Life Settlement Valuation Methods
Actuarial approaches to valuing life settlement transactions and the key assumptions involved.
What Are Life Settlements?
A life settlement is the sale of an existing life insurance policy to a third party for more than its cash surrender value but less than its death benefit. The buyer continues paying premiums and receives the death benefit when the insured dies. Actuarial valuation of life settlements requires estimating the insured's remaining life expectancy, projecting future premium payments, and discounting the net cash flows at an appropriate rate. The value of a life settlement depends critically on the accuracy of the mortality assessment and the cost of carry (ongoing premiums).
Valuation Approaches
The deterministic method uses a single life expectancy estimate and projects cash flows under that assumption. The probabilistic (stochastic) method uses a full mortality curve, computing expected present values across the distribution of possible death dates. The stochastic approach is more theoretically sound because it properly accounts for the convexity of the present value function with respect to the time of death. Key assumptions include the mortality table (often developed by specialized life expectancy underwriters), interest rate for discounting, and premium funding strategy. Sensitivity analysis across these assumptions is essential given the uncertainty involved.