Whenever I discuss a new case, without fail the question, "How much can I get?" comes up. The interesting thing is that even agents who have completed dozens of life settlement transactions
ask that question, knowing that whatever I tell them can be off by 300 percent. So why is it so hard to determine the value of a life insurance policy when having those initial conversations?
Well, I don't have all the relevant information. Can a doctor diagnose your ailment when you tell them you have a cough? No, they need to probe further. So what is the relevant information to determine the value of a life insurance policy? The two most important factors are the premiums and life expectancy. There are other relevant factors like maturity age, carrier rating, etc., but for this discussion we will focus on the two primary factors.
How do you determine how much premium will be needed? Generally you request an illustration from an insurance carrier demonstrating the premiums going out to maturity. If you're lucky, the carrier will provide a breakdown of the cost of insurance and fees on the illustration. (Life settlement funds generally pay the minimum premiums to keep the policy in force.)
If you're not so lucky, you generally use a formula or use software that will help you determine the cost of insurance. Milliman's MAPS
(Model Actuarial Pricing Systems) is an example of commonly used software in this industry.
You now have part one of the formula. The other thing we look at is life expectancy. How is life expectancy determined in our business? We look at the medical records to provide us the answer. That means that we don't require the insured to take any examinations. We take those medical records and submit them to medical actuaries who spit back a report. The report discusses the findings in the medical records and provides an estimated life expectancy.
Now that we have the relevant data, how do we figure out the price? In simple terms, the buyer is looking for a certain annualized return. If you know what that annualized return is and you plug in the life expectancy
and the premiums into an internal rate of return model, then you can arrive at your purchase price. Obviously, you can use a more sophisticated model, but in a nutshell, that's all there is to it.