Outlook for life settlement funds in 2020
January 2020 | TALKINGPOINT | FINANCE & INVESTMENT
Financier Worldwide Magazine
January 2020 Issue
FW discusses the outlook for life settlement funds in 2020 with Corwin Zass at Actuarial Risk Management, Ltd.
FW: In your opinion, should valuations use updated life expectancies or those acquired more than a year ago – or even longer?
Zass: Let us start with the purpose of life expectancy (LE) in the life settlement space. Akin to getting an appraisal of your house, or a physical from your doctor, the objective is to gain a fresh perspective as to the condition of whatever is being inspected or underwritten. Since LE is one of the critical variables in computing the value of a life settlement, the value as of a measurement date would appear more accurate with a current assessment. The fair value of a life settlement looks at the price between a buyer and a seller, whereby such negotiated price generally depends on an updated underwriting assessment. Unlike a house appraisal that generally does not see material changes in value, there is clear evidence of increasing level of morbidity as a person ages. This means that there is a higher likelihood that the LE of a person in their 80s can change rapidly, measured in weeks and months, not years. Since the rate at which a person changes out of a healthy state is heterogeneous and varies between individuals, the ability to capture this shift on a person is critical to garnering a better view of their level of morbidity or impairment. All things equal, there is less likelihood that morbidity risks, thus mortality risks, lowers at these upper ages, especially if a person has already shifted out of the health state. As such, the use of an aged LE would serve to understate the value, since the LE and value are inversely proportional. We strongly suggest updated assessments on an annual basis. If you are using non-fair value accounting or are closely held with less focus on the balance sheet, plus you prefer to not incur the additional, and frequent, underwriting cost, then you could argue it is conservative to not update the LE, and thus understate the policy’s asset value. Whatever you do, document your rationale, reasons and positions for not updating them.
FW: How have continued low interest rates impacted the ability of retirees to continue their chosen lifestyle? To what extent would that have an impact on the supply of life settlement policies?
Zass: The US governmental treasuries are at historical lows, unlike other areas of the globe that are in fact negative, and thus continue to slow the growth of retirement funds growing at bond yields. With less money than expected, or hoped, retirement money for those risk-averse US retirees with no affinity to the stock market, these retirees will look to monetise other available assets. Those assets will include their unneeded life insurance policies. Any prolonged depression of bond yields will inflect lower growth and have the potential to increase the number of policyholders exploring the sale of their life insurance policies. This is only predicated on the notion that the option to sell their life insurance policy is one that is known in the first place.
FW: Could continued low interest rates lead to problems with major life insurers’ profitability, that would impact life insurance policies that could become – or are – life settlements?
Zass: Any person or organisation expecting their investments to grow at historical yields is generally disappointed in an era when actual yields are less than historical yields. Pension schemes plans and insurance carriers are no different. For the latter group, they originally set promises or policy features based on some future expectation – from the number of insureds who will continue to pay the life insurance premiums, to the investment yield on their assets supporting the policy reserves to expected levels of insured mortality. In theory, to stay on expectation, when one of the profit drivers stress the others must make it up. With many contracts of the universal life (UL) variety, with crediting rates tied to an insurer’s asset bond portfolio, those policies began to operate on a glidepath that diverged from the original illustrations used at the time of issue. This scenario has been operating in general for a few decades. Right now, UL policies issued in the 80s and 90s are seeing their contract fund values erode, since credited interest was not high enough to offset the increasing cost of insurance rates. This means policyholders will face a dilemma: start to pay more premiums into their UL policy or consider other options, like selling their policy into the secondary life settlement market.
FW: Do you see life insurers becoming a competitor to the actual life settlement market by negotiating with their own life insurance policyholders?
Zass: As far as we know, there are a few carriers exploring this path. From the life settlement community’s position, are insurers acting in the same fashion as a licensed life settlement broker and adhering to the strong compliance requirements? From the carrier’s view, they need to look at the overall economics of taking such a drastic measure. These few carriers are not performing any longevity underwriting to assess the insured’s level of impairment. This means that the policyholder is possibly leaving money on the table as the secondary life settlement market could offer something greater than the carrier’s offer. The analogy is that these carriers believe heading off what they expect to happen is best medicine, yet to open the barn door well in advance of what they believe is the barn burning down seems a little extreme. However, regardless of the legal nature of such a transaction, if the math shows it is the best option for the carrier, and speaking as a former chief actuary, then this path does not seem irrational.
“Given the long-term view for suppressed fixed income yields, we believe life settlement returns remain attractive.”
FW: Could electronic medical records reduce the time required for life expectancy providers (LEPs) to issue life expectancy reports, and thereby reduce the time required to fully settle a policy?
Zass: In an era of instantaneous gratification, a larger percentage of the first world seems to accept that anything that cannot be accomplished in minutes seems archaic. The US healthcare market – both providers like hospitals and physician practices to payer side of insurers and the like – is actively trying to create structured data warehouses or data lakes to aggregate doctor records, pharma usage and health telemetry of all types, including that from wearables. Our expectation is that with technology you can create near instant profiles of survival that will become the basis of settling a life insurance policy. It is coming to this space, and it is coming fast.
FW: Has there been a push to create an automated underwriting platform so life expectancy reports are produced in minutes, not weeks?
Zass: The era of quicker underwriting is here in the primary insurance market. Carriers are using these approaches for quicker and deeper underwriting at the time of policy acceptance, creating consistency and less subjective decisions in how to assess health. The current class of automated underwriting will be looked at in 10 years the way we look at mobile telephones today. Things get faster, smaller and more powerful; to think that the LE process will not evolve is simply naïve.
FW: Can investors expect returns on life settlement assets to remain well above the rates on treasuries and corporate bonds?
Zass: If the underlying portfolio of life settlements was in the magnitude of millions of people, then determining an expectation of such mortality events becomes less volatile and more predictable sans the impact of idiosyncratic risk. This also means that the risk is smaller and thus the returns could gravitate toward less risky investment returns having less uncertainty in the cashflows from the collateral. However, we are not dealing with portfolios of millions, but rather double or triple-digit numbers. This means much smaller pools of life insurance policies that create more volatility around the mortality expectation. Such volatility creates wider swings in return profiles. So, until portfolios get much larger, or there is a mechanism to participate in a larger pool of insureds, we can expect a larger risk premium on yields since predicting a single person’s actual date of death is not possible, regardless of the amount of data. Our rule of thumb for determining a price is to take half of the interest rate used to discount a life settlement policy’s cashflows. If you can accept this return, then life settlement-based investments make sense, more so if you are looking for minimally correlated assets. There will be insureds who do not outlive the life expectancy as well as those who do. Given the long-term view for suppressed fixed income yields, we believe life settlement returns remain attractive.
FW: Will the growth in the retiree population segment contribute to an increase in life settlement policies available?
Zass: The supply of customers is at the heart of any business and the secondary life insurance market is no different. The bigger questions are as follows. Does the larger retiree population have tradable life insurance policies? Does this group even know about trading a life insurance policy? Are they of less than average health for their age, thus influencing whether or not the trade economics will work? Are there enough buyers to offer a tradeable offer? And lastly, at what price point would the transaction occur? In the end, bigger is not always better.
FW: Are the potential increases in long-term care (LTC) costs likely to lead to an increased desire to sell life insurance policies?
Zass: The cost of retiring is a big concern of many. Have people accumulated enough retirement financial security, regardless of sources, to fund later in life medical and living costs? According to the US Department of Health and Human Services, the current monthly cost varies from area to area and level of care or facility. By way of example, in-home care is about $4400 per month, an assisted living facility is about $4100 per month and a nursing home facility is $7500 or higher. With these costs escalating at a clip greater than current inflation, the size of these expenditures is real and consumers need a real plan to fund them. We see the pent-up value intrinsic in a life insurance policy no different than a piece of land: there are people who will sell at different times or not at all while balancing whether it is more beneficial compared to tapping other financial funding outlets, especially when interest rates are so low. In other words, we may see policyholders posting their life insurance policies as collateral to get a loan to pay for long-term care (LTC) costs or just sell the policy outright. As with anything, you will see some take one path and others an alternative path. Regardless, the consideration of selling or posting as collateral can only occur if the policyholder knows this is even an option, otherwise the policyholder might just stop paying their life insurance premiums – and we know what happens then with that asset.
FW: Does increased consumer advertising just increase competition for the policies available for sale, or does it increase the overall supply of policies available for sale?
Zass: Consumer awareness efforts are a real challenge. One of the larger players is spending a lot of money on advertising campaigns. Have they seen an increase in inquiries? Yes, but they found many ‘customers’ are just window shopping or really never were a candidate to even transact. A healthy 35-year-old trying to sell their policy will be disappointed, yet a less than healthy 68-year-old could create a positive price. So, will further customer awareness help? The answer is yes, but we also need to construct an easy, and quick, approach to categorise the insureds by health since their level of health impairment is a big driver to create a positive price point to sell. It is important to understand that because of increasing morbidity risk as one grows older, any policy where the insured is not impaired enough will ultimately get to the point in the future where the economics will have them become a seller. How long that takes is the unknown, but understanding their level of current health is the starting point.
Corwin (Cory) Zass is the founder and principal of Actuarial Risk Management, Ltd, a 14-plus year-old consultancy. For over 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. His actuarial training rests on a foundation blending common sense, business views and actuarial technical aptitude. He can be contacted on +1 (512) 345 5200 or by email: czass@actrisk.com.
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