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'Unaffiliated Policies' And The Secondary Market

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The secondary market in life settlements has suddenly become a huge reality! This has led to intense debate. Let’s try to clear up some of the mysteries.

A bit of history: Assignment and Change of Ownership clauses have always been valuable features of our policies. They have long been used for estate and tax planning purposes. Then about 1990 a surprising use of those clauses came along: viatical settlements for AIDS victims. Lessons were learned when many AIDS patients (happily for themselves) did not die. Viatical policies were typically small. But then life settlements of much larger policies came along; those were for older insureds with ailments. Now, in 2006, life settlements are packaged into securities and sold to investors, large and small. It’s a big business!

We’re talking here about “unaffiliated policies”–the original owners, beneficiaries, and insureds have deliberately relinquished rights (and have been adequately compensated). That’s what takes place in a life settlement.

The term “unaffiliated policy” clears up a lot of confusion. Ownership of such policies by strangers is O.K. because the original owners, having been adequately compensated, are actually glad that this market came along. The important previous rules about insurable interest, suitable size, etc., are seen as relating back to the original point of sale.

About the previous situation: The parties must have decided that the former reasons for the insurance no longer apply, for such reasons as retirement, close-down of business, families now grown up, etc. So the policy is a candidate to become unaffiliated. Presumably, any settlement offer considered would be higher than the current cash value of the policy.

Chart I, which speaks for itself, shows secondary market sources. I’ll comment only about item 2: life settlement of more recently issued policies. This involves large-amount, older-age business, which has become common because of increased life expectancy, longer working lives, and estate concerns. We shouldn’t interfere in its sale, but a whole host of better underwriting tools are needed for this market.

Chart II shows current concerns about the secondary market.

Insurer concerns: Attitudes vary from acceptance to outright opposition. Some say, “Maybe it’s O.K. after 5 years.” Some even say, “Maybe we should settle our own policies, or at least have a first refusal.” But the main insurer concern seems to be interference with “lapse-based pricing.” Life settlements guarantee a no-lapse situation.

Confusions and misunderstandings: In the early days, there appear to have been comical misunderstandings about the term “life expectancy” (which was usually provided by clinical people, not actuaries). A common misunderstanding seems to have been: They’re all going to be dead by the life expectancy date! By 2006, however, the market has realized that only about half die by the life expectancy date; that the spread of deaths is far more important than the life expectancy itself; and that life evaluations should be done by proper actuarial methods using accurate underlying tables and valid mortality ratios reflecting the impact of known medical impairments.

Need for better underwriting: More knowledge is needed about the effect of impairments at older ages. “Table shaving” needs to stop.

Need for better life evaluations: The scene contains many distressed blocks (where wrong life expectancies had been used). Some are in receivership. (The life expectancies were far too short). We need to get them right, not just to protect investors, but to protect our insureds.

A final word: I was impressed by an article in the Wall Street Journal of Aug. 9, 2006, by Holman W. Jenkins Jr. The article ends: “Insurers may soon begin to notice a happier ending, in which the existence of the secondary market actually makes life insurance a more attractive product”.

Maybe there will be a happier beginning, too, if our product becomes more attractive at its point of sale.

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