As the secondary market for life insurance policies continues to grow, life settlement providers have begun taking steps towards bringing smaller face value policies into the fold.
Traditionally, providers have looked for higher end policies to bring in higher returns for their investors and also because small value policies were seen as not being worth the effort.
“In the past it was very difficult,” said Michael Quinn, executive vice president of Baltimore-based Cielo Life Settlements, for the “very simple reason” of the costs of conducting a transaction. “Across the board, everyone had the same problem–creating a less costly process,” he said. Settlements of smaller value policies “were just absolutely out of reach for anyone to remotely get involved.”
The problem, according to Cantor Life Markets President and CEO Stuart Hersch is that while the settlement of a smaller value policy will not bring as big a return, it can cost just as much for the provider to make the transaction.
The key question, he said, is, “Are the economics there to make it attractive?” The process of settling a policy, be it small face or multi-million dollar, is essentially the same, involving the same amount of paperwork, evaluation and due diligence, Hersch noted. These factors also don’t take into account the fees being collected by a broker and a life agent or advisor. With a small value policy, “the minimum fee could be a significant amount of the settlement offer.”
Craig Seitel, CEO of Abacus Settlements, LLC in New York, said there are actually two small value markets: the “ultra-small” policies with face values of $100,000 or less and those above that threshold but below the traditional $500,000 floor that the secondary market operates on.
It is that second segment of the smaller market, he said, that is most affected by the economics of the transaction.
“It takes the same time, effort and expense to close a small transaction as a larger one,” he said. “Many large institutional investors will not pursue life settlements in that category because of expense and capacity issues.”
However, the lower demand for those policies has led to a greater profit potential for the funders willing to pursue such policies, and Seitel speculated that the markets “will ultimately equalize.” That leveling, he said, will likely be driven by advances within the industry to make the transaction process more efficient, as for example, through standardized paperwork. This market is also one where Seitel believes there is “still a very significant lack of awareness about life settlements.” And one, he believes, could expand dramatically as the 78 million baby boomers reach their senior years.
The “ultra-small” market, Seitel said, remains “largely untapped.” This is the arena in which Cielo operates.
Cielo’s founders, according to Quinn, were able to devise a system that would “drastically reduce the costs of these transactions” allowing for smaller policies to settle with a focus on keeping the process simple and efficient. “No quality was lost,” he said, “What was lost was a lot of excessive cost and time.”
Quinn said Cielo’s process “shrinks the paperwork that the agent or advisor is subjected to” and involves filling out an application form and providing an illustration of the policy.
Once an application is submitted, Quinn said that within about a week the policyholder will receive any offers made by Cielo’s institutional funders. The policyholder will receive all offers made, which he said “speaks to the fiduciary responsibility,” but those offers are made on a “best offer first” basis and not open to negotiation.
“The decision to come back with best offer first was driven by the rigorous enforcement of the simplicity rule,” he said regarding Cielo’s desire to keep the process a simple as possible.
Seitel said the business model for companies in the “ultra-small” market generally involves pricing policies based on actuarial mortality tables.
“The concept is if the insured says yes, and they are an ‘ultra-senior’ as defined as being 70-plus, the provider will develop a price based on actuarial mortality.” The “key” to this model, he said, is that a senior with a medical impairment is not going to live as long as the actuarial tables would suggest, and the process allows for a quick pricing of the policy. The challenge, according to Seitel, “is that it’s a volume business” and there are still expenses that have to be paid as with any settlement.
“There’s still a lot of paperwork that needs to be signed and notarized,” he said. “They have to figure out a way to keep costs down.”
The challenges of settling smaller value policies are not limited to the area of economics, however. Some of the concerns have to do with the policyholders themselves, who are likely not as financially savvy as a wealthy individual selling a million dollar policy.
“They’re generally less sophisticated,” and don’t have access to the same quality of legal advice, which Hersch noted equates to a “greater potential for abuse.”
Hersch said Cantor will be “testing” the concept, trading some policies with lower value, and that the company has been in contact with regulators to ensure that everything is done to their approval. “This is not a simple area with a simple solution. If you do it wrong there could very negative repercussions.”
Seitel also spoke of the dangers of working with “ultra-small” policyholders, noting that such transactions could draw more regulatory scrutiny as those policyholders “often times are not represented by a financial professional.”
However, Quinn said that many of the problems associated with the secondary market, such as stranger- or investor- originated life insurance, or the use of trusts to foster an immediate sale of a policy, are nowhere near as prevalent when the discussion revolves around smaller policies.
“We don’t see a lot of trust-owned policies,” he said referring to one aspect that has begun to draw regulatory attention. Schemes such as STOLI, IOLI or trust-owned policies “are basically non-existent in the small market.”
Many of these problems, he said, particularly STOLI, are not as significant in the smaller value realm due to the same economics that have made them so difficult for the secondary market. However, Quinn said Cielo is not unaware of the issues and their potential implications, and as a result the firm tries to steer clear of any policies that may have problems or were purchased under questionable pretenses.
With many of such policies having been purchased in the past few years, “we are interested in working on cases that have been in force for a while,” he said, adding that Cielo is “not interested in anything ‘new’ or ‘newish.’”
Despite the current concerns, Hersch said the secondary market “is something that we ought to make available to these policyholders,” noting that lower value policies have a higher lapse rate than more valuable policies.
Quinn echoed that sentiment, and noted that seeking out smaller policies will ultimately be good for the market as well as the percentage of policies that would be considered “small” make up 80% of the life insurance in force. “You’ve got an industry that’s huge, and getting larger by the month, focused on a small percentage of the policies that are out there,” he said.