May 2018 Issue
FW speaks with Corwin Zass at Actuarial Risk Management, Ltd about the outlook for life settlements in 2018.
FW: Could you provide an overview of current developments in the life settlements market? What trends are having a notable impact?
Zass: Four areas are the focus: quicker or alternative underwriting of an insured’s health which translates into a mortality profile, more investor interest from the retail side vis-à-vis an investment fund or the like, more institutional players looking to retain for their own balance sheet, and finally consumer interest to bring to light the fact that policyholders can sell their policies. On the underwriting front, a more recent phenomenon is exploring different ways to evaluate a person’s health impairment, and thus lifespan, using predictive analytics tied to Big Data or wearables. Over the last few years, the baby boomer transition has continued to make headlines, which, in part, has entertained the interest of new capital into the life settlement space. One of the most important aspects of investing in this space is the supply of the assets – in this case, US life insureds who understand they can monetise their life insurance policy. Larger campaigns are in the works to make the consumer aware they can possibly sell their unneeded or unaffordable policies to deploy the proceeds for various uses, including medical costs, long-term care expenses and so on.
FW: What are the main benefits of investing in the life settlements market? Conversely, what are the overriding challenges and issues that investors need to be aware of?
Zass: One of the main challenges is the attempt to extend the law of large numbers to the proverbial law of small numbers. Here, the focus is on categorising an insured into some risk category, with the hope of understanding the longevity profile of the larger group, and then extending your views down to a single person’s own longevity profile. People forget that insurance is tied to risk pooling with triggering events happening above and below the average – some insureds will live longer than average for their group, and others will live shorter. We must make it abundantly clear: you cannot legally and accurately predict a person’s date of death. This implies you need enough capital to absorb adverse events going against your average. Besides the need to develop bespoke insured survival curves, the investor needs to have patience – you are betting on longevity not ‘shortevity’. The 1980s AIDS viatical settlements era produced mostly failed returns since there was a very short window of time for death for the economics to work. Similarly, if you acquire policies with perceived very short life expectancies you have less ability to make up for someone living longer than the average. Not unlike other investments, proper diligence of the risks is a critical step with one challenge being to determine if a life insurance company might increase, and by how much, the underlying product cost of insurance rates, thereby increasing a policy’s premium costs. The diligence of that risk is not easy and requires knowledgeable life insurance experts, coupled with tools to perform an in-depth credit risk analysis, to evaluate the financial stressors on a carrier then at a granular level assess the likelihood of a change at a product level. Turning to the benefits, we believe the secondary market gives a social benefit so more unhealthy life insureds can tap their hidden money to use while they are alive. The lack of correlation between longevity and the financial markets has been written about ad nauseum. So, from a diversification perspective, a longevity-mortality themed investment adds to that notion, yet understanding what you are investing in is far more important than the theoretical diversification benefits.
FW: How would you characterise the ways in which the investment manager role has evolved as the life settlements market has grown? What strategies have you observed investment managers employing to attain stronger yields?
Zass: Many investments require a proactive, experienced investment manager. Life settlements are the same. Some view life settlement investing as simple discounted cashflows produced by some pricing software or spreadsheeet. This approach is far from optimal. Larger institutional investment managers have a solid team who investigate mortality experience and look for ways to understand the risks they acquire, while also spending time constructing the premium schedule. We tell people there is no software programme to construct the optimised premium schedule for the most complex UL secondary guaranteed life insurance products. This needs to be done by first principles and, in fact, by hand, since the illustrations made available by the insurance company often tell little about the secondary guaranteed economics of the contract. Simply put, this is not an investment where you buy and ‘clip coupons’ or pick up ‘mailbox money’. You need to work at this to minimise your loss exposure and increase your return potential. This takes capital to hire people or use consultants. Like a commercial real estate investment, you cannot just buy it and collect rental income.
“To perform the necessary diligence of one life settlement policy requires thorough legal, actuarial, and underwriting diligence.”
FW: What advice would you give to life settlements investors in terms of undertaking efficient and effective diligence? What, in your opinion, are the elements of a life settlement transaction that require the most scrutiny?
Zass: To perform the necessary diligence of one life settlement policy requires thorough legal, actuarial, and underwriting diligence. Elevating the diligence to a level we deem as best practice varies by the origination of the life settlement – the legal risk, the complexities of the policy form and the underwriting insurer – as well as the terms of the contract and the driver of the economics, and the insured’s impairment versus the underwriter’s report. Each policy can easily take eight to 12 hours between those functions. You need to build that cost into the acquisition price. We have seen the other end of the spectrum where a buyer receives a zipped file of policy documents only to check some box with no further work. I can only say I hope that luck is more on their side as the lack of attention will only come back to haunt them.
FW: What advice would you offer in terms of utilising the best drivers to maximise return on investment (ROI)?
Zass: This should apply to any investment, not just life settlements: understand what you are buying, hire someone to educate you on all aspects of the risk-reward efficient frontier, and perform diligence on third-party professionals before you spend one dollar on investing in the space. Finding the right advisers to act as the chief sceptics goes a long way toward minimising your loss position. Anyone can make money; the good ones are able to minimise when you lose and by how much.
FW: How would you evaluate the accuracy of methods used by underwriters to measure life expectancies?
Zass: First, we believe there is a lot of misunderstanding of the metric ‘life expectancies’, which can be defined in terms of age or a length of time. A couple definitions – life expectancy is based on an estimate of the average age that members of a specific population group will be when they die, or, for example, this insured has a life expectancy of 72 months, which means that 72 months from the date of the underwriting, a crossover point occurs where 50 percent of a group of individuals with the same characteristics would have died during that 72 months; thus leaving the other half still alive, to die beyond 72 months. This metric tells nothing about the dispersion around that average. When you are evaluating longevity, the most important note is the shape of the survival curve and the ability to measure how long people will live. There are other ways to understand or measure lifespan that are more informative. Take the underwriter function, for example. These are professionals who blend medical knowledge and historical trends on how certain impairments or risk profiles impact mortality. This makes them a good source to classify an insured’s profile, yet there is not enough information about the conditions and the degree of impairment past and present. They are performing a snapshot view at one point in time, not forward looking, to assess the degree the insured gets worse. This is important information that needs more focus. Frankly, underwriters should stop and just provide the market with this assessment of the insured, and not extend it to a single metric like life expectancy. Let the market come up with its own view of mortality.
FW: Could you outline any legal and regulatory developments that have impacted the life settlement market in recent times? For example, how has the market in the US responded to the Tax Cuts and Jobs Act of 2017 (TCJA)?
Zass: There are two points of interest. First, the fact that the IRS and the US government included anything on life settlements in the 2017 Tax Cuts and Jobs Act (TCJA) is a bonus as it brings attention to a policyholder, through a tax professional or estate planner, that they can sell their policy. Second, the focus is on the life insured’s side and not the investor side. The TCJA contained a positive development for people who own a life insurance policy they no longer need or can afford. Previously, policy sellers were required to reduce their tax basis in a life insurance policy by deducting ‘cost of insurance’ charges over the elapsed period of the policy. But this information was at least difficult and sometimes impossible to obtain. So, many people lapsed or surrendered a policy. The tax change eliminates that burden. Some believe this will broaden the supply of life settlements since insureds have a less onerous path to sell.
FW: What is the outlook for the life settlements market through 2018 and beyond? What activity do you expect to see?
Zass: For 2018 and beyond, we believe there to be changes on a few fronts. First, we strongly believe underwriters will stop placing any estimate of how long someone will live; and shift to a medical impairment estimator that has them focus on their views of the current healthiness of an insured and how that healthiness, or lack thereof, changes in the near future. Second, the economics of the transaction is ripe for a change, through a shift in the single cash exchange at closing but rather a multi-payment spread over a few years with the insured retaining some graduated scale of death benefits. Third, improved speed to transact as it can take months to order medical records and review before an offer is put forth. Finally, the idea that someone could create a comparable real estate multiple listing service (MLS) platform for life settlements.
Corwin (Cory) Zass is the founder and principal of Actuarial Risk Management, Ltd, an independent member of the BDO Alliance USA since 2006. For close to 25 years, Mr Zass, a trained life actuary, and his team’s collective advice have been sought on topics such as M&A, product & risk management, capital strategy and financial reporting paradigms. Over the last 10 years, he and his firm have regularly advised clients on life insurance matters and life settlement investments. He can be contacted on +1 (512) 345 5200 or by email: czass@actrisk.com.
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