A “life settlement” is the sale of an in-force life insurance policy to an unrelated party, typically for investment. That party continues to pay the premiums and collects the death benefit when the insured passes away.
Over the past 30 years, a niche industry has emerged around this practice in the United States. In the industry’s early days, one might have heard, on occasion, the seller of life insurance ask, “Is my policy being sold to The Sopranos?”
While this question was asked tongue in cheek, it was a reflection on the market during its infancy. In those early days, the life settlements sector could be characterized as reminiscent of the “Wild West,” governed by few rules, and where you survived by your own initiative and perseverance.
While The Sopranos quip may be a myth, today it is perhaps also a myth that life settlements are unregulated and somehow “unsafe”. In fact, what was once an unconstrained, rough and tumble landscape, has matured: on one hand, into a highly regulated business that provides newfound liquidity to consumers, and on the other hand, into an exciting institutional market for biometric insurance risk.
Oversight and Regulation
Virtually every participant involved in purchasing life policies from consumers is subject to comprehensive oversight. Life insurance agents who represent life policy seller, life settlement brokers who source policies for sale, and life settlement providers who purchase policies on behalf of investors are all regulated by a web of state and federal laws and regulations that cover consumer protection, market conduct, and privacy.
In addition to regulating transaction participants, the states oversee certain aspects of transactions. At a high level, officials approve forms used for purchasing a policy, just as they have to sign off forms issued by insurance companies.
Different states have different rules on which policies can be purchased in certain circumstances. For example, some states require a five-year waiting period after a policy’s issuance, but some only require two.
The bottom line is that life settlements are regulated using much of the rubric used to regulate life insurance.
The Covid-19 Pandemic Has Not Had The Perceived Impact
In terms of the fallout from the Covid-19 pandemic, the near-term impact will likely be less significant for the industry than widely assumed. We have certainly seen individuals in a life settlement setting die from Covid. But on average, Covid-related deaths have not materially increased the level of claims relative to what would have been expected.
A lot of the people who are in the life settlement pool tend to be healthier and wealthier than the general population. While Covid doesn’t care how much money you have, insured people who comprise life settlement portfolios have better access to healthcare and can afford to work or live remotely; this means that life settlements managers haven’t, by and large, been paying out early, which would hamper returns.
What we don’t have a good grip on at present, which has the potential to be substantially more impactful on the industry’s performance, is the long-term impact of Covid on morbidity. We know of people who recovered from Covid quickly and six months later suffer from lingering effects. You also have other issues at play, such as mental health problems, which may not be directly due to Covid but are a by-product of the environment. While these issues may have a longer-term impact on the performance of our business, the direct impact from Covid hasn’t been significant.
Models and Returns are Improving
Talking about returns in a credible and consistent fashion has always been a challenge in this industry. However, much has changed in recent years. Some investors got burned in the early days of the market. They were looking at outsized returns and were sold on the idea that as everybody dies, the investments always pay off. However, you have to bear in mind that these are negative carry investments – in other words, you have to pay to keep the policies. While everyone dies eventually, you can actually pay a lot more than you get back, if you are not careful.
Life settlements are a long duration asset and as such the performance takes decades in some cases to emerge. The industry has only been around three decades and does not have a long history to look upon. Investors should be aware there is a difference between the return on an investment and the implied return on a particular policy or portfolio.
In any case, the level of knowledge around longevity is evolving every day. Modelling it isn’t the hard part, rather it is what assumptions go into the models and much of that is based on experience. The most important assumptions are those that describe the longevity profile. In the early days, medical underwriting and longevity modelling by life settlement market participants was rather unsophisticated compared to that done by life insurers and reinsurers. Yet, that too, has changed over the years. Now, the life settlement industry is home to life actuaries, home office underwriters, demographers, and other professionals with deep roots in the life insurance business.
Transparency has also bought discipline to the marketplace. They say transparency is the best antiseptic. For example, disclosure regarding compensation, which is generally required in transactions with consumers, has helped the industry grow up a bit.
Investors have also evolved in their level of sophistication. Few investors today do not have their own underwriting views. They might not go to the extent of completely re-underwriting a policy, but they have a reasonably informed opinion on what the underwriting of a particular case should look like.
Institutional Choice Isn’t Limited
The investor mix in the life-settlement arena may surprise people. In the old days, there were a lot of retail and near-retail investors at large in the market but that is no longer the case. Today, the sector has evolved into a largely institutional investor space, with a wide range of investment managers from which to pick
For example, many US pensions, endowments, and foundations have life settlement investments, although it took some time for these to become commonplace. In addition, pension funds spanning the Asia- Pacific region have put substantial capital to work in the sector.
Presently, there is little take-up from European pension funds…but that may be changing. As is widely known, some pensions in Scandinavia, Belgium and The Netherlands got into the market too early and got their feet trampled.
However, there is increasing interest across the continent, as well-respected institutional managers are proving and validating themselves and the asset class with the European set. Many of these managers now have 10-year plus track records in life settlements. If you asked about track records a decade ago, there would be few managers who specialize in this space who would have been able to advertise 10 years’ experience.
in general, pensions have been allocating more and more to alternative asset classes, and in that bucket to insurance-linked securities and other insurance-related risks. That is a general trend and is leading reluctant folks to take another look at life settlements, not just in Europe but globally. They are able to see that certain segments of the market have performed well over the past decade or so.
Life Settlements Can Fit Into The ESG Box
People may not know that life settlements have a lot to offer under the ESG banner. Not every investment ticks every box, but they tick certain boxes. For example, life settlements can play a pivotal role in plugging US retirement deficits. Over 40% of Americans have zero retirement savings and 80% of Americans have retirement savings less than their annual salary. Social security cannot make up the difference – the program is projected to have insufficient funding to pay more than 79% of entitled benefits after 2034.
Life settlements can help fill long-term care gaps. Some 95% of Americans over 65 are covered by Medicare which covers major costs due to acute illness or manifestations of chronic illness, such as surgery. However, Medicare was not designed to pay for long-term care, which approximately 47% of men and 58% of women of retirement age or older will need in future. The average annual cost of a shared room in a skilled nursing facility is $80,000, a punitive amount to pay out of pocket on a limited income.
Additionally, insurance premiums are a significant financial burden for seniors on a fixed income. According to LIMRA (Life Insurance Marketing and Research Association). 4.5% of American policyholders over age 65 lapse their policy each year for which they are not paid a benefit, after paying decades of accumulated premiums.
The Covid-19 crisis has triggered unprecedented economic chaos for millions of Americans, including seniors. Market volatility and uncertainty is impacting household savings and financial resources. Life settlements can be a solution to these significant ESG issues providing a non-traditional source of capital and liquidity and a consumer-friendly choice.
The life settlements industry, like many industries, endured difficulties in its early days, something that many emerging industries go through. These difficulties gave rise to certain views about the industry; views which are now little more than myths. Life settlements has evolved in the past thirty years into a mature, well-regulated asset class; indeed, one can argue that there is nothing ‘mythical’ about this asset class at all.
Scott Willkomm is CEO at Life Equity
Any views expressed in this article are those of the author(s) and do not necessarily reflect the views of Life Risk News or its publisher, the European Life Settlement Association