The life settlement market won’t realize its potential until two things happen: (1) commissions on the transactions are much reduced, if not eliminated; and (2) reporting of closing prices and transactions costs of life insurance policy sales are available to the public.
This is the view of Dr. Lauren Cohen, professor of finance at Harvard Business School; and Michael Freedman, president, GWG Life LLC., a life settlement investor and provider.
To learn more about the market’s promise and continuing challenges, LifeHealthPro Senior Editor Warren S. Hersch interviewed the two experts. The following are excerpts.
Hersch: Dr. Cohen, what’s your assessment of the long-term prospects for the life settlement market?
Cohen (pictured at right): The life settlement market is, like other asset markets, governed by inertia. Without a significant external force — and exogenous shock — I don’t see the market remaining viable 10 years out. Life settlement transactions might still happen in small volume, but the market will not develop.
That’s not because the life settlement space doesn’t have the potential to become a large and important market. Life settlements aim to rectify what in economics we call a market failure: when the supply and demand of a product don’t meet.
The life settlement players endeavor to close this gap by creating a secondary market for life insurance policies. Yet, most life insurance policies that qualify for this market — contracts that policyholders no longer need or can afford — are instead lapsing or being surrendered for their cash value, an amount below that of their fair market value.
Hersch: I had interviewed advisors for National Underwriter’s April feature on life settlements. They noted that life settlement sales had increased by 15 to 20 percent during the past year. How does this rise dovetail with your pessimistic forecast?
Cohen: These figures are a bit misleading because you’re looking only at a percentage change in the market’s size. Since the early 2000s, the market has largely contracted, most especially during the economic downtown of 2008-2009. When the market size is small, as it is now, then an increase in year-over-sales can appear large in percentage terms.
Hersch: As I understand it, one factor contributing to the life settlement market’s contraction during the credit crisis was a decline in funding by institutional investors. But the advisors I interviewed told me that institutional investor money is coming back into the market.
One example: Life settlement provider Abicus, which recently secured $250 million-plus to purchase secondary market policies this year. Do you disagree with the advisors’ assessment?
Cohen: No, institutional investors are dipping their toe back into the water.
But you have to look at the larger picture. One of those advisors you interviewed, John Welcome, also noted that life insurance policies valued at some $100 billion lapse annually. I’ve separately heard estimates ranging from $80 to $100 billion.
These policies should be in the life settlement market. If you add to this all surrendered policies that could have gotten a better price through a life settlement, the $250 million you cite amounts to a mere fraction of a percent. So, I see the amount of institutional investor money entering this space as comparatively small in value.
I don’t think you’ll see serious amounts of money entering the market until there is a better benchmarking system. By that I mean financial returns of settlement transactions need to be audited so there is some way to assess the financial performance of the intermediaries and investors involved. This doesn’t exist now.
Hersch: Benchmarking aside, might macroeconomic factors observed by market proponents — growing savvy among institutional investors in valuing policies, low prevailing interest rates, the value of life settlements as a non-correlating asset class, among other factors — help the market to grow in future years?
Cohen: I agree — and portfolio theory would tell you — that life settlements are great assets to have in your portfolio, and for the reason you mention: they don’t correlate with other assets. Given current low interest rates and the market’s huge potential, it can also scale to meet investor demand. But all these points beg the question: Why hasn’t the market grown more, especially since 2009?
Hersch: Could one factor be opposition from life insurers, who don’t like life settlements because the transactions upset their assumptions about policy lapse rates and, therefore, how they price the products?
Cohen: That argument seems like a tough pill to swallow, given that the policies do legally belong to the policyholders. There are only so many roadblocks that life insurers can put up.