A.M. Best late last month issued a revised rating methodology to be used in the securitization of a life settlement portfolio, placing more of an emphasis on what the agency sees as the increasingly critical issue of life expectancy estimates and medical underwriting.
The newly revised methodology, according to Emmanuel Modu, managing director and global head of structured finance, places the emphasis on what Best sees as the largest potential trouble spot for life settlement portfolios: the life expectancy estimates on which buyers decide to price their offers.
The concern, he said, is that there is still a significant variance between the estimates provided by different medical evaluation firms and that those differences could lead to “examiner shopping” among firms looking to enhance their portfolio.
The potential for expectancy shopping could be an “Achilles heel” for the life settlements market, Modu said, adding that the new methodology “limits the kind of gaming that goes on in the industry.”
Effectively, he said, Best’s new methodology puts a “floor” to life expectancy. On average, he said, a pool of 100 lives would have a life expectancy of about 10 years. “I don’t think you could find enough impaired people to reduce that number below 8,” he said.
In the methodology itself, Best explains why it would be difficult to find enough policies to create a lower life expectancy.
The agency had a research showing that in a “typical distribution” of life expectancies for individuals 65 years of age or older, less than 20% will have a life expectancy of 8 years or less.
The research, Best noted, “is important because it shows that the highly coveted low life expectancies sought by some investors in life settlements just are not plentiful.”
To further illustrate the point, Best also looked at the issue on an individual level. A 75-year-old nonsmoking male, the agency said, would typically have a life expectancy of 14 years based on a 100% mortality rating.
“The mortality ratings generally issued by medical examiners for the impaired lives of this age, sex and smoking status normally would range from 300% down to 150%, which translates to life expectancies between approximately 8.7 years and 11.8 years,” Best noted. “To achieve a life expectancy of about 7 years or less for this type of individual, the mortality rating would need to be about 460% or more–rare mortality ratings for individuals with the profile under consideration.”