The life settlement market, in its current form, is approximately 25 years old; in November 2000, the National Conference of Insurance Legislators (NCOIL) adopted its Life Settlements Model Act, which, whilst undergoing several adjustments since then, remains one of the foundational frameworks upon which the 43 US states that oversee the secondary life settlement market base their regulatory regimes.
During that time, the market has had to negotiate the global financial crisis, increasing competition from other alternative credit-like assets, and regulatory changes. But one thing that hasn’t changed is the seemingly constant requirement for investor education in the market.
“Investors are familiar with assets like credit card receivable securitizations and mortgage securitizations, where the underlying asset is similar, or in many cases, the same,” said Scott Rose, Partner at Fifth Season Investments.
“But in life settlements, every policy is different, because the insured is different, the insurance company is different, and the premium stream is different. It’s a complicated asset class that requires deep analysis so that investors can understand it.”
Foundational to the investor education angle are the investment risks that come with an allocation to life settlements. Understanding the exposure of the asset class to longevity risk and the impact that either accurate or inaccurate modelling has on asset and portfolio returns is arguably the biggest driver of investment success in life settlements; while plenty of risk mitigation tools exist, such as ensuring a critical mass of policies in a portfolio to benefit from the law of large numbers; diversification by state, age, health impairments, and the policy premium payment structure, actuarial assets like life settlements are still actuarial, which brings complexity and specialism to the table, expertise which has a price.
That’s not all. You can have the best actuarial support that money can buy, but they can only model what they have access to.
“The policy seller always knows more than the buyer, and compensating for that, pricing that risk and understanding that risk is critical to the success of life settlement investing. In the secondary market, no one knows the insured’s health status better than the insured. And sometimes, the insured will say things to their doctors that they know will get in the medical records, that they know will spark the interest of investors. Effectively managing and mitigating origination risk is critically important in our market,” said Rose.
While life settlements carry unique risks, so do other alternative credit strategies. Private credit investors face borrower defaults and illiquidity. Distressed debt strategies can suffer from protracted legal proceedings or restructuring outcomes that dilute recoveries. Litigation finance depends on uncertain court outcomes and shifting legal precedents. Even trade finance has exposure to fraud or counterparty failure. Every alternative credit niche comes with its own idiosyncratic challenges, which often feeds into the ‘you won’t get fired for buying IBM’ refrain so commonly heard in private asset circles.
“Investors expect results to be replicable over time. Even when principles and philosophy align, the risk of non-replicability poses a reputational challenge,” said Raffaele Dell’Amore, Investment Managing Director at Cambridge Associates.
“Private asset classes carry higher career risk than traditional assets, so investments must compensate for potential setbacks. Rather than focusing solely on technical risks like longevity, investors ask: ‘What could go wrong, and are those risks already considered – or could surprises emerge?’ These uncertainties often make investors hesitant to allocate capital,” he added.
Another elephant in the life settlement room that has been something of a permanent presence in the past 25 years has been a perceived ethical concern that the industry benefits when insured individuals pass on.
That’s an insurmountable challenge for some capital allocators – but not all of them. And again, it’s a conversation where the investor education angle comes in.
“Some investors simply cannot reconcile their philosophy with this asset class, and we respect that decision. For others, education is key. Understanding the motivations behind policy sales – often sensible and beneficial – can help overcome misconceptions. Many investors are unaware of these drivers, so it’s crucial to explain why this market exists” said Dell’Amore.
The social benefit to the life settlement market is one that the industry at large tries to push. A significant example of that is the funding that Washington, D.C-based industry group the Life Insurance Settlement Association recently provided to support the production of Cashing Out, a documentary from New York-based filmmaker Matt Nadel that tells the stories of three people who had a direct link to the viatical settlement industry (which arose in the US in the 1980s as a vehicle to offer financial relief to AIDS patients who had lost income or required funds for end-of-life care) – the beginnings of what is now the life settlement market.
Thanks to significant advances in treatment, people living with AIDS can now expect much longer, healthier lifespans. But the original raison d’être of the viatical settlement market still applies to the secondary life settlement market today.
“For many people, the purpose of having life insurance is for their children when they pass away. But when they don’t need it for that purpose anymore or when they need money now, our market provides a huge benefit. If someone is terminally ill and they can’t afford their treatment, selling a life insurance policy can help. Or if they want to take that last trip with the family, selling a life insurance policy can pay for that. We literally had a policy seller tell us she was using the proceeds to buy her grandson a Corvette – there’s no other way she could have done that,” said Rose.
The social benefit of the life settlement market alone is arguably unlikely to get an institutional allocator to commit. But those in the market argue that the asset class has other compelling features; they say that returns on life settlements tend to be less tied to the ups and downs of capital markets than other alternative credit strategies, helping diversify a portfolio. And because cash flows are driven mainly by policy details like face value, premiums, and life expectancy, rather than economic cycles or market mood, well-managed, diversified life settlement portfolios can deliver lower volatility than even other alternative credit assets, let alone public equity markets and liquid fixed income. All of which reinforces the need for the market to continue preaching the good word.
“There’s a continuing education and awareness requirement in our market,” said Rose.
“And the more investors get comfortable with it, the more of the right investors – larger, sophisticated, professional investors with a medium to long term investment horizon – will enter and importantly, stay in the asset class. That’s how we will grow the industry.”