In a typical structured settlement, the original payee has a monetary award for life, with a certain number of years guaranteed. An award may read ‘$2000 per month for life, with 240 months guaranteed starting on 1/1/1995 and lasting until 12/1/2014’.
But what if the seller wants to sell 180 monthly payments from 1/1/15 to 12/1/2029? These are “Life Contingent” payments that stop if the seller dies, and life insurance is a perfect hedge to insure the payments.
The cost of life insurance in an amount sufficient to insure the investor’s principal and any accrued interest is part of the discount that seller must take to sell the payments, but thanks to the insurance, the investor’s un-returned principal and interest is fully protected during that entire assigned 15 year term.
If properly insured, a life contingent payment streams can offer an enhanced yield on this safe asset class. You can view them as you would a bond with a call provision that has potential to return your principal early.
In years past however, typical life insurance products were ill suited to properly insure a life contingent payment stream. The traditional method of hedging involved a collateral assignment of the life insurance policy with a face value high enough to cover the maximum amount of principal and interest due to an investor.
But this method of insuring the payments would leave excess life insurance (after the investor was repaid) to be allocated to the sellers heirs. This is an opportunity for contention in the future. Questions also arose in these transactions about the quality of the application, STOLI issues, the ownership of the policy, and how premiums were to be paid over the term of the investment.
In short, the ‘old way’ of doing life contingent secondary market annuity transactions was fraught with pitfalls. Sadly, other vendors of SMAs offer insured payments with this hodgepodge of insurance, but we stopped offering payments insured this way several years ago.
DCF Exchange does not offer life contingent payment streams at this time and furthermore, does not recommend them to investor or advisors. In our opinion, the risks in the placement and administration of life insurance and the complexity of underwriting exceed the small yield enhancement.
Why We Do It
The DCF Exchange helps savvy institutions and investors earn uncorrelated, guaranteed yields in a unique “set-and-forget” product.