Life Settlement Note Book

Opinions and Judgments

For society

pro

1. Addressing aging problem

   • (Sheridan 2014) Life settlements provide useful, real-world lessons - such as awareness of informational asymmetries and the use of big data techniques - in managing longevity risk, many of which are applicable to the developing macro-longevity markets.

   In recent decades, the west especially has witnessed a trend to subtly shift longevity risk to the consumer. This is evidenced most in the changes in pension schemes: defined benefit schemes are phased out and replaced with defined contribution plans (401(k) in the U.S.). Pensioners are no longer guaranteed a fixed payment until death, and instead now have to bear the risk of the annuity market at retirement, as well as the risk of financial markets in between.
   As societies age and the traditional pay-as-you-go social security systems come under increasing pressure due to the changing ratio of workers to retirees, the ability to determine accurate life expectancies becomes increasingly important. An open market in life expectancies, enabling the wisdom of the actuary to be replaced by the wisdom of crowds, is a potential conduit to that accuracy.
   A properly functioning life settlements market can offer that window in the way that many macro-longevity markets cannot. (Pension buy-ins / outs for example are too large and infrequent) The current market suffers from a dearth of secondary supply; policyholders can see as far as the short term cash they will receive for the policy but, as yet, are awaiting the “Don’t mess with Texas” equivalent that helps them see further to a broader societal good. The tarnished reputation of life settlements is a result of the survival bias – as a young industry involving long-duration investments, those good players who have been surviving so far do not get exposed ofte since most of their investments in life settlements haven’t matured; on the contrary, bad-performed investments are covered more often.

   • (Blake, Cairns, and Dowd 2008) The existence of longevity-linked instruments facilitates the development of annuities markets in the developing world and could well save annuities markets in the developed world from extinction.

2. Welfare benefits and efficiency gains

   • (Doherty and Singer 2003b, 478) A rudimentary secondary market for life insurance has always existed; policyholders could surrender their policies to the incumbent carrier. However, the incumbent was a monopsonistic buyer and extracted rents on these transactions. Entry by firms into the secondary market for life insurance policies has created competition on secondary transactions and generated welfare benefits and efficiency gains.
   • (Evans, Russell, and Sager 2013, 116) By including a contractual provision that gives the life insurer the right of first refusal to match any viable life settlement offer, the life insurer would easily recapture most of the value lost to intermediaries in life settlement transactions.
   • (Stone 2009, 110) Life settlement market becomes efficient through an increase in the elasticity of both the supply and demand curves, positively related to the liquidity, transparency, and integrity of the market.

con

1. Moral issue

   • (Quinn 2008, 741) Settlements are in tension with the principle that life insurance is primarily a sacrifice that insured people make in order to provide for families left behind.
   • (Quinn 2008, 741) Settlements undermine the spirit of insurable interest, which has historically established the decency of life insurance.
   • (Nurnberg and Lackey 2010, 528) Life settlement is pure betting, where the outcomes are determined by actuarial factors that have nothing to do with wise choices made by the investors or by the creditworthiness or profitability of companies.
   • (Piontek 2005, 4) Investor-owned life insurance, which moves far from the noble basis of protecting loved ones, inevitably cheapens the concept and should be banned.

For insurance companies

pro

1. Positive feed back to the primary market of life insurance

   • (Doherty and Singer 2003b, 478; Ingraham and Salani 2004, 75–76) Secondary markets for financial products provide liquidity and thereby enhance the value of these products. This value enhancement usually feeds back to the primary market in an expansion of demand.
   • (Gatzert, Hoermann, and Schmeiser 2009, 905) In the long run, both consumers and life insurance carriers will benefit from a competitive secondary market.

2. hedging

   • (Mott 2007) Longevity derivatives allow the insurance industry to identify, concentrate, and hedge the risks to insurers, perhaps more effectively than the insurers can do themselves.

For policyholders

pro

1. Better alternative than lapsing
   • (Dibrell 2010, 95) Life settlement firms have created an innovative financial tool to create wealth for individuals by not letting their whole life insurance policy lapse.
   • (Doherty and Singer 2003a, p.) A competitive secondary market benefits policyholders by allowing them to realize the economic value for the sale of impaired policies.
   • (Leimberg and Gibbons 2003) Life settlements make the most sense where it is likely that, in spite of significant health impairment, the insured may live beyond the point where continuing to pay premiums is economically feasible and the death benefit is exceeded by the overall (including time value of money) cost, a risk that the life settlement company can afford to take because of the pooling concept.
   • (Simon 2005, 22) When an insured key person retires or resigns, instead of cancelling its corporate-owned policy and taking the cash-surrender value, if any is remaining, the company can sell the policy, be rid of any future premium obligation and receive a lump sum in cash well.
   • (Alexander 2011, 113) Clients can recover significant wealth that may betrapped in unneeded life insurance.
   • (Gardner 2005, 29) Life settlements could help foundations, universities and organizations make better decisions as it relates to managing their donated life insurance policies and donor acceptance programs.
   • (Adams and Sabes 2009, 318) Life settlements give a family business a measure of security in the face of market downturns, the death of a key business member, or other changed circumstances that disproportionately impact family businesses.
2. Tax benefit
   • (Warring 2005, 45) A life Settlement can be a better alternative than surrendering a policy, especially with the possible repeal of the federal estate tax still on the horizon.
   • (Breus 2008, 45) As a charitable donor, a settler can support a favorite charity, while reaping an unexpected harvest of tax deductions through a CRT (a charitable remainder trust).
   • (Roth 2004, 15) A life settlement can remove the policy from the taxable estate, avoiding application of the three-year rule under IRC section 2035, in order to transfer additional assets tax-free to descendents. +(Friedman 2004, 51) In select circumstances, life settlements provide a win-win way to receive value in excess of the simple cash value of a policy, while gaining a tax advantage and putting more cash into a business, an acquisition, or an individual’s retirement.
3. Psychological value
   • (Quinn 2008, 759) Viaticals provide funds to ameliorate the devastation of terminal illness, helping people die with comfort, peace, and dignity.
   • (Quinn 2008, 768) As estate taxes are rolled back, insurance policies bought to defray them become superfluous and so may be resold. From
   • (Leimberg and Gibbons 2003, 521) Life settlements make the most sense where it is likely that, in spite of significant health impairment, the insured may live beyond the point where continuing to pay premiums is economically feasible and the death benefit is exceeded by the overall (including time value of money) cost, a risk that the life settlement company can afford to take because of the pooling concept.
   • (Leimberg et al. 2006, 18) Life settlement creates a new dimension to estate and financial planning for seniors that requires life insurance to be actively managed no different from fixed income, equity, and real estate asset classes.

con

1. tricked into purchasing more expensive policies
   • (Martin 2014, 128) First, young families and small businesses should know that many financial planners recommend term life insurance as the cheapest way to protect against economic hardship in the event of unforeseen death.261 When the family or business is no longer dependent on the insured, the policy can be dropped and no further premiums have to be paid. Congress would also encourage the purchase of term insurance instead of whole life if it eliminated tax preferences for life insurance over other investment vehicles.
2. increased premiums
   • (Martin 2014, 122) With fewer policies lapsing, premiums will be higher for young families and small business owners who need the insurance for basic financial protection.

For investors

pro

1. Portfolio diversification
   • (Ziser 2005, 12; Bajo-Davo, Mendoza-Resco, and Monjas-Barroso 2013b, 22) The introduction of life settlement funds in investment strategies produces greater value due to their low correlation with the other financial asset classes, even lower than the correlations between fixed income and equity indexes. +(Bajo-Davo, Mendoza-Resco, and Monjas-Barroso 2013a, 69) Life settlement funds can reduce portfolio risk in combination with fixed income and equity indexes and commodities due to low or inverse correlation.

con

1. Risks
   • (Braun, Affolter, and Schmeiser 2015, 173) A majority of asset managers seem to substantially overvalue their portfolios relative to the prices of comparable transactions that have recently been closed.
   • (Braun, Gatzert, and Schmeiser 2012, 223) Latent risks associated with life settlement funds, such as liquidity, longevity, and valuation risks, cannot be captured by classical performance measures, but should be considered by investors.

• (Quinn 2008, 750) life settlement businessmen claim that the insurance companies actively lobbied to hinder the industry in order to prevent a decline in the number of insurance policies that policyholders allow to lapse, something that is very profitable for companies because they never have to pay out a death benefit despite receiving years of premium payments; meanwhile, insurance companies deny including lapse rates in their pricing or efforts to make profits.

Facts and Stats

health insurance

uncertainty/ certaity

https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/downloads/highlights.pdf

financial crisis

real estate market value loss 2006-2011:

25043.0-18182.8=6860.2 million (1.37 trillion per year)

https://www.federalreserve.gov/releases/z1/20120607/z1.pdf

http://www.mybudget360.com/the-balance-sheet-recession-42-trillion-lost-in-residential-real-estate-value-yet-mortgage-debt-down-by-140-billion/

https://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932008#Causes

lapse loss

For 2015:

5.4% * 12,342,152 + 5.9% * 8,360,705 = 1,159,757.803 (1.16 trillion per year)

The number and amount of lapsed life insurance policies by Americans over the age of 65 is staggering: more than 250,000 policies with a combined face value of more than $57 billion are lapsed and surrendered back to life carriers each year. And that only includes universal and variable life policies; if term life and whole life policies are added, the total exceeds $140 billion.

• (Quinn 2008, 740) The Wall Street Journal has reported that the estimated trade in life insurance policies was at $2 billion in 2002 (Opdyke 2004) and $12.2 billion by 2007 (Tergesen 2008). A study by LISA (2007) estimated that around $13 billion in face value flowed through settlement contracts in 2004 and 2005, which represented an estimated 43% rise in the number of settlements and a 38% rise in business growth over that period. A 2007 cover story in Business Week (Goldstein 2007) offered a cautiously opti- mistic outlook for the industry. Citing a dramatic increase in attendance for the industry’s annual conference, from 250 attendees in 2005 to 600 in 2007, the author crowned settlement-backed bonds “the next exotic investment coming down the pike. The Life Insurance Settlement Association’s commissioned “Data Collection Report 2004–2005” (LISA 2007, p. 3) lists three reasons for this: “Not all states require reporting; no uniform data collection process exists; relatively few companies file official reports.” The following numbers reflect, to my knowledge, the most accurate estimated figures for the entire market: in 2005, LISA surveyed its members and found that 11 of its member companies”settled 2,025 policies with a total death benefit of $3.9 billion" (LISA 2007, p. 5). This was up from 1,412 settled policies with a total death benefit of $2.8 billion in 2004. The authors of the report then estimated that this represented approximately half of the market in that time period (LISA 2007, p. 3). This report does not disaggregate viatical and life settlement sales.
• (Blake, Cairns, and Dowd 2008, 19) The first SLS securitization was Tarrytown Second, involving $63 million SLSs backed by $195 million life policies. 13
• (Adams and Sabes 2009, 310) One estimate put the amount paid for life settlements in 2005 at $5.5 billion (Conning Research, 2005). Another estimated $10 billion to $15 billion (Furman, 2007; M. Goldstein, 2007; Panko, 2006). Doherty and Singer (2002) estimated life settlements business has a potential market of $100 billion (Garrison-Sprenger, 2007), whereas Sanford C. Bernstein & Co. predicted the value of life settlements will eventually reach $160 billion (Baird & Brooks, 2002; M. Goldstein, 2007). The total value of life insurance policies held by seniors is $492 billion (Doherty & Singer, 2002)
• (Breus 2008, 44) Approximately $15 billion worth of life insurance policies were sold on the sec- ondary market in 2006, according to the Life Insurance Settlement Association in its 2007 handbook.
• (Gardner 2005, 31) The U.S. Census Bureau estimates that there will be 50 million people age 65 and older by 2010 (15 percent of the population). A large segment of this group owns life insurance purchased for earlier life-stage milestones and is no longer necessary for those needs. According to a 2002 Wharton School of Business study, it is now estimated that the potential life settlement market could reach $100 billion.
• (Giacalone 2001, 6) Chodes, Tow, and Hoopingarner (1998) cite a 1995 research report by Milliman & Robertson, Inc., that broadly estimated the market potential at $500 billion. A recent, more systematic, analysis estimated the market potential at $134 billion (Conning & Co., 1999). The Conning study divided the market into three segments: AIDS victims aged 25- 44, other terminally ill aged 45- 64, and the life settlement group aged 65 and over. The $134 billion figure is derived from applying a percentage of the segments that would be open to selling their policies to the amount of life insurance in force for these groups.
• (Martin 2010, 218) Life insurance companies should reconsider the amount they pay out in surrender value so that life settlement offers would not look so attractive.

Bibliography

To Literature Sweep

Adams, Edward S., and Jon R. Sabes. 2009. “The Role of the Secondary Market for Life Insurance in Preserving a Family Business.” Family Business Review 22 (4). SAGE Publications: 309–18. doi:10.1177/0894486509337506.

Alexander, Neil. 2011. “New Value in Old Policies.” Journal of Accountancy 192 (4): 113–14. https://www.journalofaccountancy.com/issues/2001/oct/newvalueinoldpolicies.html.

Bajo-Davo, Nuria, Carmen Mendoza-Resco, and Manuel Monjas-Barroso. 2013a. “Financially Diversified Portfolios with Alternative Investments: The Impact of Life Settlements.” The Journal of Wealth Management 15 (4): 69–87. doi:10.3905/jwm.2013.15.4.069.

———. 2013b. “Portfolio Diversification with Life Settlements: An Empirical Analysis Applied to Mutual Funds.” The Geneva Papers on Risk and Insurance 38 (1): 22–42. doi:10.1057/gpp.2012.44.

Blake, David, Andrew J. G. Cairns, and Kevin Dowd. 2008. “The Birth of the Life Market.” Asia-Pacific Journal of Risk and Insurance 3 (1). The Asia-Pacific Risk; Insurance Association: 6–36. doi:10.2202/2153-3792.1027.

Braun, Alexander, Sarah Affolter, and Hato Schmeiser. 2015. “Life Settlement Funds: Current Valuation Practices and Areas for Improvement.” Risk Management and Insurance Review 19 (2): 173–95. doi:10.1111/rmir.12042.

Braun, Alexander, Nadine Gatzert, and Hato Schmeiser. 2012. “Performance and Risks of Open-End Life Settlement Funds.” The Journal of Risk and Insurance 79 (1): 193–230. doi:10.1111/j.1539-6975.2011.01414.x.

Breus, Alan. 2008. “Virtues and Evils of Life Settlement.” Journal of Accountancy 205 (6): 40–41, 44–45. http://www.journalofaccountancy.com/issues/2008/jun/virtuesandevilsoflifesettlement.html.

Dibrell, Clay. 2010. “Life Settlements from the Perspective of Institutional, Real Options, and Stewardship Theories.” Family Business Review 23 (1). SAGE Publications: 94–98. doi:10.1177/0894486509335815.

Doherty, Neil A., and Hal J. Singer. 2003a. “Regulating the Secondary Market for Life Insurance Policies.” Journal of Insurance Regulation 21 (4): 63–99. https://search.proquest.com/docview/204961044.

———. 2003b. “The Benefits of a Secondary Market for Life Insurance Policies.” Real Property, Probate and Trust Journal, Wharton financial institutions center, 38 (3). Wharton Financial Institutions Center: 449–78. https://www.jstor.org/stable/20785738.

Evans, Bruce D., David T. Russell, and Thomas W. Sager. 2013. “Operational, Legal and Tax Issues in Life Settlement Transactions.” Journal of Insurance Regulation 32 (1): 101–18. https://search.proquest.com/docview/1537587497.

Friedman, Lori. 2004. “Using Life Settlements to Tap the Value of Hidden Assets.” The CPA Journal 74 (8): 51. https://search-proquest-com.ezp-prod1.hul.harvard.edu/docview/212320760.

Gardner, Rick. 2005. “Life Settlements: A Legitimate Financial Planning Tool.” Journal of Practical Estate Planning 7 (4): 27–32. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=873553.

Gatzert, Nadine, Gudrun Hoermann, and Hato Schmeiser. 2009. “The Impact of the Secondary Market on Life Insurers’ Surrender Profit.” The Journal of Risk and Insurance 76 (4): 887–908. doi:10.1111/j.1539-6975.2009.01320.x.

Giacalone, Joseph A. 2001. “Analyzing an Emerging Industry: Viatical Transactions and the Secondary Market for Life Insurance Policies.” Southern Business Review 27 (1): 1–7. https://www.academia.edu/814586.

Ingraham, Harold G., and Sergio S. Salani. 2004. “Life Settlements as a Viable Option.” Journal of Financial Service Professionals 58 (5): 72–76. http://www.sandorcapital.ca/press/articles/article08.pdf.

Leimberg, Stephan R., and Albert E. Gibbons. 2003. “Life Settlements and the Planning Opportunities They Offer.” Estate Planning 30 (10): 517–21. https://search-proquest-com.ezp-prod1.hul.harvard.edu/docview/197673674.

Leimberg, Stephan R., E. Randolph Whitelaw, Richard M. Weber, and Liz Colosimo. 2006. “Life Settlements: Tax, Accounting, and Securities Law Issues.” Estate Planning 33 (9): 3–4, 6, 8, 10–18. https://search-proquest-com.ezp-prod1.hul.harvard.edu/docview/197669612.

Martin, Susan Lorde. 2010. “Betting on the Lives of Strangers: Life Settlements, STOLI, and Securitization.” University of Pennsylvania Journal of Business Law 13 (1): 173–219. http://heinonline.org/HOL/Page?handle=hein.journals/upjlel13&id=175&div=7&collection=journals.

———. 2014. “Life Settlements: The Death Wish Industry.” Syracuse Law Review 64: 91–130. http://heinonline.org.ezp-prod1.hul.harvard.edu/HOL/Page?public=false&handle=hein.journals/syrlr64&collection=journals&id=99.

Mott, Antony R. 2007. “New Swaps to Hedge Alpha and Beta Longevity Risks of Life Settlement Pools.” The Journal of Structured Finance 13 (2). Institutional Investor Journals: 54–61. doi:10.3905/jsf.2007.690268.

Nurnberg, Hugo, and Douglas P. Lackey. 2010. “The Ethics of Life Insurance Settlements: Investing in the Lives of Unrelated Individuals.” Journal of Business Ethics 96 (4): 513–34. doi:10.1007/s10551-010-0480-7.

Piontek, Steve. 2005. “It’s Time To Ban IOLI.” National Underwriter 109 (24): 4. https://search-proquest-com.ezp-prod1.hul.harvard.edu/docview/228463804.

Quinn, Sarah. 2008. “The Transformation of Morals in Markets: Death, Benefits, and the Exchange of Life Insurance Policies.” American Journal of Sociology 114 (3): 738–80. doi:10.1086/592861.

Roth, Ronald M. 2004. “CPAs and Life Settlements: Due Care, Competence, and Objectivity.” The CPA Journal 74 (9): 15. https://search-proquest-com.ezp-prod1.hul.harvard.edu/docview/212294983.

Sheridan, Matthew. 2014. “Lessons from the World of Micro Longevity.” Institutional Investor Journals 2014 (1): 82–87. doi:10.3905/sp.2014.2014.1.082.

Simon, Larry A. 2005. “Life Settlements: Means for Cashing In Key-Person Policies.” Financial Executive 21 (9): 22. https://search-proquest-com.ezp-prod1.hul.harvard.edu/docview/208900777.

Stone, Charles Austin. 2009. “The Supply and Demand for Life Settlement Contracts.” The Journal of Structured Finance 15 (2): 101–11. doi:10.3905/JSF.2009.15.2.101.

Warring, James D. 2005. “Turn Unneeded Policies into Cash.” Journal of Accountancy 200 (3): 39–45. https://www.journalofaccountancy.com/issues/2005/sep/turnunneededpoliciesintocash.html.

Ziser, Boris. 2005. “Life Settlements: An Option for Seniors, an Opportunity for Investors.” The Journal of Structured Finance 11 (2). Institutional Investor Journals: 12–14. doi:10.3905/jsf.2005.570540.

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1. Java is a PhD candidate from the University of St. Gallen (supervisor: Prof. Dr. Alexander Braun), and is cuttently conducting research at Harvard University (supervisor: Prof. Dr. Lauren H. Cohen) as a visiting fellow.↩