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Life Settlements: Signposts to a Principal Asset Class
Abstract
The paper offers an explanation for the evolution and increasing maturity of the life settlement market and the implications for all longevity based financial instruments and products by exploring the market dynamics and asset valuation processes. The paper begins by revisiting the brief history of the life settlement market before examining the market's evolution, finding that the increased participation in this multi-stage market has driven innovation, leading to the commoditization of various services and products which forces present service providers to either withdraw or adopt one of the operational marketing models, and lowers the barriers to entry for revolutionary service and product development. The paper then examines the value that the life settlement asset provides to both parties and establishes how that value is assessed. The paper finds that for impaired lives and specific other policies the settlement value is significantly greater than the surrender value, and that the calculation of worth to both buyer and seller must calculate both financial value and utilization value; the seller gains utilization from releasing liquidity, the buyer from portfolio diversification in an asset class whose underlying is at most weakly correlated to equities, bonds, real estate and commodities. The paper examines the value, considerations and risks for institutions considering investment in life settlements and other longevity based financial instruments. The paper finds that there are individual and market benefits from the asset class, that the asset class also creates macro- economic benefits, and that it is simply a matter of time before life based financial instruments join equities, bonds, real estate and commodities as a staple of portfolio diversification.
... attributes tend to make a life insurance asset uncorrelated with other common asset classes, such as equities, fixed income securities, money market funds, and so on. In addition the death benefit is contingent on death and not a capital market event that might cause a change in value, giving it another distinction as an " zero–beta " asset class. Rosenfeld (2009) provides further discussion related to life settlements as an asset class. ...
A life settlement is a financial transaction in which the owner of a life insurance policy sells his or her policy to a third party. We present an overview of the life settlement market, exhibit its susceptibility to longevity risk, and discuss it as part of a new asset class of longevity-related securities. We discuss pricing where the investor has updated information concerning the expected life expectancy of the insured as well as perhaps other medical information obtained from a medical underwriter. We show how to incorporate this information into the investor's valuation in a rigorous and statistically justified manner. To incorporate medical information, we apply statistical information theory to adjust an appropriate prespecified standard mortality table so as to obtain a new mortality table that exactly reflects the known medical information. We illustrate using several mortality tables including a new extension of the Lee–Carter model that allows for jumps in mortality and longevity over time. The information theoretically adjusted mortality table has a distribution consistent with the underwriter's projected life expectancy or other medical underwriter information and is as indistinguishable as possible from the prespecified mortality model. An analysis using several different potential standard tables and medical information sets illustrates the robustness and versatility of the method.
We analyze the prevailing valuation practices in the life settlement industry based on a sample of 11 funds that cover a large portion of the current market. The most striking result is that a majority of asset managers seem to substantially overvalue their portfolios relative to the prices of comparable transactions that have recently been closed. Drawing on market-consistent estimates with regard to medical underwriting, it is possible to trace back the observed discrepancies to inadequately low model inputs for life expectancies and discount rates. The main consequences are a dissimilar treatment of investor groups in open-end funds structures as well as an unduly high compensation for managers and third parties. To address this predicament, we suggest defining life settlements as level 2 assets in the fair value hierarchy of IFRS 13, improving transparency and disclosure requirements, and developing new incentive-compatible fee schedules.
This article examines the formation of efficient portfolios using mutual funds that invest in life settlements in combination with fixed-income and equity index funds. We investigate the optimal weighting of these assets and their contribution to performance and portfolio risk. We find a significant negative correlation between the selected life settlement funds and certain U.S. and European fixed-income and equity funds. Furthermore, these correlations are lower than the correlations between the index funds that replicate each other. These results suggest that life settlement funds are an appropriate financial instrument to achieve greater diversification for a portfolio made up of a fund of funds and to improve fund performance as they provide a fixed return with a lower level of risk.
The huge economic significance of longevity risk for corporations, governments, and individuals has begun to be recognized and quantified. By virtue of its size and prevalence, longevity risk is the most significant life-related risk exposure in financial terms and poses a potential threat to the whole system of retirement income provision. This article reviews the birth and development of the Life Market, the new market related to the transfer of longevity and mortality risks. We note that the emergence of a traded market in longevity-linked capital market instruments could act as a catalyst to help facilitate the development of annuity markets both in the developed and the developing world and protect the long-term viability of retirement income provision globally.
In this article, we examine the benefits that accrue to policyholders and incumbent insurers from an active secondary market for life insurance policies. We begin by examining the benefits of secondary markets in the home mortgage and catastrophic risk insurance industries as points of comparison for the benefits of the secondary market for life insurance policies. Next, we outline the economic theory of a life insurance market both before and after the introduction of a secondary market. Although competition among insurance companies in the primary market leads to reasonably competitive surrender values given normal health, surrender values based on normal health do not appropriately compensate individuals with impaired life expectancies for the resulting appreciation of their policies. Without an active secondary market, the equilibrium quantity of impaired policies that is surrendered is inefficiently low. Incumbent insurance carriers have no incentive to eliminate this inefficiency because they hold monopsony power over the repurchase of impaired policies. Viatical and life settlement firms erode this monopsony power. Finally, we examine the benefits of an active secondary market for life insurance policies to policyholders and incumbent insurers in the primary market. The magnitude of the benefits is positively correlated to the quantity of coverage sold to life settlement firms and to the improvement in the terms of accelerated death benefits offered by incumbent carriers. The emergence of the secondary market for life insurance policies has been pro-competitive and pro-consumer. Lawmakers should therefore design regulations that encourage, rather than dissuade, participation and investment in this secondary market.
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