If you ask a life settlement broker if they think that secondary market activity was higher in 2022 than in 2021, you’ll likely receive an enthusiastic ‘yes’. Industry body the Life Insurance Settlement Association has published their annual data now, and trade magazine The Life Settlement Report, part of The Deal, also collects its own data direct from the states, so shortly, empirical evidence will be available to either support or contradict those views.
Transaction data in the tertiary market isn’t as straightforward to come by, but Zurich, Switzerland-based investment advisor AA-Partners (AAP) collects some of this data, and 2022 provided a welcome rebound in activity in the life settlement industry’s most opaque space.
“In the tertiary market, the number of single transactions bounced back last year. While activity was still slightly short of the 2020 level, it was up substantially on 2021,” says Beat Hess, Managing Partner at AAP.
AAP data suggests that the average face value of single transactions decreased from $4m to $2.4m last year, the average age of insureds decreased to 80.6 years of age (down from 84.7 years in 2021) and the average life expectancy of the insureds increased to 70 months, up from 62 months the previous year.
Unlike the life settlement industry’s secondary market, however, inferring trends from tertiary market data isn’t as straightforward, and Hess cautions newer investors that are looking at the space to take it with a pinch of salt.
“70% of the reported activity in our life settlement transaction data collection is transacted in the tertiary market, so more than twice the secondary market,” he says. “But tertiary market deals are to a significant part driven by supply. The data is much less homogenous than in the secondary market – it’s very dependent on who comes to market, and with what.”
Of course, that’s not to say that the data is irrelevant. Investors, whether they be new or familiar with the space, can make good use of tertiary market information.
“The primary way that investors should use tertiary market data is as a check and a balance on valuations. Policies are only worth what another buyer is willing to pay. Therefore, tertiary market transactions are the correct reference point for the valuation of life settlement portfolios,” says Hess.
In the industry’s secondary market, activity level information does provide investors with a solid pulse on the overall direction of the market. The life settlement market needs a constant supply of ‘new blood’ in order to be sustainable in the medium to long term, so any growth in these numbers would be welcome to investors, managers, and service providers alike.
But even in a growing secondary market, Hess urges investors to drill down into the life expectancies (LE) that managers are using. Data collected by AAP shows that the average LE used for closing in the secondary market was similar in 2022 to those used in 2021 or 2020 – however, these are considerably longer than they were in 2018 and 2019. Furthermore, the number of LEs per transaction has decreased from approximately 1.8 in 2014 to 1.14 last year. The trend in the decrease of the number of LEs used per transaction was overlapped by a significant switch from the firms that were the dominant medical underwriters until about 2018 to newer, and previously less often used, medical underwriters.
“The LEs are provided by the sell side, which has an interest in short LEs since the transaction price becomes higher with shorter LEs,” says Hess. “But starting back in fall 2018, a significant lengthening of LEs occurred and consequently, the market for LEs started to shift. The use of the two main medical underwriter firms dropped off and they were replaced by historically less often used medical underwriters or even new medical underwriters with a short track record. The average medical underwriting is significantly longer today than in the years up to 2018, and this is a good thing. This does not mean that the LEs are overall correct today, but the LEs are overall longer than in the past which improves the situation for today’s investors overall.”
The impact of longer LEs on the life settlement market is that projected IRRs have fallen. AAP also collects valuation data, and a regression analysis conducted by the firm shows that valuations haven’t changed materially in the past five years. Lower projected IRRs in today’s market environment therefore don’t reflect higher prices. The relative prices today are largely in line with 2018/2019, the lower projected IRR therefore don’t result from higher prices but from longer LEs.
“Therefore, it’s wrong to use discount factors from actual transactions and actual medical underwriting and to apply it to policies purchased in 2018/19 because by doing that, you’re inflating the value of your assets. If the assets are priced higher, the regressions should be distinct. The valuation has not substantially changed,” says Hess.
Still, positive trends in the life settlement market, like in other asset classes, are to be cautiously welcomed.
“Some of the trends that we have observed, both in the past year or so and in the more medium term, should provide encouragement to investors,” says Hess. “But there are still a lot of blind spots that investors need to try and be aware of.”
