Standard & Poor’s Ratings Services says that it sees inherent risks in securitizing life settlements and that it won’t be rating this type of investment any time soon.

When a company creates a life settlement security, it buys in-force life insurance policies, pools them, then uses the pool to back notes or other debt securities. Institutions and other investors buy the securities in an effort to diversify their portfolios.

Recently, institutions have been asking S&P about the securities, the rating agency says.

“Although both investors and originators see the potential benefits in this asset class, we believe there are inherent risks in, and obstacles to, securitizing life settlements,” says Winston Chang, a credit analyst at Standard & Poor’s, New York, who helped write an article about the topic posted on an S&P website.

S&P analysts write that one concern is that the pools backing life settlement securities rarely hold more than 100 policies.

“In our view, statistical credibility is unlikely to be achieved with a pool of less than 1,000 lives,” S&P analysts write.

The analysts also express concern about the issue of insurable interest. In a number of states, they write, the question of whether one can legally own a policy on a life in which one has no insurable interest remains an open issue, and courts in some states have ruled than an insurable interest must exist for a life insurance beneficiary to receive payment upon the death of the named insured.

In addition, “there is limited historical data comparing the projected mortality versus the actual mortality rates,” making it difficult to judge the accuracy of medical reviews, the analysts write.

Most life settlement originators’ track record is relatively short, and, because they usually put only a limited amount of their own money into life settlement securities, “bondholders assume the lion’s share of the risk,” the S&P analysts write.

The analysts also question whether life settlement payment streams are completely uncorrelated with the stock market.

“There is a correlation between the condition of the economy and the credit quality of the insurance providers,” the analysts write.

If the life insurer backing a policy failed, it is not clear how a guaranty fund would treat policies involved in life settlement securitization arrangements, the analysts write.

S&P has never rated a life settlement transaction, and it is unlikely to do so unless its concerns are addressed, the analysts write.