Outlook for life settlement funds in 2021
February 2021 | TALKINGPOINT | FINANCE & INVESTMENT
Financier Worldwide Magazine
February 2021 Issue
FW discusses the outlook for life settlement funds in 2021 with Corwin Zass at Actuarial Risk Management, Ltd.
FW: Reflecting on the last 12 months or so, how would you characterise the state of the life settlement space? What trends are having a notable impact on funds in the market?
Zass: 2020 was chaotic and eventful to say the least, on many fronts. Coronavirus (COVID-19) seemed to create the anticipation that the life settlement industry would see an increase in realised mortality events. While some funds have purported some increases in deaths due to the pandemic, it is also not surprising that the life settlement industry would not see the ‘big’ jump in deaths simply due to the socioeconomic profile of large face amount policyholders. Smaller face amount policies may see some uptick in mortality events. Looking at the data, dying from COVID-19 trended to the elderly, those nursing home residents, and more specifically persons from less advantaged socioeconomic groups. Obviously with variants of the coronavirus expected, and with a lag in producing such variations in the vaccine, we expect there to be some trickledown effect where even the more advantaged socioeconomic groups cannot escape. For those funds looking at smaller death benefits, we expect an increase in supply of life insurance policies but the economic upheaval has policyholders looking to lapse their policies. The challenge is to continue to try to inform those policyholders about the option to monetise their policies. The adage of ‘over promising and under delivering’ seems to continue in the life settlement space, where some fund managers realised “deaths were not occurring like we thought”. From proverbial fire-sales of subsets of policies to closing of funds, the market continues to see fund managers bet wrong on their understanding of mortality.
FW: How accurate are life expectancy assessments? To what extent has the underwriting process, and methodologies used, advanced over the years?
Zass: While with sufficient time, all life expectancy (LE) assessments are accurate because everyone will die, the bigger point is how to measure that accuracy. In our view, you need to understand how that experience will develop by duration from the original LE underwriting date. It is clear to everyone that there is a general trend for the LE to extend over time, yet few public studies exist that correctly measure this trend by duration. While there are certain trends to change the process and methodology to produce quicker turnaround of LE results, those changes concentrate on the smaller face amounts rather than the more prominent large face amounts target of the life settlement market five years ago. The broader life insurance industry is seeing new start-ups and larger reinsurers dive into the deep end on less evasive, more insightful underwriting that leverages technology and science advances. The question is not if but when the life settlement industry will diminish the need for medical underwriting in its current form. It is unknown how the corporate combination of ITM TwentyFirst and Fasano will impact their different processes and methodologies over the next few years.
FW: How has the role of the investment manager developed in recent years? What strategies are they employing to achieve higher yields and maximise return on investment (ROI)?
Zass: The buy low, sell high approach is not the typical approach for improving returns in this space. It is more like expect long, realise short, as in LE. Until the life settlement market changes how it transacts, the reliance on LE underwriters as the bid-ask basis means you need to identify areas in which, frankly, the LE underwriters have understated the level of inherent extra mortality. Is that by diagnosis codes or ICD-10 codes or some other identifier that showed an unexpected and unknowing bias in the underwriting? Simply put, you are trying to identify where the LE profile from the underwriter assumes a shorter lifespan than what is likely to be the case. While different companies have different views on how to accomplish this analysis, it really boils down to the need for historical data, coupled with strong predictive algorithms and professionals with disease management expertise.
“The continuation of some open class action cases could impact the life settlement space. The moral is to diversify your holdings – a tried and true form of risk management.”
FW: Have you seen any new investment vehicles come onto the market, with a shift in strategy or focus for example? If so, what benefits do they seek to offer?
Zass: We continue to see the fund option as being the most common vehicle to invest in this space. There are a couple of publicly listed entities that have life settlements as a focus. There are some groups working on coming to market with the holy grail of a fixed income security, whether in the form of asset-backed securities or a plain vanilla bond with the collateral being mostly life settlements. For large institutional investors, you can expect some to look to more sophisticated options, like swaps. Maybe in a few more years you will see the reintroduction of a formal life settlement index.
FW: What advice would you give to investors on performing due diligence? What areas of life settlements do you feel require the most scrutiny?
Zass: There are two areas of diligence – the legal aspects and the other areas, most of which we call actuarial-themed types. There are plenty of very good law firms that have checklists and can provide full advisory support on the diligence. It is important to determine any ownership and beneficiary issues up front rather than waiting for them to surface at the time of policy maturity. A diligence checklist serves as a set of points to consider, yet the critical step is to simply gather as much information as possible. Besides the typical know your customer (KYC) approach, there are some additional items we believe are critical to diligence. First, the policy application with the insurer. Second, the policy form and any attached rider forms. Third, the policy illustrations, with cautionary points that include whether they are back to issue or just recent illustrations, whether they are from the carrier or an agent with illustration software, whether the software is updated for current carrier credited rates and whether they run to maturity at stated premium. Moreover, there is a need to have recent and complete policy annual statement reports, premium payment history detailing amounts and dates paid, medical records and LE reports, which list who provided them and how old the reports are. They should be complete, as should all past reports.
FW: What steps should be taken to ensure that portfolio valuation is consistent for all investors?
Zass: This is truly a vexing problem as we see variation in the discount rates used on portfolios, adjustments to mortality tables, as well as some differences in how LE is interpreted. While we are unlikely to see consistent portfolio valuation anytime soon, the best solution would be a standard valuation method and a set of standard assumptions that every fund uses to produce results and send to a third-party aggregator, who could then publish the industry results as a means of providing some form of measuring stick. This would require use of a standard base discount rate and a small set of discount rate adjustments that measure certain aspects of policy risk. The results could be segmented into a matrix format with age versus level of impairment rating. What this does is produce a life settlement version of a Kelly Blue Book used for buying and selling cars and trucks.
FW: Could you outline any legal and regulatory developments that have impacted life settlement funds in recent times?
Zass: The only key development is from early 2020: the ‘Senior Health Planning Account Act’, which is bipartisan legislation to help millions of seniors generate billions of dollars for their healthcare needs through the sale of their life insurance policies by permitting them to use the proceeds, tax-free, to pay for their healthcare costs. This serves to create a conduit for more supply, albeit the policy sizes will almost certainly be smaller in face amount. In 2018, there was almost 8 million policies, with an aggregate face amount of almost $600bn lapsed policies. On the legal action side, with the insurance sector continuing to feel the impact of a low interest rate investment environment, and thus pressure on meeting shareholder return targets, the cost-of-insurance (COI) lawsuits should continue against those carriers with perceived inadequate support or rights to change the COI rates per the contract terms. These cases add uncertainty since a big driver of a valuation is the estimate of future premiums to be paid to the carrier.
FW: What is the outlook for life settlement funds through 2021 and beyond? What activity do you expect to see?
Zass: We expect to see some negative impacts during 2021 on funds with any concentrations of policies from the old Phoenix Mutual/PHL. The moratorium is expiring and Nassau Re has announced cost-of-insurance (COI) increases. The continuation of some open class action cases could impact the life settlement space. The moral is to diversify your holdings – a tried and true form of risk management. For those with smaller face amount holdings, and a greater probability of COVID-19 effects, it is not unreasonable to assume that some unexpected maturities due to the pandemic are simply a form of an acceleration of death, thus we might expect some slowing down of maturities in 2021-22, all things being equal. The underwriting route will continue to expand and move beyond the traditional medical underwriting approach to other methods that leverage technology and science expansion to ancestry profiles to DNA and genetics. As such, we continue to be very bullish about investing in mortality-based assets, like life settlements. Just do the diligence.
Corwin Zass is the founder and principal of Actuarial Risk Management, Ltd, a 15-plus year-old consultancy, with 125 global actuarial resources. For close to 30 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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