#6 - Senior Life Settlement Anatomy 101
The present value of the expected cash flows over the life of an investment in a Senior Life Settlement Policy determines its value.
When an insured sells a policy, he/she receives a cash payment greater than the surrender value set by the carrier but less than the face amount of the contract.
The buyer will pay all future premiums until the policy matures and is then entitled to the death benefit.
There are four elements to consider when valuing a life settlement policy:
- The amount of the death benefit
- The assessed life expectancy of the insured
- The amount and frequency of the premiums payments
- The investor's required rate of return or discount rate
The amount the seller will receive is a calculated assessment of these four factors. Higher premiums, longer life expectancies and a higher discount rate lower the value of a policy. Inversely, lower premiums, shorter life expectancies and a lower discount rate increase the value of a policy.
Each policy is unique. The face amount of the policy and the premium streams can be reasonably ascertained. The remaining longevity of the insured is the crucial variable and the primary risk associated with the asset class. Age, gender, life style and health conditions play a role in creating the uncertainty around the insured's mortality. To be certain, mortality cannot be accurately assessed.
The discount rate an investor applies is based on the perceived risks and uncertainties with the expected cash flows relative to the returns one could expect from investing capital elsewhere.
Unlike other market-based investments, life settlements have inherent qualities that other capital instruments do not:
- The payment of death benefits have a very high degree of reliability by virtue of the life insurance industry's adherence to the US Legal Reserve System.
- Life settlements have an extremely low correlation coefficient to most all other investments providing portfolio efficiency through diversification away from market volatility.
- A Senior Life Settlement is always worth the face amount of the policy.
Capstone Alternative Strategies recognized early on that if hedges could be applied to mitigate the risk of an investor's yield being eroded by premium calls resulting from insured's living well beyond their assessed life expectancies (Extended Longevity), a life settlement investment would provide the benefit of avoiding volatility and stabilizing the return characteristics of a portfolio.
Capstone's exclusive Premium Reserve Management (PRM) Solution is engineered to transfer the risk from an investor to Capstone to preserve the spread between acquisition cost and face amount. The effect of the solution equates to reliably purchasing dollars at a steep discount receivable in the future.
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