Life Settlements Require A Complete Underwriting Workup
The concept of a life settlement is receiving more notice in the life insurance industry. Some major insurers are even providing financial support to companies engaged in this new market. This article looks at how the settlements are underwritten and why.
Life settlement is a euphemism for the purchase of an in-force life insurance policy by a third party that has no insurable interest in the insureds life.
It is an outgrowth of the viatical businesses of the 1980s and 1990s. The viatical companies bought life policies from the terminally ill, such as AIDS patients.
Life settlements differ from viaticals in a key way: The life settlement company buys policies from insureds who may not have a significant medical condition but who are usually in their retirement years and who may benefit in several ways from the sale of a life insurance policy they no longer need.
Changes in circumstance, such as a decline in estate values, can result in the need for less estate coverage. Or, the sale of a business can negate the need for a buy/sell policy. Until life settlements were introduced, an insured faced with these situations had only two options to avoid continuing the now not needed coverage: either surrender or lapse the insurance. Now, however, they have another option–sell the policy.
This third option has appeal to older clients. Retirees, for example, may need more financial resources than allowed for in their current retirement plan. That will become an increasingly important issue, because baby boomers are within striking distance of retirement, and projections are that the age 65 and older population will increase by 76% in the next 20 years.
Life settlements also provide new opportunities and challenges for the companies that buy the policies. For example, the seller frequently will have owned the policy for 10 to 20 years before considering offering it for sale. The settlement company doesnt have access to the original underwriting and must rely on the policy itself to determine how it was issued. The settlement company also needs to determine if the insureds health has changed in the intervening years, and if so, to what degree and what effect it will have on the insureds life expectancy.
This requires the life settlement underwriter to go beyond the risk acceptance limits typically used in life insurance underwriting. In identifying an appropriate rate class, life insurance underwriters typically look to protect against premature death. But where life settlements are concerned, the underwriter looks to protect from unanticipated longevity.
The methods used to accomplish both goals are similar, but the tools are different.
In typical life underwriting, for instance, especially for large amounts of coverage, the underwriter examines results of the applicants physical exam, blood and urine samples, electrocardiograph test (and possibly a stress test, as well), and a detailed medical history verified by an attending physicians statement. This information provides a snapshot of the applicant and allows the underwriter to determine whether the applicant is within the acceptance parameters established by the company.
For a life settlement, on the other hand, the only requirement, in addition to the application, is the medical history. But this history needs to contain more than the traditional summary statement prepared by the physician. It needs to be a complete copy of the applicants medical records from the attending physician, all consulting physicians and medical facilities, including results of all laboratory and special studies. These reports, which may be hundreds of pages long, can help the underwriter develop a complete picture of the applicant.
An applicant wants to appear as healthy as possible when purchasing life insurance. In the life settlement, however, the motivation is just the opposite.
Therefore, the life settlement underwriter aims to assess the complete picture of the applicants physical condition, including treatment and results, mental attitude, functional ability today and what it may be in the future. For instance, a 75-year-old life settlement applicant who claims to have “a severe heart condition,” but who frequently travels to foreign countries or plays golf every day, probably has a good chance of being on the long side of the mortality curve.
Most life settlement companies use this or a very similar underwriting method. The difference in their results and what determines their final cash offer is the life expectancy table.
A life insurance policy is issued after a selection process and priced according to years of accumulated mortality experience. For that reason, a life settlement company should also use tables based on underwritten mortality experience and updated to reflect reported improvements in experience between table publications. The use of tables built for other reasons can result in a longer life projection and less of a payout for the insureds policy.
Using a table of shorter life expectancies may allow a higher payout to an insured, but may hurt settlement company investors when maturity expectations run longer than projected.
Those who choose a life settlement do have to undergo a quite thorough underwriting process, but the end result should make it worth their while.
is CEO of Life Projections, an underwriting consulting firm specializing in life expectancy evaluation. Retired from CNA, he is also an independent consultant to Living Benefits Financial Services, LLC, a Minnetonka, Minn., institutionally funded life settlement provider. He can be reached at email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, October 28, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.