Life settlements: Investing in mortality

By Scot Blythe | June 25, 2010 | Last updated on June 25, 2010
3 min read

There’s a relatively new product out there for pension plans and high net worth investors seeking stable returns with relatively low volatility. But it comes with a hitch—it’s about cashing in on death.

In the U.S., at least, there is a growing industry in life settlements. Older policyholders may decide that, after years of paying into a life policy, they’d like to take some of the benefits now instead of when they’re dead. But life companies often give pennies on the dollar when a policy is surrendered. The alternative, particularly for an expensive policy, is to let it lapse.

With a life settlement, an investor agrees to maintain the premiums while also offering policyholders a fair bit more than they would get from a life insurance company—roughly three times the cash surrender value.

There are some who find the whole enterprise somewhat unsavoury. But, according to Avery Michaelson, an associate in capital markets with Coventry Capital, “it’s a pro-consumer transaction. It’s a way for seniors to achieve value for an asset that they have.”

Speaking at the IMN Canada Cup of Investment Management in Toronto this month, Michaelson explained that for investors, “longevity-linked” assets have a number of advantages. They are uncorrelated with capital markets since they are a play on longevity risk—whether policyholders live longer than expected—and mortality risk—whether individuals have shorted lives than expected.

Dirty little secret Life insurance companies use actuarial tables to price both risks. Plus, they are aided in the fact that the majority of life policies never pay out on their death benefits because the policies have lapsed or been surrendered.

“Life insurance has a dirty little secret that I don’t think it would like many people to know. But 88% of universal life insurance policies never pay a death benefit,” he said. “That creates an incredible amount of value for those life insurance companies.”

He suggests that life insurance companies are charging less than the actuarially necessary premiums. Media reports, however, suggest that as life settlements take hold, life insurers will have to increase their premiums.

Yet, that fact also requires special underwriting for life-settlement funds. It is not enough to rely on insurers’ mortality tables said Vince Granieri, CFO and chief actuary at 21st Services. Life settlement populations have different characteristics than the population as a whole. In addition, insurance companies determine risk at the time of underwriting. “They don’t have the ability, five years later, when this person acquires a cancer or has a heart attack to then say, ‘oh, I’m going to charge you higher premiums now,’ ” he said.

According to Michaelson, Coventry has that ability. “We underwrite at the time of purchase and that’s typically five to 10 years after that policy was issued.” That allows the life-settlement fund to “pick out policies that have a lot of value in them.”

Diversified assets Michaelson suggests a 10%-13% income stream can be achieved with low volatility from a diversified life-settlement fund—one with at least 300 insured lives. “You need a mix of different age ranges and life expectancies. You don’t want any one insurance carrier to dominate the portfolio.”

But a fund should also be diversified by potential mortality factors. “You wouldn’t want all of your lives to have one particular type of cancer or a particular type of heart impairment.”


Scot Blythe