How a life settlement offer is priced and why offers differ

A life settlement offer is the buyer's answer to one question: what is the most we can pay today for this death benefit, given how long we expect to wait for it and what we must spend on premiums until then? The answer is a present value, and it moves a lot when any input moves. That is why two reputable buyers can look at the same policy and bid amounts that differ by tens of thousands of dollars, and why a seller who gets one offer knows very little.

This post explains the buyer's pricing view in plain steps, then runs a worked example with invented numbers so you can see which inputs matter most. It does not predict what any policy will fetch, and it names no buyer or price. The broader process, regulation and taxes are in life settlements: selling your life insurance policy.

The buyer's basic arithmetic

When a buyer purchases a policy, it takes over the premiums and collects the death benefit when the insured dies. It pays the seller now. So the buyer's maximum price is roughly:

the value today of the death benefit, minus the value today of the premiums it will have to pay, minus its own costs and required profit.

"Value today" means a future dollar is worth less than a dollar now, and the discount rate says how much less. A higher discount rate shrinks the value of money received far in the future more than money received soon. Premiums, which are paid earlier, shrink less. That asymmetry is why timing drives so much of the price.

Four inputs do most of the work.

1. The face amount (the death benefit). Larger policies can support larger offers, and many buyers have minimums.
2. The insured's life expectancy. How long the buyer expects to wait.
3. The premium needed to keep the policy in force. What the buyer expects to pay each year until then.
4. The buyer's discount rate or required return. What it demands to compensate for waiting and for the risk that the insured lives longer than expected.

A fifth group of factors, the type of policy, the insurer, and the transaction costs, adjusts the result.

Where life expectancy comes from

Life expectancy, in the life expectancy sense used in this market, is not the general-population average. Buyers order estimates for the particular insured from firms that review medical records and apply their own models. Two firms can read the same records and reach different numbers, and a buyer may blend several estimates or apply its own judgment.

Three things follow.

• A shorter expected life usually raises the offer, because the death benefit is expected sooner and fewer premiums are expected to be paid.
• Estimates carry real uncertainty. An expected life of eight years is an average of outcomes ranging from much shorter to much longer. A buyer prices the average but bears the spread.
• Different views produce different bids. A buyer who reads the records as pointing to a shorter life will bid more than one who reads them as pointing to a longer one. Neither is necessarily wrong.

State law regulates how medical information is used and shared in a settlement. The seller authorizes release of records, and the confidentiality rules in the NAIC model act limit further sharing, as the life settlements: selling your life insurance policy guide describes.

A worked example

Everything below uses invented numbers and a deliberately simple model. It treats death as arriving on one expected date, whereas real buyers weigh the full range of possible dates, so the results show the direction and relative size of effects, not what a real transaction would pay.

The policy. A universal life policy with a $500,000 death benefit. The in-force illustration says it needs $20,000 a year in premiums to stay in force. The insured is older and in poor health. The policy's cash surrender value is $60,000 (the cash surrender value), so any serious offer must beat that.

The method. Discount the death benefit from the expected year of death back to today. Add up the premiums, each paid at the start of a year until that year, also discounted. The difference is the indicated value, before the buyer's costs and margin. Figures are rounded to the dollar.

How the life expectancy estimate moves the price

Holding the discount rate at 10% and premiums at $20,000:

Look at the 8-year row. The death benefit's value is $500,000 / 1.10^8, which is $500,000 / 2.1436, or about $233,254. The premiums, $20,000 paid at the start of each of eight years and discounted, are worth about $117,368. The difference is $233,254 - $117,368 = $115,885.

Moving the estimate by two years in either direction changes the indicated value by roughly $70,000 in one direction and $58,000 in the other. Notice that the 10-year row, at $57,591, is only slightly below the $60,000 surrender value. A longer expected life brings the offer close to what the seller could receive by surrendering.

How the discount rate moves the price

Now hold life expectancy at 8 years and premiums at $20,000, and change the buyer's required return:

A buyer with a lower required return, perhaps because of cheaper financing or a more patient investor base, can bid $146,007 where a more demanding buyer can bid $90,666. The gap is $55,341, with no disagreement about the insured's health.

How the premium assumption moves the price

Premiums also differ. Suppose the buyer's analysis of the policy, based on the in-force illustration and the policy's charges, says it needs $30,000 a year instead of $20,000 to stay in force. At 8 years and 10%, the premiums are worth $30,000 x 5.8684, or about $176,053, and the indicated value falls to $233,254 - $176,053 = $57,201. A $10,000 difference in the annual premium assumption takes $58,684 off the price.

This is why the policy type matters. A universal life policy whose cost of insurance charges rise with age can need much larger premiums later to avoid lapse, and a buyer will price in the higher figure. A policy with a no-lapse guarantees on universal life: how they work can be much cheaper to hold, because the premium that preserves the guarantee is known. The universal life cost-of-insurance increases and what to do guide explains the charge mechanics.

Why competing bids differ

Put the effects together. Three hypothetical buyers see the same policy.

The highest of the three is about 1.9 times the lowest, a difference of $74,561. Each buyer made reasonable assumptions, and the spread comes from three legitimate disagreements stacking on one another. X reads the records as pointing to a shorter life and demands a higher return. Z reads them as pointing to a longer life and accepts a lower return. Their offers then fall after the buyer's costs and margin come out, so the real bids would be lower than these indicated values.

None of these figures is a forecast. The lesson is that the range of reasonable bids on one policy can be wide, and that a single offer says little about where the market is.

What makes a policy more or less attractive

Across the inputs, a few patterns hold.

• An older or sicker insured shortens the expected wait, which raises the price. A younger and healthier insured often draws no offer above surrender value.
• A larger face amount supports a larger price and clears buyers' minimums.
• A lower and more certain premium raises the price. Guaranteed designs are easier to price than policies whose charges can change.
• Policy type. Universal life, whole life and convertible term are treated differently, as the life settlements guide notes. Term policies are harder to sell unless they can be converted.
• The insurer's financial strength matters because the buyer's return depends on the insurer paying the claim years from now.
• Clean ownership and records. Liens, loans, assignments or a missing beneficiary change create friction and cost.

How the policy type changes the buyer's work

The same arithmetic applies to every policy, but the premium input is far easier to pin down for some types than others.

Universal life. The buyer needs to know how much must be paid each year to keep the policy from lapsing. That depends on the cash value today, the monthly cost of insurance charges, the credited rate and the planned premiums. Because the charges rise with age and can be changed by the insurer within the contract's stated maximum, the buyer models a path rather than a single number. A policy with a secondary guarantee may need only a known minimum premium to stay in force, which is simpler to price. A policy without one, and with a thin cash value, may need steadily larger payments, and the price falls accordingly.

Whole life. Premiums are fixed and cash value is guaranteed to grow, so the premium input is stable. Dividends, if the policy is participating, may offset premiums in some designs, and buyers treat them cautiously because they are not guaranteed. A large loan against the policy changes the picture, since the buyer takes the policy subject to the loan.

Term. A term policy has no cash value and expires. A convertible term policy can sometimes be converted to permanent coverage and then sold, but the conversion changes the premium sharply, and many buyers pass. This is why term policies draw fewer offers than permanent ones.

In every case, the in-force illustration is the starting document. Ask your insurer for one that shows the policy to a late age, and make sure it uses current assumptions. Buyers will run their own versions, and a difference between your illustration and theirs is a reason for different bids.

What the insured should expect after a sale

A sale is not only a financial event for the insured. Some points from the NAIC model act, as described in the life settlements guide:

• The insured's health information is shared with providers and buyers, subject to confidentiality rules.
• After the sale, the provider may contact the insured about health status only once every three months if life expectancy exceeds a year, and at most once a month if it is a year or less. Those contacts exist because the buyer needs to know when the death benefit is due.
• The seller may rescind before the earlier of 60 days after all parties sign or 30 days after the proceeds are paid, by giving notice and repaying the proceeds. States set their own periods, and some are shorter.

Many people find the idea of a stranger tracking their health uncomfortable. That feeling is a legitimate reason to decline an offer even when the number is attractive.

When a sale is not allowed or is restricted

Not every policy can be sold. The NAIC model generally prohibits settling a policy within five years of issuance, with exceptions such as terminal or chronic illness, the death of a spouse, divorce, retirement, disability or the owner's bankruptcy. The NCOIL model uses a two-year period instead. These waiting periods exist to discourage buying a policy on a stranger in order to sell it, a practice described in the Stranger-originated life insurance (STOLI): what it is and why it is restricted guide. If your policy is only a few years old, the waiting period may decide whether you can sell at all.

Costs that come out of the headline number

The indicated value is not what reaches the seller. Brokers and providers are compensated, and the NAIC model requires disclosure of that compensation. A broker deemed to represent the seller has a duty to the seller, and the seller can ask what the broker earns and whether it comes out of the offer or is paid by the buyer. Escrow, legal and administrative costs also apply. When comparing offers, compare what you would receive after all of them.

Using this as a seller

1. Know your floor. Find the cash surrender value, any loans and the death benefit from your latest statement and an how to request and read an in-force illustration. An offer under surrender value is not an offer.
2. Get several bids. One bid shows one buyer's view. Several show a range.
3. Ask how bids are structured. Is the figure a total or net of fees? Is any part contingent or deferred?
4. Ask who represents you. Confirm the broker's license, who pays them, and whether you are told of all offers.
5. Compare against keeping and against an accelerated benefit. The keep, surrender or sell your policy? helps, and the wider comparison is in should you sell, surrender or keep a policy you may no longer need?.
6. Remember the beneficiaries. A sale ends the family's claim on the death benefit, and a tax professional should model the gain.

For the sale process after a bid is accepted, see how a life settlement sale works from appraisal to closing. For how the proceeds are taxed in principle, see how the tax on a life settlement sale works in principle.

Key takeaways

• A buyer's price is the present value of the death benefit minus the present value of the premiums it must pay, minus its costs and required profit.
• Life expectancy, the discount rate and the premium assumption move the price most; in the worked example, shifting life expectancy by two years changed the indicated value by tens of thousands of dollars.
• Three reasonable buyers with different life expectancy views and required returns produced indicated values of $161,220, $115,885 and $86,659 for the same hypothetical policy.
• Policy type and premium certainty matter: policies with changing charges are harder to price and tend to attract lower bids than guaranteed designs.
• Get several offers, compare them after fees, and measure them against the surrender value and the alternatives before selling.