A New York Times article comparing the bundling of life insurance policies to the packaging of mortgage-backed securities is generating quite a bit of notice in the life settlement industry.
The article in the September 6, 2009 Times reports that investment banks such as Credit Suisse Group bundle life insurance policies into bond-like investments in an effort to spread risk and attract institutional buyers and other investors.
With an estimated $26 trillion of life insurance policies in force in the United States, life settlements represent enormous financial potential for investment banks and others in the industry, according to Times reporter Jenny Anderson. Experts in the settlement industry estimate that the market for life-insurance-backed bonds could reach $500 billion, the article says.
Investors may be attracted to settlement-indexed bonds as a relatively safe alternative to the now-discredited mortgage-backed securities, which have plunged unrelentingly along with mortgage lending in general, the article notes.
The article also reports that credit agencies such as Standard & Poor’s and Moody’s are cautious about rating life settlement-based investments.
One criticism of life settlements noted by the Times was that insurance premiums could rise in the short term if insurers have to pay out more death claims than they had expected.
The article also cautions that computer programs that project life expectancies for policy holders in a settlement package might prove inaccurate. What would happen, the Times asks, if a cure-all for cancer were discovered?
“If the computer models were wrong, investors could lose a lot of money,” the article notes. “As unlikely as those assumptions may seem, that is effectively what happened with many securitized subprime loans that were given triple-A ratings.”
The article has generated considerable interest in the life settlement industry, according to sources. Despite its cautions, the article has brought exposure to a financial product that is widely seen as exotic.
David Mickelson, head of David Mickelson Insurance Services, Oceanside, Cal., says he found that the article may have “overplayed its hand” by comparing life settlement securitization to the mortgage meltdown.
“If you read it from the point of view of, ‘Oh no, here we go again,’ you could get the impression settlements are bad,” Mickelson says.
Mickelson believes there are a number of fundamental distinctions between mortgage securitization and life settlement bonds.
For one, agencies ranking settlement risks are quite conservative, and the underlying assets are individually far more secure than are mortgages.
“You might have a securitization of 500 policies, but each policy has the backing of an insurance institution with a rating no lower than AA,” he says. “And the insurance industry has a perfect record of always paying death claims.”
On the question of longevity, if policy holders do live longer than expected, investors in settlements won’t lose money, even if their return is lower than expected, Mickelson observes.
Moreover, the risk of extended longevity could be mitigated depending on how the settlement deal is packaged, he notes. The third party that sets up a securitization might tie it together with another product that would provide the actual income stream. For instance, a real estate portfolio can be backed with life settlements in order to guarantee a return of principal, he says.
Mickelson reports that far and away most attempts to securitize life insurance policies are not by big banks like Credit Suisse or Deutsche Bank Group but by smaller operators that use a life settlement component to diversify a deal and enhance credit.
As for the risk that a lopsided amount of an insurer’s business could be in policies that ultimately end up in life settlements, there are a number of reasons this is unlikely, Mickelson says.
For one, most policy holders in these deals are of an advanced age, so it seems unlikely their life expectancies could be stretched more than 20 to 40 months beyond what the experts estimate.
“We have portfolios of males in their 80s, who have had their average life expectancy extended by at least 120 months, according to the new tables,” he says. “It could happen, but I honestly believe that’s not happening that much.”
Besides, Mickelson says, most life carrier executives say they never assume a policy will lapse when the policy carries a high face value and the owner is aged 70 or more.
“If you are the carrier, you have to assume that people who can afford a policy and who are old enough when they buy it are going to keep it.”
If anything, publicity from the Times could only serve to spur sales of high-value life insurance policies, Mickelson maintains.
“You should have no qualms to buy [a policy], because should your needs change, it will be worth more than you paid for it. Settlements are actually a net benefit to insurance companies because right now, a very small percent of people who could buy insurance don’t buy.”
The idea that life insurance could be turned into an asset will make sales of life insurance sales grow dramatically, he predicts.
Andrew Calhoun, president and chief executive officer of Pacific West Capital Group, Los Angeles, says of the Times article that he’s glad to see the growth potential of the industry is finally being recognized. He also questions, however, the analogy the article makes between settlements and mortgage-backed securities.
“If consumers quit paying their mortgage, it can lead to a meltdown in the economy,” he says. “That would be impossible in this industry, because no one can avoid death.”
Rob Haynie, managing partner, Life Insurance Settlements Inc., Fort Lauderdale, Fla., strongly takes issue with a number of points in the article, including an allegation that “the industry has been plagued by fraud complaints.”
Not only did the reporter fail to back up the statement, Haynie argues, but life settlements are actually a tremendous opportunity for consumers who no longer can afford, no longer want or simply no longer need a policy.
He accuses some life insurance companies of actually forbidding agents and employees from discussing the availability of life settlements with clients.
“I consider that criminal, not to tell clients of their options,” he says.
As for settlements being the next subprime mortgage disaster, Haynie doesn’t see it. The reason underwriters of mortgage securitization got in trouble was that many of the loans were bad, he notes.
“Many of the individuals who were given a loan shouldn’t have been given it to begin with,” Haynie says. “The bankers assumed the housing market would continue to grow and that homes would continue to be more valuable so that if they had to take a house back, they could still resell it at a profit. That wasn’t the case.”
One good result of the Times article, Haynie acknowledges, is that it may have made many more consumers aware of the secondary marketplace.
Meanwhile, the executive director of the Life Insurance Settlement Association, Orlando, Fla., has written to the New York Times taking issue with some of the points in the article.
“By the tone of the piece, one might have thought that Wall Street created the secondary market for life insurance; clearly not the case,” Doug Head, LISA’s director, says in his letter to the Times. “Owners of life insurance have long enjoyed the ability of treating their life insurance policies like any other ‘ordinary property.’”
The purpose of life settlements is to give older Americans a chance “to profit from an asset for which they have bought and paid,” Head writes.
Over the past 10 years, life settlement companies have paid policy owners more than $10 billion, which was $6 billion to $7 billion more than the cash surrender value of their policies, he adds.