Securitization Of Life Settlements: A Pivotal Phase In The Product Life Cycle
Few of us would have predicted several years ago that the increased interest from both foreign and domestic institutional funders in the life settlement marketplace would help to redefine the industry and bolster its credibility within the financial services arena.
Although life settlements evolved from the viatical settlement market in the 1980s, which was dominated by individual investors who purchased policies from terminally ill AIDS patients, the industry has undergone a metamorphosis resulting in a shift in the products demographic focus.
With this shift in focus from terminally ill insureds to high-net-worth seniors generally over age 70 seeking an exit strategy from unwanted policies, the industry entered a new era of sophistication and a new stage of the product life cycle that brought greater credibility and a clearly defined value proposition for all players in the life settlement supply chain.
In spite of the structural complexities in securitizing life settlements, it is a growing asset class that has captured the interest of investors from around the worldparticularly in the last two years, investors from Germany. Clearly, we are seeing an increasing number of parties interested in entering the industry, whether as originators, brokers or funders.
According to the Viatical & Life Settlement Association of America, the number of industry players has doubled over the past five yearsa good sign for this asset class that will help the segment grow.
Although money managers consider a portfolio of life settlements a great asset class because it diversifies investment, the classification of life settlement transactions has been difficult, as they contain elements of a loan, a sale, an equity investment and securitization. Life settlement transactions do not fall into any single category, as various structures are available for these deals.
One of the interesting but also most challenging aspects of life settlement transactions is that they require intensive structuring, particularly with respect to tax considerations. While favorable yields attract investors to participate in life settlement transactions, tax considerations drive the structures. In fact, special tax advantages afforded to German investment funds under the U.S.-German Taxation Treaty have helped drive the influx of significant amounts of German capital into the marketplace.
Similar to other types of corporate deals, a tax-efficient structure is a central goal. Any inefficiency in the tax aspects of the transactions has a rippling effect on the entire outcome, as the tax liabilities reduce the yield, often forcing the investor to underbid for policies (risking losing such policies), in an effort to maintain certain levels of return on investment.
Many of the transactions completed to date have involved investment funds located outside of the United States. Since the life settlements and the payments they produce originate in the U.S., a tax-efficient structure will permit such payments to reach the fund, and ultimately the investors in the fund, in a tax-efficient manner. The extent to which tax consequences can be minimized will, in most cases, depend on whether a tax treaty is in effect between the U.S. and the country of which the investors in the fund are tax residents, and the specific provisions of the tax treaty.