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Pros And Cons Of New "Synthetic" Life Settlements Assessed

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A new wrinkle on traditional life settlement contracts, so-called “synthetic” life settlements, is starting to surface.

Synthetic life settlements, in which investors can trade mortality risk without actually purchasing products, offer similar benefits for investors with fewer transactional burdens. They are creating opportunities, and, for some, concerns.

Alexi Poretz, an attorney in the New York office of the firm Sidley Austin, LLP specializing in insurance and finance, says that synthetic life settlements can take many different forms depending on the parties involved and their needs. “You’ll continue to see all sorts of variations,” he says. Generally, however, the principle behind such deals is the same: 2 or more counter-parties enter into an arrangement based on a pool of actual lives or data that mimics actual lives.

In many cases, he says, the transaction actually more closely resembles the sale of life insurance, with one party providing the other a steady stream of payments until a previously agreed upon “triggering event,” which could be something as simple as a set date, at which time the other party provides a payment based on how the pool has performed.

One example of a synthetic settlement structure is the QxX index maintained by Goldman Sachs, New York. Michael DuVally, a spokesman for Goldman Sachs, said the index is comprised of almost 50,000 actual lives.

“Investors gain exposure through swaps” of risk, he says. In entering a swap, Mr. DuVally says an investor, which would be a large institutional investor, can “sell protection” in which they would benefit from lower than expected mortality, or buy protection that benefits from greater than expected mortality.

Mr. Poretz notes that it is possible, in some transactions, for 1 of the parties to own some of the policies in a given pool and that a synthetic life settlement could be used by some institutional investors as a hedging tool for the mortality risk they’ve acquired through more “traditional” life settlements.

Using an index such as QxX provides significant advantages aside from a hedging capability, Mr. Duvally says. One such advantage is that “there’s a limited supply and access” to the pool, and that Goldman Sachs ensures that the information used in the pool is accurate and kept up to date, he adds. In addition, he says that the index allows for a more standardized version of a mortality risk swap, with less labor than a more traditional life settlement.

At the heart of a synthetic life settlement, Mr. Poretz says, is the information underlying the pool of lives. “The key is having access to the data,” such as life expectancy reports for those in the pool, he says, and the ability to monitor those lives on an ongoing basis to gauge the pool’s performance.

There are numerous different ways to acquire that data.

For the QxX index, the data is provided to Goldman Sachs by American Viatical Services, Roswell, Ga., which Mr. DuVally said obtains the rights to use the information. However, he notes that while certain “descriptive data” such as the insured’s date of birth and life expectancy are used in the pool, individual lives have been “de-identified” to ensure that no significant personal information is released.

Consent can also be obtained by those who have already taken part in life settlements through a disclosure form during the original settlement transaction that allows the purchaser or later owners to use the insured’s information, Mr. Poretz notes, adding that institutions engaging in synthetics have undertaken efforts to obtain the consent of the insured to be a part of a pool by offering payments and “buying the rights” to use the insured’s information.

The risk, he says, is making sure that when consent is given that it is fully-informed consent.

The issues regarding the lives of those in the pool have given rise to concerns, particularly for those in more “mainstream” life settlements.

Doug Head, executive director of the Life Insurance Settlement Association, Orlando, Fla., says that among the red flags raised by synthetics are that without actively involving the insured, “money will flow into speculators’ hand” without necessarily providing a tangible benefit to the insured, as would occur should they sell their policy in a traditional life settlement. Synthetics, he says, “smooth the edges” of a life settlement for the investor without providing a benefit to the individual with the policy. Mr. Head says that because of that situation, and with mortality involved, synthetics could become portrayed as investors “gambling” on peoples’ lives.

“I don’t know if it is an issue,” Mr. Poretz says of the “gambling” concern. He explains that the issue with synthetic life settlements is the overall performance of the pool as an asset, rather than any specific life. However, he says that he recognizes that the perception could be created.