Life Settlements
Shop and Research to Get Best Deals for Clients
Senior Life Settlements Are Still Viable and Profitable
by Mark B. Leeds

Reports are somewhat exaggerated that the credit crunch is drying up life settlements as a viable source of cash for seniors. More selective shopping among fewer provider firms has lead to the best deals for individual insured persons. Settlements still offer a recession-proof alternative given the crises in other sectors of finance and the losses in consumers’ nest eggs. With representative $1-million (face) policies being settled, the broker’s 1% to 2% of face commission is attractive.
To be sure, there have been problems that have affected some institutional funding sectors resulting in a number of settlements being reduced, delayed, or cancelled. However, the concern over increased life expectancy rates, which would lower payments to selling insured persons, has been overblown. Overall growth in annual settlement volume continues to increase. However, 2008 estimates passed the $12 billion of 2007 and the trend is expected to continue in 2009.

Michael Lebowitz, president and CEO of InVescor, Ltd. reports that back office and brokerage services for settlement providers has risen and applications increased 25% last year.

Many providers (who arrange the settlements and secure the funding) are not being as generous with their offers. The majority of those firms, which rely on bank loans or funding from major institutional sources, continue to feel the crunch.

But some providers do not rely on bank loans or major institutions and their settlement transactions are sailing through pretty much as usual or have decreased marginally.

There are very few publicly owned companies in the settlement quarter, but there are some providers are sufficiently financed to close transactions smoothly and quickly. So it is incumbent on the broker to try and determine the liquidity of a prospective settlement firm before going further with the deal.
Seniors’ representatives just need to shop around for deals, which would make sense even if there were no credit crunch. Failure to do so is likely to lead to shrinking offers, cancellations, and delays. Hundreds of deals were cancelled or renegotiated downwards during most of 2008 and the problem has not abated in all quarters. Providers made good using their own funds in a few instances in which the funding sources backed away from virtually “done deals.”
 
Put Up Or….
 
There has been talk of asking funds to put money, up front, in escrows so there would be an incentive not to abandon deals. Many state regulators followed this model and require the purchaser to place the funds in an independent escrow account several days before closing. Retirees should be sure that this is in place before going forward with a settlement. Similarly, providers seeking institutional funding should also make sure the money is in place.

 J. Mark Goode, chief executive of The Peninsula Group, Washington, D.C. has advised providers to try to verify whether there is cash in the purchase account of the funding sources they are using.
Historically, life settlements have been considered non-correlated with the overall economy and recession-proof. However, the sub-prime and credit crises have hit funding institutions hard. A number of providers that relied strictly on major institutional funding have been caught off guard and are ill prepared for the consequences.

Cynthia Poveda, executive vice president of broker Life Settlements Insights in Cleveland says that at least 10% of the -offer amount go into escrow once the seller signs a contract. She also thinks breakup fees could be included in deal terms to discourage funding institutions from over committing their money. She explains, “The life settlement market has transitioned from a seller’s (seniors) market to a buyers market in a very short period of time. But this does not mean a settlement is not a viable option for certain clients considering the surrender or lapse of a life insurance policy.”

A Mortal Blow or Not?

When a life insurance policy is offered for sale to a settlement provider, life expectancy estimates are used to project the length of time the insured person is expected to live. That figure is used to project how much must be paid out in premiums before the policy matures (when the originally insured dies). At which time, the new owners/investors start to receive a payout. Industry estimates of the annual investment return have ranged from just under 10% to over 20%, with 12% to 15% as typical.

That probably accounts for the success of the life settlement industry, which has enjoyed substantial growth since the mid-1990s. The underwriter’s life expectancy estimate is based on the insured’s medical records, which determines how a policy should be priced, i.e., the settlement offer.

The selling senior gets a lump sum of cash (a multiple of the policy’s surrender value); the provider and intermediaries earn handsome fees; and the investors do well, earning larger returns than from most other forms of investment. The only loser in the transaction is the insurance company, which is compelled to pay out the full death benefit. The insurance company would prefer to have the policy lapse or be surrendered for a token amount.

Last September, amid the worsening credit crunch, 21st Services, a leading life expectancy underwriter in Minneapolis, announced changes to its mortality tables based on actuarial consultants and other sources. Its ratings climbed 15% to 30% or more and threw the settlement industry into turmoil. At one extreme, what was once a 9-year remaining life expectancy was upgraded to 12 years. In general, settlement transactions have been limited to seniors with life expectancies of 12 years or less.

Percentage-wise, returns to investors could be chopped. Deals in process would be revised with the offers to insured persons lowered considerably, delayed, or cancelled outright. Future transactions would also be attenuated because the incentives to transact a settlement have been reduced considerably with the looming lower internal investment return rates. The result is a smaller lump sum offer, which means less money for the client and a lower comp for the broker.
Securitized settlement portfolios have been downgraded. On top of the credit crunch’s toxic effect on institutional funding capabilities, this is a double-whammy across the spectrum, from the individual insured to the institution that faces a downgraded portfolio.

However, the industry has long regarded 21st Services as the source for the shortest life expectancy reports; some observers have said they were unrealistic. In the interim, some competitors have increased their mortality ratings by about half the 21st Services’ figures. Rival AVS of Kennesaw, GA., decided to lengthen its tables by only a few months, not years.

ISC Services, Clearwater, Fla., lengthened its life expectancies by about 4%, said its president, Morris Fishman. Fishman explains that there is a 1% decrease in the rate of return for every 12 months’ increase in life expectancy.

Fasano Associates in Washington, D.C. is an actuarial firm of a different feather. President Michael Fasano says his company has been one of the underwriters with the longest life expectancies and that no changes are planned. “The changes announced by other competitors “will put most of us in the same ballpark and our firm will enjoy the virtue of consistency,” he said, broader studies of mortality rates raise questions about the new actuarial estimates. Over the four decades since 1961, life expectancy increased from 67 to 74 for men and 74 to 80 for women, according to a recent Harvard study. Respectively, those gains were approximately 10% and 8%, over a 40-year period. It is true that the wealthy have higher life expectancies than do the poor and that reductions in smoking and obesity and greater access to healthcare further extend life.

Fasano is critical of the Valuation Basic Table, which The Society of Actuaries publishes to help insurers price their policies. He says that it is based on healthy people. But, the life settlement industry also includes people with health- and other problems.

Dr. Robert Shavelle of the Life Expectancy Project in San Francisco says, “Frankly, survival time cannot be predicted, even within five-year prediction intervals.” The Project is an actuarial organization that studies individuals with personal injury scenarios and medical conditions. Dr. Shavelle explained that probability of survival figures is based on averages and comparisons made with a larger group of similar populations. Another expert, Dr. Emmanuel Modu, associated with A.M. Best flatly stated, “You really can’t predict how long people are going to live.”

Fasano believes in a flight to quality in uncertain times. Premium finance deals will suffer as policyholders can no longer get short life expectancy estimates to justify higher prices in the secondary (settlement) market. Fasano says that this arbitrage will no longer be available when life expectancy estimates converge as life expectancy underwriters that had the shorter estimates come out with longer estimates.

As for the escrow issue, LPI’s Pardo says, “Obviously, anyone who resists escrowing purchase funds must have problems obtaining purchase money or, perhaps, intends to try and get ownership without paying for the policy at the time of title transfer. In our view, there can be no legitimate reason to object to escrowed transactions.”

Poveda of Life Settlement Insights says, “Uncertainty has lead many investor groups, but not all, to step back from the market to re-evaluate current portfolio holdings and to review the underlying investment assumptions.” She advises the buyers that remain active to be more selective in their purchases.

Optimists say new sources will provide an influx of capital in 2009. In the interim, providers are more likely to extend short offer response periods or withdraw an offer not accepted in a timely fashion. The messages are clear: shop; verify the funding; and be decisive about offers.

Why Bother Borrowing?

In their determination to stifle growth in life settlements, insurance carriers have offered alternatives to seniors. One option is the accelerated death benefit, which is tailored to the terminally ill virtually exclusively. However, the criteria are strict and complex and there are tax liabilities. Most important of all, the accelerated death benefit is not available to healthy seniors.

Another tack insurers offer to seniors is borrowing based on the policy’s cash value.
But, such loans require repayment of principal and interest and they result in decreasing the death benefit. Moreover, term insurance policies, which are generally eligible for life settlements, lack cash value, which precludes the borrowing option. Accordingly, the settlement is the better choice in the great majority of cases.
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Mark B. Leeds, MBA and MBD, writes about business, financial, investment, political and environmental topics. The author of “The American Presidency,” a historical treatment of the modern Chief Executives, he also appears on the Families in Transition cable television program. Formerly an editor of a management-planning newsletter, Leeds is based in New York City.