deal, the insured is happy, his broker is happy, the viator is happy, and if everything is done right, the investor is happy. So who are the losers in this deal? Well, the insurance company certainly is. They were hoping to get out of paying the death benefit. The heirs are also losers. If holding on to the policy is such a great investment after paying the broker and the viator, it was certainly a great investment before! If I were the heir, I would have taken over those premiums. Another loser is all the other people who buy permanent life insurance. Since the policy stays in force rather than being surrendered for chump change, the price of insurance goes up for everyone else. I kind of feel badly for the heirs, but I don't have much sympathy for the insurance companies or those dumb enough to buy permanent life insurance policies.
- High Returns– I don't mind giving up some liquidity if I am rewarded for it. The expected returns for this scheme are usually set up to be in the double digits. That's sufficient reward for me.
- Low Correlation– These alternative investment guys (especially the insurance agents) are always bagging on stock investors. That's totally unnecessary. There is no reason why one cannot invest in both stocks AND life settlements (and real estate, and bonds, and life insurance, and P2P Loans etc etc etc.) I love that this investment ought to have a correlation of pretty close to zero with my stock portfolio.
A Few Cautions
A few words of caution before you go out and start investing in life settlements. This area of finance is filled with scam artists and con men. Typically, the con is on those who are selling their polices. If they're really going to die in just a few years, they're selling their policy for dimes on the dollar of what it is really worth. However, that doesn't mean investors can't be conned too. Like any investment aimed at accredited investors, due diligence is required. You had better check out the viator carefully. Be sure somebody else is the custodian of the escrow money. Chances of losing your entire investment seem low unless he runs off with it.
You should also realize that predicting someone's death is a “garbage in, garbage out” process. Viatical settlements really got a bad name in the 1980s with the AIDS epidemic. There were thousands of people who were supposed to die in a year or two. Unfortunately, somebody came up with a bunch of antiretrovirals and all those guys who were supposed to be dead are still walking the streets. You can imagine how those investors made out. The difference between a great return and a mediocre one (that ties up your money for extra years earning low returns) can be just a few years difference in life expectancy.
Diversification matters. Ideally, you could just buy shares of a fund doing this so instead of owning a piece of one or two policies, you would own hundreds. That would sure hedge against somebody living a miraculously long life. But, like most accredited investments, you'll be required to put in $10K, $25K, $50K, or perhaps even $100K into each policy. That makes it tough to be very diversified. Nevertheless, do what you can.
Read the medical reports. Make sure it really does sound like the insured isn't going to live much longer. If they won't show you the reports, find another viator to invest with.
Make sure the viator has some skin in the game. Even if he is getting a few “free” shares, he ought to also have purchased a significant amount of “real” shares like yours.
What do you think? Have you invested in life settlements? What was your experience? Would you consider it? Why or why not? Comment below!
I was given the same book to potentially market this investment to my clients, read it and came to many of the same conclusions that you did.
There used to be a listed company that did life settlements, Life Partners Holdings. I had some of my play money here (actually part of my Deathcare Portfolio aka the Heads I Win Tails You Lose Portfolio) and was making a killing until their bubble popped. Luckily I sold for “only” a 50% loss on my initial investment; looks like a share is now worth a penny. I can think of funner ways to gamble…at least that shipwreck salvage company is interesting to read about.
“I don’t have much sympathy…those dumb enough to buy permanent life insurance policies..”
I would argue that you do. I believe that this is a key reason why you started this website. To help prevent naive doctors and others from making such mistakes, and educating them on to correct the course when they do.
Good point.
Reminds me of the book The Devil in the White City, about Americas first serial killer. He would buy policies on people, then kill them and collect later. It was actually the insurance company that finally caught onto what he was doing. Anyways, interesting idea, and great to know for when I get approached about it, but I’m to lazy for it so I’ll stick to what I’m doing.
Second that argument. Actually, rather than “Devil in the White City” (which I also read, fantastic book!), it reminds me of Cook’s most recent medical thriller “Death Benefit”. The investment derivative promoted by the protagonists therein sounds very, very close to the one discussed above. So close, in fact, that Dr. Cook must have heard of it and researched it somehow.
This makes me think of how it feels to start a bunch of fantasy football players when they’re playing your home team… there’s a little emptiness in the victory.
My boss was actually trying to set up his son to work with a friend of his in this business. And he’s a big catholic too so that was pretty funny. As I recall, it seemed like the conversation was around insureds with much shorter life expectancies, e.g. a number of months, a year, or perhaps two years at max, but in return for a smaller profit.
The investors are getting the death benefit(rather, the promise of one) for cents on the dollar, but they’re also purchasing a huge amount of risk, or at the very least, tremendous uncertainty. A four year life expectancy is an eon. Even at eath, patients are often kept alive unethically for far too long.
After a year of due diligence I bought into a fund in Nov 2013. Since I have received roughly 13% annual returns. The reason I used the fund was to mitigate a number of the concerns above: 1. gets the law of large numbers on my side (hundreds of policies will make actuarial tables more accurate). 2. increased liquidity (after 2 years I can get my money back out). Non correlated assets are great, but if you can’t actually rebalance from them you don’t increase portfolio efficiency. 3. the fund only buys policies from healthy individuals (this might seem backwards but healthy people don’t get healthier, so you avoid the AIDS scenario in the article)4. If the manager does their job I can make an investment of whatever amount I want without being on the hook for additional payments later (obviously if everyone outlives their life expectancy returns will drop).
Cons. I do not consider this a low cost investment 1.5% management plus 5% of profits from sales. However, returns are net of fees. Ethical – I thought about this long and hard, but I don’t really see any ethical concerns. Yes, I would make more if they died early, but if investors didn’t step the seller of the policy would be worse off. Many of these policies were improperly sold decades ago and now someone in their 80s has to pay hundreds of thousands to keep the policy in force. They either sell or surrender. If they’ve borrowed from the policy they might even owe taxes.
Mind naming the fund?
Some one I know bought a policy for $55,000.00 and received the Benefit of $398,000.00 in one year. My question is …is this normal? I am asking because I am about to buy one of these from the same company he bought
Nope, just got lucky!
Vida Longevity Fund does NOT buy policies covering healthy insureds. In theory, healthy insureds are a bad purchase risk from a life settlement perspective in that the insurance company that issued the policy established a baseline expectation for future mortality. If the insured remains on that trajectory, the carrier priced the policy correctly and it therefore would have no real “excess economic value”. Life settlements arbitrage the underwriting risk allocable to an insured/policy at inception against the “change in circumstances” to which some insureds in a cohort population eventually are exposed. If you buy policies on healthy insureds you have bought into what happened in the viatical era. Life settlements are driven by the difference between what the carrier thought would be the case (on the averages for a given cohort) and what an individual insured experienced in terms of impairment post-issuance of the policy. If there is no change, there is no value. You also need to be aware that valuation of open-ended life settlement funds worldwide is typically a modified form of mark-to-model and therefore subject to a high degree of subjectivity as to the assumptions used to establish “value”.
DWolf:
Sounds interesting.
How much was required for the investment you did?
And how did you decide on a company to do it with? Google? Friends?
VIDA Longevity fund. It was $100k at the time. It has since dropped to $50k (must be an accredited investor). It took a year for me to pull the trigger, so I researched through a number of channels and looked at other opportunities.
This is the first non traditional investment I think I might understand and would consider putting some money toward. It’s not clear to me how to find the opportunity. But it it was there I might jump in
I was considering the risk side of this investment and thought of one more potential issue…do these policies have a clause regarding INTENTIONAL death? If the person you buy the policy from offs himself, is the contract void and a total loss? worth considering if you are dealing with people who a. are so sick their life expectancy is four years. b. are in desperate need of money so are selling their policy c. have no friends or family to be heirs to their estate d. have realized how stupid they were for buying a whole life policy. Sure makes ME want to jump out a window!!!!!
I had a client last year that was introduced to this from someone walking around the hospital. After doing a fair amount of research I also came across Vida. I spoke with one of the managing directors(Chris) and was fairly impressed with his lack of insurance sleaziness! The minimum is $50,000 and looks like according to him they are the only open ended life settlement type approach. The downside is the cost(fund expenses 2% plus performance fees). I do like the fact there is no market correlation.
I’ve been emailing them. That $50K minimum seems to be up to $100K now, which probably takes this option off the table for me given my portfolio size and desire to limit an asset class like this to a relatively small portion of it.
If the proper due diligence is performed then this can be a good investment. The policy holder needs to undergo a complete medical exam similar to what is done when the policy was first underwritten. All medical records need to be evaluated by a reputable and experience underwriter and an actuarial estimate of longevity analysis completed. A proper analysis can accurately predict longevity based on historical data based on age and various medical conditions.
For a doctor to be involved as well. Wow what about ethic code now? Unbelievable. Although it is just a professional responsibility to determined a life expectancy, it is a doctor we are talking about..
What is this? Doctors should be banned from these investments?
A bit smarmy on your part….
Doctors do NOT determine life expectancy though they may be asked to do so, most have neither the training nor experience, let alone the time to asses this issue beyond broad generalities.
Someone needs to write the novel about the investors in such a scheme, maybe even a group of doctors who hear about it on a website like this one, who band together to kill off the covered lives lowering their returns.
I found one that does 15k min email them at [email protected] i wanna see if they have any lower than that
Some needs to write the novel about family members who kill family members to collect on insurance. The fact is there is not a single case in which an investor in life settlements murdered an insured to make money.
We hear about how life settlements can be both good and bad for people selling their policy, but investing in them seems to be something different. This was a really good article. The information on the book was very enlightening, especially if the person keeps on living. Thank you for also explaining all the other parts of how life settlements really work and what to be aware of.
I found your blog quite interesting. Thank you for posting it.
I found out about this type of investing from therealestatecrowdfundingreview website. It has become a kind of club for accredited investors where the individuals add comments on due diligence about an investment and then the web owner (a retired software engineer) compiles the information into a spreadsheet.
They were looking at a couple life settlements funds. Those funds required 250K +. Sometimes the club could get them to reduce the minimum.
The research they did showed that you should have around 800 policies in the fund in order to minimize risk. The bell curve for how long the insureds live becomes wider with fewer policies.
Anyway, I’ll also try looking into Vida Capital. I like non-correlated investments. The fact that some funds went under because of health improvements (like the AIDs treatment), scares me a little into not getting too greedy.
Fascinating article. You did a thorough job of reviewing pros and cons and your take on it.. You saved me 138 pages.
I’m sure you’ve followed up with Google in the last 6 yrs. Vida Longevity Fund started in 2010. Results started tanking in 2018. Interestingly they came up with 3 classes of investors around that time. Class A buy in was 500K with exorbitant fees and bonus. 2/20% Class B + C was buy in of 250K with a 2 or 3 year lock-up and obscene fees, again like 2/20.
They’re being sued by at least 3 attorney groups as of October 2020 as a classic Ponzi. Pump and dump.
It would be great if you’d like to do follow up blogpost identifying viatical funds not run by crooks, if that even exists.
I like the concept of viatical investment as having no correlation to stock market and without hassle of being a landlord.
This is an area where doctors should have small home court advantage. I’ve already crossed real estate investment funds off the list. I got return of capital from P.S. but not much else. It’s a jungle out there.
Interesting. Thanks for the update.