The Sticky Business of Life Settlements
Policies are “banking on another person’s early demise”
It’s been a busy year for those investigating the life settlement industry—highlighted in April by a hearing of the U.S. Senate Special Committee on Aging, to explore its impact on seniors, and again in the summer with the creation of the Securities and Exchange Commission (SEC) Task Force on Life Settlements, in light of “the recent movement toward securitization of life settlements.”
A life settlement, or senior settlement, is the sale of an existing life insurance policy to a third party for more than its cash surrender value but less than its net death benefit. The buyer (or investor) continues to make the premium payments to maintain the policy and collects the benefit upon the seller’s death. “What that means,” SEC Chairman Mary L. Shapiro said in a speech, “is that someone is actually hoping and banking on another person’s early demise.” How much is earned depends on the life expectancy of the insured: the sooner the seller dies, the more money the investor makes. The Washington Post calls these “ghoulish products.”
Life settlements may make sense for those who no longer need or want their insurance policies and might otherwise allow the policy to lapse. “The amount paid in life settlements represents real and meaningful value to America’s seniors that would have otherwise been lost,” notes the Life Settlement Institute, a trade association.
But life settlements are “complex financial arrangements,” noted Fred Joseph, president of the North American Securities Administrators Association (NASAA), in his testimony before the Senate committee in April. Because they involve both securities and insurance transactions, “regulating them requires a joint effort by securities and insurance regulators, each applying their laws and expertise to different aspects of the product.”
Life settlements were born from viaticals, which emerged in the late 1980s in response to the AIDS crisis and offered patients a way to pay medical bills. Generally, a viatical settlement involves a policyholder with a life expectancy of less than two years. Life settlements, which began to appear in the late 1990s, involve a policyholder (the elderly or chronically ill) with a life expectancy of more than two years. A controversial offshoot of viaticals, the stranger-originated life insurance (STOLI) transaction, has developed as well. Investors entice seniors to take out policies specifically with the intention of transferring most of the benefits to investors, who, again, profit when the senior dies.
Viaticals have been riddled with fraudulent practices. “These abuses have been documented in scores of enforcement actions by securities regulators over the years, as well as scholarly articles profiling the viaticals industry,” Joseph testified. “At one time, the industry was characterized as ‘infected with scam artists, ponzi schemes and other fraudulent activities.’ ”
An emerging investment idea
The growing life settlement market was the focus of the Senate hearing “Betting on Death in the Life Settlement Market—What’s At Stake For Seniors?” The industry has doubled in value since 2006, to a worth of $12 billion, and analysts expect it will exceed $160 billion within a few decades.
“A committee investigation uncovered unintended consequences for consumers, sales and marketing abuses, and insurance fraud, all of which are exacerbated by the high commissions earned by life settlement brokers,” according to the Senate committee’s press release. “The committee also examined how life settlements are being bundled and used as potentially risky investments by some of America’s largest investment companies.”
According to an article in Investment News, “For securitizations to be successful, they must amass large pools of policies to provide sufficient diversity among the health conditions of the policyholders in the pool.” Hundreds of policies could make up a single securitized pool, though there would need to be a large influx of seniors who were ready to sell their policies. “Such an undertaking would require a solicitation effort to sign up individuals for coverage and to sell the policies on the secondary market—and that raises the risk of fraud and insuring people just for the sake of selling the policy on the secondary market.”
Still, there have been only two “rated life settlement securitizations,” according to Jack Kelly, with the Institutional Life Markets Association, who spoke before a House subcommittee hearing on Wall Street’s involvement in the life settlement market in September. One, coincidentally, happened the same month the Senate committee met. AIG completed an internal company transaction that resulted in the largest securitization of life settlements—from within its own portfolio—to date. The transaction yielded more than $2 billion, and AIG used a portion of the proceeds to pay down its loan to the federal government. The other securitization was in 2004.
At the same hearing, Steven Strongin, a managing director of Goldman Sachs & Co.—which just exited the life settlement market—said that life settlement securitizations have had “little or no impact” on the market and don’t appear to pose any risk. “However, there do appear to be special issues in terms of consumer protection in life settlements in general that may be appropriate for Congress or a regulator appointed by Congress to address.”