The life settlement industry — with its focus on the acquisition and possible re-sale of certain kinds of life policies — is still in the very early stages of development, but it has been hit more than a few times by controversy and outright fraud.
That fact, coupled with recent media focus on the possibility of securitising life settlements into so-called “death bonds”, means it has tended to attract more attention that you would expect given its niche nature.
On the other hand, there are sound reasons for shining more light on this sector. Consider the following comment from Moody’s, published on Monday (emphasis FT Alphaville’s):
Last week, AXIS Capital’s reported earnings included a substantial loss related to a life settlement transaction with longevity risk. This is the most recent of a series of similar losses reported by various participants in the life settlement market as policyholders are living longer than expected.
These life settlement losses should not have a negative financial impact on the life insurance companies that underwrote the policies; in fact, lower-than-expected mortality may actually benefit the insurers’ earnings over the long-term. But the continuing stream of negative news and controversy related to the life settlement market has contributed, along with other factors, to the substantial decline of new life insurance sales for the industry in recent quarters. If sustained for a prolonged period, the controversy will put pressure on insurers’ credit profiles. However, we believe that higher volumes of life settlement-related sales would also be negative for the industry. Higher life settlement sales would prompt greater scrutiny of — and possible reduction in — the tax advantages embedded in life insurance policies.
In addition to heightened regulatory scrutiny in recent months, the industry has also received quite a lot of bad press. Exhibit A comes from the New York Times, which in September published a piece focusing on the still-nascent death bond market:
Indeed, what is good for Wall Street could be bad for the insurance industry, and perhaps for customers, too. That is because policyholders often let their life insurance lapse before they die, for a variety of reasons - their children grow up and no longer need the financial protection, or the premiums become too expensive. When that happens, the insurer does not have to make a payout.
But if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have been abandoned; as a result, more policies will stay in force, ensuring more payouts over time and less money for the insurance companies.
Industry practitioners argue that this is something of an exaggeration, since the the total number of life settlements in force represent around 2 per cent of all life policies. Accordingly, they contend, the change in the lapse rate — defined as “the rate at which life insurance policies terminate because of failure to pay the premiums” — will be minuscule.
On to Exhibit B in the case of the media vs life settlements, via Forbes:
Transactions like these with strangers are euphemistically called life settlements. But they are really about death. The stranger buying you out is hoping you get flattened by a train, preferably the day after the deal closes.
Indeed.
Fortunately, Moody’s provides a non-sensationalist critique:
Interestingly, since investor losses on life settlement transactions are primarily due to lower-than-expected mortality on the life policies in question, the life insurers are experiencing gains on these policies for exactly the same reason. Even though life settlement-driven sales could be profitable for the life insurers if people continue to live longer than expected, we have concerns for the industry about the future growth of the life settlement market.
The increasing interest in these settlement transactions is seen as a possible catalyst for triggering adverse changes in the federal income tax treatment of life insurance, especially during a period in which the Federal government is seeking new revenue. To the extent that life settlement transactions recede in the market, the life industry may avoid the government’s focus on life insurance taxation. Over the longer term, the industry needs to see renewed sales momentum in non-life settlement-related sales to maintain and strengthen its credit profile.
There is much about this industry that is little understood, and FT Alphaville will continue to explore the issues around, hopefully in non-sensationalist fashion. Unless, of course, we get hit by a bus.
Related links:
Preliminary Information Regarding Third Quarter 2009 Financial Results - Axis Capital
MetLife opposes life settlements - statement to US House Financial Services Committee (PDF)
‘2009 will prove to be decisive year in the future of life settlements‘ - Life Settlement Political Action Committee statement
