Reinsurers need to better manage risk to reflect the growth of the life settlement market, according to life reinsurance experts, who say part of this process entails helping direct writers manage new risks that surface as the life settlement industry evolves.

Life settlements “have grown exponentially in recent years, and that trend appears likely to continue,” according to an NASD Notice (06-38) released in August 2006. The notice cites a recent study that estimates policies settled in 2005 had a collective face value of $5.5 billion and others that say the “potential market exceeds $100 billion.”

Additionally, a May 2006 COSSNewsline article by Chris Kite, an insurance attorney, cites remarks made during an industry meeting by Brian Casey, a partner in Lord Bissell & Brooks’ Atlanta office, as placing the market in 2005 at between $5 billion and $9 billion in face amount, with estimates rising as high as $14 billion in 2006.

Risk management using a best practices approach may be the best way for reinsurers to prepare for the growth in the life settlements market, say executives at Transamerica Reinsurance, Charlotte, N.C.

During their conversation with National Underwriter on how life settlements will impact reinsurers, Jim McArdle, senior vice president, sales and marketing; and Ken Conners, vice president, chief underwriting officer, both with Transamerica Reinsurance, were careful to make 2 points. The first point is “there are certain legitimate and very good uses of premium financing,” but non-recourse premium financing is a cause of concern for reinsurers. The second point is that “a life settlement of and by itself is not necessarily an evil thing,” but you have to identify the abuses.

They both differentiate between those products that are originated with the intent to sell the policy and those products that are held for a period of time and are sold because the needs of the insured legitimately change.

The interests of both direct writers and reinsurers are aligned in identifying and managing those abuses, says McArdle. “The first defense is to know what is going on.” Detection and then prevention are important steps in the process, he adds.

Conners agrees, saying it is important that direct writers be attentive to whether policies are likely to be sold again shortly after purchase, and best practices established by a reinsurer can help a direct writer “if not discourage such contracts, at least identify them.”

Originators of non-recourse contracts are quick to sense direct writers who are not able to detect these contracts, says McArdle.

To the extent that direct writers are not able to work toward best practices to detect potential abuses, McArdle said it could conceivably be factored in to the price of those direct writers’ reinsurance contracts. To the extent that is negative, those contracts would be negatively impacted, he adds.

Reinsurers can also treat contracts that could involve premium financing on a facultative or case-by-case basis so that the reinsurers can be part of the decision-making process, says McArdle. It is the non-recourse premium financing that is “really the red flag,” Conners adds.

McArdle maintains that “insurance companies themselves need to be more flexible and offer more liquidity than they currently do through cash value.”

When asked if reinsurers could offer consultative services to help direct writers achieve this goal, he responds that they could provide advice on analytics and on product design, but changes in the regulatory and accounting practices need to be put in place in order to make this possible.

David Mendelsohn, a partner with DLA Piper U.S. LLP in Chicago, says that if growth projections turn out to be true, then the advent of the life settlement industry could affect reinsurers in 3 ways: as a risk awareness issue; at some point in the future as a reporting issue; and conceivably, a financial issue.

Mendelsohn says life reinsurers have to educate themselves on the life settlement market and make it a point to know life settlements and premium financing better than they now do. That education has to be continuous because “those are the types of transactions that are evolving.”

General concerns for reinsurers as this market develops, Mendelsohn continues, include whether there is a violation of laws, including laws on rebating and insurable interest.

Reinsurers will also need to look at whether there are components of business that they did not consider when pricing reinsurance, he says. Life reinsurers can write new business on a facultative basis, and life insurers can look at the issue of life settlements internally as a function of underwriting, Mendelsohn adds.

Better monitoring of these contracts for the potential for settlement is needed because actuarial assumptions could be impacted, he continues.

However, currently, it is a “wait and see period” as the industry tries to determine if the life settlement industry really takes off and how it does that, Mendelsohn says. How the market evolves may determine whether treaties are reached that include contracts that could settle or whether such contracts are reinsured separately using different assumptions, he adds.

At this point it is too early to say how the life settlement business could impact reinsurers, according to analysts with Moody’s Investors Service, New York.

“It is not obvious how tremendous an impact it will have on life reinsurers,” says Arthur Fliegelman, Moody’s vice president and senior credit officer.

“It is certainly not a positive, but we are monitoring it just like the industry is…we are not ready to assign a particular impact to it,” notes Laura Bazer, a Moody’s vice president and senior credit officer.