It turns out that Charles Darwin’s The Origin of Species sets forth a theory of evolution that applies not only to the plant and animal kingdoms, but to the life settlement business, as well. While plants and animals evolve in response to changes in the environment, the life settlements industry is evolving in response to a number of secular trends, as well as economic catalysts.
Through this transformation, the life settlements business is moving away from niche market status to becoming a mainstream financial alternative with the big winners being owners of life insurance policies, and the agents and brokers who serve them.
Trends fomenting evolution
Some of the trends that are exerting influence on the life settlements business range from the obvious to the not so obvious. The most obvious trend–consumers need alternatives–bears repeating. The disappearance of defined benefit plans, whose values are insulated from the volatility of the markets, the softening promise of Social Security and longer post-retirement life expectancies, are conspiring to create the need for tools, techniques, strategies, liquidity–call it whatever you will–that enable seniors to fund a long retirement.
This very notion leads to another long-term trend, though one not so obvious as consumer needs. That is, the life settlements industry will become increasingly important to the life insurance industry. Heresy, perhaps, but the emergence of the former has challenged the latter to re-think historic views of life insurance. Some life companies are responding by adding new riders and liquidity options to make policies more valuable. Others are looking further down the road at new product designs to extend the useful life of an insurance policy.
More importantly, the growth of the life settlements industry will continue to push the envelope by challenging traditional life insurance views regarding older-age underwriting and mortality experience. The importance of this cannot be underestimated. Specifically, the high lapse rate on life insurance policies has left the life insurance industry without a clear understanding of the efficacy of its underwriting. While this is not material, per se, when the strategic focus of the industry was on high net worth individuals, it is quite material in an environment when the mantra of most insurance companies is to sell more life products and services to seniors.
The older age underwriting techniques and tools developed in the life settlements industry, as well as the capital markets tools developed for life settlement providers–such as Goldman Sachs’ QxX, which can help manage exposure to longevity and mortality risks–are in fact the very same tools that the life industry will use to execute on its strategy of selling more life product to seniors. In this regard, the life settlements industry is blazing a path for the next generation of life insurance products.
The third major trend driving evolution is regulation. As it stands today, regulation falls in to two schools of thought, with each endpoint epitomized by two states. On one end of the spectrum is West Virginia, which with the passage of SB 704 on February 29 of this year, performed surgery with a spoon, and as a result, potentially hurt West Virginia consumers by criminalizing certain life settlement transactions. On the other end of the spectrum is Kentucky, where the House of Representatives passed HB 348 which focused on the insurable interest concept, but without impairing property rights or prohibiting legitimate life settlement transactions.
But all is not lost. The NAIC model life settlements act proposed in June 2007, which was followed by a model life settlements act from NCOIL, created the conditions for a real public policy debate. This debate will ultimately deliver the fair, equitable and nuanced regulation that, when consistently applied, will expand the size of the life settlement market through the affirmation of the property rights of consumers and principles of transparence. While we are not there yet, life settlements are on the long path toward regulatory rationalization.
While long-term trends drive the evolution and convergence of the life settlement and life insurance industries, cyclical catalysts–such as the current turmoil in the capital markets–are exerting their influence on the process, both positively and negatively.