From the February 2011 issue of Investment Advisor • Subscribe!

February 1, 2011

Beating the Odds

The life settlement industry can bring both danger and opportunity

We’ve explored life settlements and their securitization in these pages before, covering everything from  legal issues to emotional and medical ones. But there’s another facet of this business raising its ugly head in the press these days: ethics.

While the business of life settlement securitization is most likely here to stay, there is the potential for abuse, whether it’s talking a senior citizen into taking out a life insurance policy to resell it (stranger-originated life insurance, also known as STOLI); whether an investor is paying a fair price for an investment in such a security; or whether the securitization itself is adequately regulated.

This time, however, the issue does not address itself to those who sell their life insurance policies (also known as “settlors” in life settlement securitization terminology), but instead to the firms that collect and securitize them for resale to investors—or, rather, one firm: Life Partners Holdings Inc. The Wall Street Journal, on Dec. 21, ran a piece that questioned the validity of the estimates obtained by Life Partners of settlors’ life expectancy that the company used when valuing the securitized policies it sold.

The questions, basically, are three: whether the company is using the best method of obtaining life expectancy estimates; whether risk disclosure and claims of returns to its investors are adequate and reasonable; and whether investors are paying more than reasonable costs for their investments.

Underestimating Expectancy
It seems that, according to a WSJ investigation, the company has made a habit of underestimating how long its securitized settlors would live. The authors of the article pointed out that independent life-expectancy firms within the industry gave higher estimates of life expectancies to settlors, including some specific ones from Life Partners’ securities. The article also explained that if a settlor survived long enough past the estimated life expectancy date, investors might not just be left hanging for a return on their investments, they would also have to kick in to pay additional premiums to keep the policies in which they’d invested in force. When they invest in these policies, the money they pay to Life Partners is partly for fees, partly in escrow to cover possible additional premiums, and, of course, partly for the purchase price of the policy itself. If the escrow funds are exhausted because a settlor has outlived the estimate upon which the escrow was based, investors have to pay more, thus reducing their return, or run the risk of the policy’s cancellation.

Brian Pardoe, the firm’s founder and CEO, denied in the article that life expectancies were routinely underestimated so that the firm could charge more for investing in those policies (the shorter the life expectancy, the more desirable—and expensive—the investment); he also said the Journal’s sample of policies on which its evaluation was based was too small.

The WSJ piece was followed by a letter of response by Life Partners to its investors, in which it again denied the allegations made in the article. A New York Times blog piece by Floyd Norris that roundly criticized the reliance of Life Partners upon one doctor instead of on independent life-expectancy firms. The doctor used by the company said in a deposition two years ago that Life Partners sends him 100–200 cases for review each week. At the time of the deposition, he worked three days a week for the company, which translated to 33 to 66 evaluations each working day. At one of the outside firms, Fasano Associates, President Michael Fasano said that for his company, doctors reviewed six cases per day, explaining that they were “complex medical histories of older people.”

Industry Performance
Life Partners, a pioneer in the life settlement market, saw some volatility in its stock price in 2010 (it closed on Dec. 31 at $19.13 per share, with its 52-week high at $24.50 and its 52-week low at $14.69). It declared a five-for-four stock split on Dec. 2 that was to be paid as a dividend on Dec. 31 to shareholders of record as of Dec. 21. And the industry itself is on the rise; the Amrita Life Settlement Index, which tracks buying activity among licensed life settlement providers, reported that from October to November of 2010 the index rose 4.8%, from 706.3 points to 739.6 points. In December of 2009, the index stood at about 500 points.

While the final verdict on Life Partners and, indeed, the industry, is still to be arrived at, advisors would do well to be on their guard about such investments on behalf of their clients, regardless of which end of the transaction they are interested in.    

Marlene Y. Satter can be reached at msatter@sbmedia.com.

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