Media Coverage

STATE OF THE LIFE SETTLEMENTS MARKET:
Accelerating Investment Activity Despite Looming Supply and Legal Challenges

by Donna Horowitz

The life settlements market is growing at a rapid pace and shows no signs of letting up. Bernstein Research predicts that life settlement transactions could grow to more than $160 billion over the next decade. The firm estimates total face value of transactions ranged from $9 billion to $11 billion in 2005, up from $5 billion in 2004. While Bernstein has yet to release an estimate for last year’s volume, others believe policies valued at between $14 billion to $16 billion were sold in 2006.

As with any emerging market, the life settlements business is experiencing growing pains, including a regulatory crackdown on abuses, a lawsuit charging “bid-rigging” against a key player, fraud convictions against a now-defunct company involved in a Ponzi scheme and just two months ago, a strongly worded investor
alert by the NASD.

A high-profile lawsuit, filed last October by former New York Attorney General Eliot Spitzer against what is considered the biggest provider, sent shock waves through the industry. The suit against Coventry First already is having repercussions, holding up potential securitizations and possibly further tainting an industry struggling to gain respectability. Still, no one believes the case ultimately will slow down the phenomenal growth in sales of unwanted or unneeded life insurance.

“Over the last three years, it’s probably grown at 50% each year,” said Brian Casey, an attorney with Lord, Bissell & Brook in Atlanta who concentrates solely on life settlements. “It’s an asset that’s still in the fairly early stages of its life cycle.”

Hard data on the market’s growth is still difficult to come by. Only two states—Florida and Texas—require extensive reporting on sales
of life settlements and not all providers choose to operate in those places.

The industry trade group, the Life Insurance Settlement Association (LISA), hopes to remedy the situation and develop data on the fl edging industry later this year. It has hired an outside party to collect data from its 140 members, although it is encountering resistance from some who worry about disclosure of proprietary information.

Moving into the Mainstream

Still, leaders in the burgeoning secondary life market are excited about its prospects as it becomes better known to the public and institutional investors here and abroad step in to play a key role in purchasing policies.

“This industry is coming from the Wild Wild West. We went through a frontier-town phase and we’re now poised to enter the mainstream,” said Eric Lund, senior vice president of sales and marketing for MapleLife Financial of Bethesda, Md., one of the country’s leading providers—firms which acquire policies for investors.

“As we enter into a more regulated, more mainstream sort of recognized asset class kind of environment, there are more rules and regulations,” he added. “People are paying attention.”

Meir Eliav, president of Legacy Benefits in New York, which touts itself as the oldest life settlement company in the country, believes the growth and increasing acceptance of the industry is driven by financial markets looking for alternative assets that are non-correlated to public equities.

Originally, individual investors bought life settlements, but as the market has grown in the last seven years, it has become primarily funded by hedge funds, insurance companies, German closed-end funds and specialized structured transactions, according to a report published last year by Moody’s Investors Service. Among the big names with substantial ownership stakes in life settlements are American International Group (AIG) and Berkshire Hathaway. Other big financing entities in the market or showing interest in it include Deutsche Bank, Credit Suisse, Goldman Sachs, Morgan Stanley, Citibank and Allied Irish Bank.

Arthur Fliegelman, vice president and senior credit officer with Moody’s and one of the report’s authors, said, however, the biggest issue affecting the market is the finite amount of policies available for sale. Although he believes people are starting to feel more comfortable selling their policies as the market develops, he said growth will be limited without an infusion of investor-owned policies—a controversial topic now attracting the attention of regulators.

In addition, Fliegelman’s report notes that ownership of policies is “very fragmented.” They can only be obtained one at a time from individuals or from institutions that already own them.

Furthermore, only a limited number are suitable for life settlements. The face amount generally must be at least $750,000 and the senior at least 65, the report noted. Others put the typical value of policies purchased in the secondary market from $1 million to $1.5 million.

The Bernstein report paints a much rosier picture for the life or senior settlement market than Moody’s.

Bernstein researchers believe they initially may have underestimated growth in March 2005 when they predicted it could jump from $13 billion of in force settlements in 2004 to $161 billion within as little as a decade. Last year, when they reviewed the market again, they conceded the forecast could be conservative, especially if penetration reaches 20 percent and beyond for insureds over age 65.

The Bernstein report says the market’s growth could be fueled by last year’s rule change by the Financial Accounting Standards Board. Essentially, investors can now record life settlements at fair market rather than surrender value. Before the rules changed in March 2006, buyers were forced to record losses when they purchased policies.

Mixed Response from Insiders

The insurance industry itself has had a mixed response to life settlements, some decrying the market, others joining it and some warily accepting it. “To some degree, it was an unexpected development that they weren’t sure how to respond to,” said Steve Weisbart, vice president and economist with the Insurance Information Institute, a nonprofit research group in New York funded by insurance companies.

Whatever the viewpoint, the industry’s financial exposure for life insurance payouts continues to grow. It increased from $30.56 trillion in 2004 to $32.35 trillion in 2005, Weisbart said.

But the insurance industry ultimately is notion the hook for all the policies taken out. In 2005 alone, 19.8 million policies lapsed for nonpayment of premiums, Weisbart added. In that same year, $76.5 billion in death benefits were paid on 3.19 million policies.

Whatever the future holds for life settlements, regulators are taking notice.

Beginning last May, the National Association of Insurance Commissioners (NAIC) began holding hearings on revising its viatical settlements model act to stop what it saw as abuses in the industry. The proposal is hotly contested, with life settlement companies, their trade association and the premium finance industry opposed to it and life insurance representatives lending their support.

The NAIC is primarily trying to stop Stranger-Originated Life Insurance (STOLI) in which investors entice seniors to take out life insurance policies for the sole purpose of selling them. In this scenario, premiums are paid by investors and the policies are then sold in two years after the insurers’ contestability period ends. The NAIC is recommending that all such transactions be banned for five years after a policy is sold in hopes of deterring the deals.

Now, the National Association of Insurance Legislators (NCOIL) also is considering revising its viatical model act and has asked NAIC to delay proceeding with its revisions until NCOIL has had a chance to study the issue, which could take months.

“Our legislators (on NCOIL) feel legislators make laws. We want there to be more legislative involvement in the issue,” said Susan Nolan, executive director of NCOIL.

It doesn’t appear NAIC will capitulate on the request for a long delay. At the group’s executive committee meeting March 11, it agreed to only postpone action until June when it considers new revisions making it clearer that standard bank lending arrangements in non-STOLI transactions would not be impacted. Several amendments were approved April 2 by an NAIC committee studying the issue that now will go to the executive committee.

NCOIL may be headed a different direction though. Several NCOIL members questioned the fairness or legality of imposing a 5-year ban on STOLIs at their March 2 meeting in Savannah, Ga. The group feels the issue is urgent enough that it has scheduled a day-long hearing on the topic April 21 at the Hyatt Regency Crystal City near Washington.

To top this off, several states already are discussing revisions to their laws regulating life settlements and aren’t waiting for either NAIC or NCOIL to act. North Dakota was the first state to adopt the revised model, with some changes, in both the House and Senate last month. The states, which regulate life settlements, predominantly base their laws on the NAIC model. Weisbart said the “real threat” from STOLIs is that Congress or a state will change the favorable tax treatment for life insurance. Currently, beneficiaries pay no income tax on death benefits.

Emmanuel Modu, managing director and head of structured finance for A.M. Best, believes all the talk about regulating STOLIs might stunt growth of the life settlement market.

“The legislation may stop people from transferring policies freely,” he said. “It might have an overall impact. It’s kind of hard to target
one thing.”

He added: “It’s kind of a fine line between manufacturing policies and not manufacturing them. You can’t really legislate intent.”

But the states aren’t the only regulators taking an interest in the industry. The Securities and Exchange Commission continues to prosecute life settlement companies it believes have committed securities fraud. In a perplexing twist, one court decision regards life settlement transactions as securities that come under the SEC’s purview while another decision regards them as insurance products that fall under the authority of state departments of insurance. No one has yet asked the U.S. Supreme Court to weigh in, so for now, each situation is decided on a case-by-case basis.

Besides the regulatory action, there are other signs the industry
is maturing.

Several exchanges have begun operating in an attempt to bring openness and efficiency to the process of buying insurance policies.

One of those—Life-Exchange—launched its electronic format about eight months ago and now is trading more than $20 million worth of life settlement policies a month, said David Dorr, founder of the company. The Miami auction trading company puts together funding sources and brokers for the purchase of policies.

“We’ve addressed transactional inefficiencies and regulatory issues,” Dorr said.

Brokers without licenses are unable to upload files from states requiring them and policies are sorted by such criteria as face value and premium-cost ratio.

Dorr believes his exchange creates openness in the process, saying “the marketplace needed transparency.”

If sellers request auction reports through their brokers, they can see
who made bids for their policies. Seniors also can call Life-Exchange and it will verify the information, Dorr said.

The issue of secrecy surrounding commissions surfaced in the Coventry lawsuit. The suit alleges sellers had no idea how much in commissions were paid to brokers. The revised NAIC model act attempts to remedy the situation by requiring disclosure of fees to sellers. NASD also raised the issue in its consumer alert, saying fees can run as high as 30% of the total settlement. Another study puts them as high as 47%.

Dorr, who was a life settlement broker for two years, also said efficiency is coming into the market through a reduction in intermediaries. He’s starting to see it compressing at both ends of the transaction. Life brokerage firms are beginning to sell life settlements in addition to their life insurance products. On the other end, providers are merging with funding entities or getting big enough to obtain their own financing to buy policies. Dorr predicts that many life settlement firms will be gone in two years, eased out by this process.

For one big provider firm, this trend already is noticeable.

Alan Buerger, chief executive officer of Coventry First, the Pennsylvania company that is fighting the New York attorney general’s lawsuit, estimates that 85% of his company’s business comes from insurance brokers and financial planners while 15% originates from settlement brokers.

“Those settlement brokers that provide real value will thrive,” he said. But he says “most of them are an extra commission.”

Will Menezes, business manager for LISA, disagrees. Although companies may merge, he said new players will continue entering the industry and thus he doesn’t see the number of brokers diminishing.

Securitization Activity Picking Up

Another indication of a maturing industry is the move to securitize life settlements. In 2004 a portfolio of Legacy Benefits life settlements was the first pool of assets to be rated for a successful securitization transaction. Of the total $70.3 million portfolio, $61.5 million won an A1 rating and $8.5 million got a Baa2 rating from Moody’s. Some don’t consider this a true securitization of mortality risk because annuities were used to enhance the collateral.

Interestingly, Eliav of Legacy Benefits said insurance companies were among the purchasers of the notes.

Two investment banks are currently considering non-rated securitizations of life settlements, according to Adam Balinsky, an attorney with Baker & McKenzie in Toronto. Both banks, which he declined to name, are his company’s clients. He expects the deals to be done possibly by the third quarter.

Modu, the A.M. Best analyst, is currently working on assessments of securitizations for life settlements, although he declined to say how many or the potential volume.

Modu said he rated the first life settlement securitization of $63 million for Tarrytown Second in 2004, but it eventually fell through. “We put an indicative rating on it. We removed it. It wasn’t ramping up,” he said. “The sponsors didn’t buy enough life settlements at the pace we were expecting.”

Other rated securitization efforts have been put on hold for now, according to two analysts. One analyst says the lawsuit against Coventry First put the brakes on one securitization attempt while another analyst believes the case may have damaged the industry’s reputation, slowing down similar efforts.

The suit alleges that Coventry rigged bids to get the lowest purchase prices from brokers for insurance policies.

The suit says it did this by paying “cobrokering fees” to suppress higher bids from competitors—all without the knowledge of seniors selling their policies. Coventry denies the allegations and is seeking dismissal of the case and arbitration. The company contends New York has no jurisdiction because it doesn’t have any laws regulating the industry and all but one case named in the suit took place outside the state.

“We were close to rating one and then the suit came out,” said Jay Eisbruck, team managing director of Moody’s Investors Service. “It made us look a little bit more closely. We want the issuer to be able to prove to us that they will not have issues like [those alleged in the] Coventry situation.”

The securitization deal that failed to go through involved Ritchie Capital, a co-investor of Coventry that also was facing financial problems of its own apart from the lawsuit.

“There is a lot talk about it growing and it being securitized. We don’t see a lot of deals happening, at least in the securitization [market],” said Don Thorpe, senior director of Fitch Ratings in Chicago. “I’ve talked to a lot of bankers and arrangers, people trying to put together securitizations. Typically, we have an initial meeting and we never hear back.”

Modu predicted it could take five years “to see a reasonable volume of securitizations.” Until then, he expects to see one or two securitizations a year.

One rumor persistently circulating in the industry is that the lawsuit killed a deal to sell Coventry First. But Buerger disputes that, saying: “The rumors are not true. We were not close to a transaction.”

He was quick to add: “We always listen to interest by potential investors. We still receive inquiries.”

Meanwhile, Thorpe believes the lawsuit has hurt the industry.

“I think the investigation in New York calls into question how these policies have been purchased,” Thorpe said. “I think it does some damage to the reputation of the product. It’s a product that doesn’t have a sterling reputation. Psychically, a lot of people don’t like it. You’re speculating on human lives. That leaves a bad taste in peoples’ mouths.”

Not wishing to comment on the lawsuit itself, Eliav said he had not heard of co-brokering before and doesn’t believe it’s a widespread practice in the industry. “We have never, ever done it and never thought of doing it,” he said. “We think it’s totally against the rules of ethics and people should be punished for that (if it’s happening).”

Balinsky sees other effects of the lawsuit, regardless of whether the allegations are true or not. Financing entities are starting to put new, anti-bid-rigging wording into agreements with providers—five that he knows of so far—to ensure that prices are reached in an open, competitive manner.

Despite the lawsuit’s allegations, Lund and others believe life settlements are gaining respect and credibility. It hasn’t been easy for the industry—an outgrowth of viaticals in the 1990s in which terminally ill people, many of them AIDS patients, sold their policies to raise cash. Some of them were taken advantage of by unscrupulous investors who paid cut-rate prices, tarnishing the image of such deals.

Lund said his company, which has been in business since 2000, has advocated regulatory oversight for the industry from the start, but would like consistency. He said MapleLife is forced to use “a good number” of its 55 employees to ensure the company complies with varying state laws.

A report last year by Casey, the Lord Bissell Brook attorney, found that 27 states and Puerto Rico regulate viatical and life settlements while 23 states and Washington, D.C., do not regulate life settlements.

“From our perspective, it’s got to be reasonable and fair,” Lund said of the laws. “We believe life settlements benefit all of us. There’s room for everyone in the transaction to benefit.”

NASD Warning
And although the industry appears to be entering the mainstream, the NASD warning in early February advised seniors to be aware of pitfalls in selling their life insurance—an alert that was picked up by newspapers around the country. The agency pointed out the difficulty of determining a fair price because of the lack of transparency in the secondary market, high commission fees to brokers and financial professionals, privacy concerns over medical records, the impact of lump sum payments on seniors who receive state or federal public aid and the possibility seniors may have difficulty obtaining new life insurance.

The warning said “competition among life settlement companies has become increasingly intense, making that market prone to aggressive sales tactics and abuse.”

NASD itself only regulates a small part of the industry—life settlements with variable policies. Universal life policies, by far, make up the majority of the life settlement contracts sold.

Doug Head, executive director of LISA, criticized the NASD for warning seniors that they could lose their government aid if they sell their policies. “Those circumstances are just not where the market is,’’ he said, pointing out that most seniors who sell their policies are wealthy.

He said unlike annuities, which NASD warns consumers about because of lack of liquidity, life settlements offer flexibility.

“We think we should get kudos for that. We are giving liquidity,” Head said.

He also disagreed with NASD for implying that people are being talked into doing settlements, saying “that rarely may be the case. Most of what we see are people who have a non performing policy and they can get money to buy a new policy.”

Head is peeved about a new insurance industry practice he has begun hearing about affecting seniors. Some of LISA’s members have told him that insurers are refusing to issue new policies to seniors who have previously sold policies.

“It is entirely discriminatory,” he said.

One explanation may have come from Frank Keating, president and chief executive of American Council of Life Insurers (ACLI), who testified before a North Dakota House committee in March. He said that insurance may not be available in the future after a policy is settled because of a lack of capacity for that insured, according to National Underwriter Life & Health.

In the vein of more public disclosure, Head wonders why NAIC isn’t recommending that consumers be advised of the settlement option if they are thinking of surrendering or lapsing their policies.

After attending an industry conference in Germany in February, Head said he learned that regulators in Great Britain require that option to be disclosed at time of surrender and Germany plans to do so soon.

When he brought this up with Jim Poolman, the North Dakota insurance commissioner leading the effort to revise NAIC’s viatical model act, he says he got a response that “it’s advertising for us.”
Poolman confirmed this was “a nonstarter” for commissioners who viewed the idea “as required marketing for the benefit of viatical settlement companies.”

Head argued that settlements are “a common-sense alternative” for policies that consumers no longer want. People who surrender policies usually get three to five percent of the face value from insurers. In contrast, seniors can get three to four times the surrender value in the secondary market, according to a LISA white paper.

Fliegelman, the Moody’s analyst who follows the insurance industry, finds that insurers themselves have mixed views on life settlements. Some, such as Massachusetts Mutual Life Insurance Co., actively oppose it and have funded research on the market. The insurance company study by Deloitte Consulting, with the help of the University of Connecticut, concluded it made more sense economically for a senior with impaired health to keep the policy rather than sell it.

As to why life insurers don’t shut down the life settlement industry by offering higher surrender values, Fliegelman said they can’t because the amounts are determined on a specified regulatory basis. And although their options are limited currently, the situation could change in the long run, he surmised.

For now, the only way insurers can fight back is through trying to stop issuing STOLIs and persuading seniors to hang onto their policies, Fliegelman noted.

Life settlements may cut into some insurers’ profits, especially those who rely on lapse-supported pricing, the Moody’s report says. But because so few policies overall—1% or less—meet the criteria for purchase on the secondary market, the rating agency believes life settlements ultimately won’t have a major impact on the life insurance industry.

Weisbart, the economist with the Insurance Information Institute, concurs about the lack of impact of life settlements. “We’re talking about policies that were originally intended to stay in force until the insured person dies. From the life insurance point of view, all we’re changing is who is paying the premiums.”