In the last two years AVS averaged 35 to 40 percent growth, and our 2008 volume is up 60 percent over the first half of 2007. The overall market is experiencing substantial growth; sales numbers were about $13 billion in 2005, and I think we could see $60 billion in sales within five years.

What is driving the reduced interest in premium-financed policies?
Most of the large investors who purchased premium-financed policies in the past have been scared off by the life insurance companies. These policies, sold by agents with a non-recourse premium financing mechanism, are the cause of great concern to life insurers to the point that some have challenged paying claims to investors on the grounds of insurable interest.

Many life insurers now include questions in their applications about the funding of premiums. Some have modified their product designs to include features such as policy loans based on face amount rather than cash surrender value to make them less attractive for life settlement. Also, life insurers through the ACLI are urging the NAIC to lengthen the contestability period for settling a policy.

 

Given the current environment, some investors have made blanket statements that they are not interested in taking policies that came out of the premium finance market. There may be some interest out there, but people who market these policies are telling me that they can’t find buyers for them at all.

How competitive is the market?
We’ve definitely seen an increase in the number of players in the marketplace. More competition is good, but some of the newer players are not very knowledgeable about the industry. They are underestimating the impact of the life expectancy assumption on their internal rates of return (IRR) and in turn are competing against themselves in places they shouldn’t. Still, some of the other newer investors bring a lot of knowledge with them. They come with actuaries in tow and are making much better investment decisions.

Why are there so many more players entering this market?
It has to do with market fundamentals. To grow this business, it takes a balance of enough policies and enough money to buy the policies. Over the years there have been times when the industry has had more policies than money to buy them and vice-versa. Today’s market has balance.

 

On the policy side there is more awareness among agents, brokers and other distributors. They recognize the value of life settlements as an alternative to policy lapse or surrender. On the money side, more capital is available because of failures in other markets and investors are looking for alternatives. Still, across the board they’re all competing with each other for the best policies.

How is this affecting margins?
Margins are coming down for a variety of reasons. For agents and brokers, sales are up and commission income is up, but commission rates are down because of increased competition for the business. For investors, particularly the big investment banks, income is up, but rates of return are down because of increased competition for quality assets and higher funding costs. Also, experience is showing that policyholders who entered into life settlements are living longer than we as an industry originally expected, affecting realized IRR. Nevertheless, an increase in investment capital has fueled the development of tertiary and synthetic markets. Previously, the only way investors could make money was when the insured died, but now they have other options.

Can you tell us more about tertiary and synthetic markets?
The tertiary market involves the resale of life settlement policies from one investor to another. Historically, resales were rare because the assets were difficult to value and transfer. However, the increase in large investor capital in the past few years has added liquidity and facilitated the trading of life settlements.

 

By comparison, synthetic markets offer mortality exposure without investors having to take actual possession of the life insurance policies. In other words, they are life-linked but not policy-linked. These derivatives are based on the experience of large pools of anonymous policies. Most of the major investment banks either have or plan to offer synthetic products. Both the tertiary and synthetic markets have high growth potential.

 

And both markets are certainly becoming more active. We have a number of clients in this market who call weekly asking about our mortality table, so I know there is a great deal of interest in evaluations for these markets.

What about growth in the volume of lower face amount settlements?
The smaller-face amount policy business is starting to grow dramatically, which may be a result of the current tough economic times. People still need extra money for a variety of reasons, and their life insurance policy is the one asset that has retained its value. Real estate, stocks and bonds have dropped pretty significantly. You may even see further increase in this type of business near term and certainly more marketing focused in that area.

Mortality Experience

How did the Actual-to-Expected (A/E) numbers work out in your study?
For the first time we had comprehensive data to work with, and it was a bit sobering that it was less than 100 percent. Our life expectancy valuations are consistently the most accurate in the business, but we have room for improvement. I think it will work out in the 80-85 percent A/E range once we are finished with the analysis.

 

Another finding from our A/E studies is that we performed much better with some specific impairments than with others. For example, statistically people with mild coronary artery disease will probably have one of the biggest changes for us because of their higher-than-expected survival rate. They may even look like preferred insureds with mild coronary disease, likely because of treatment with newer statins and blood pressure medications.

 

From 1999 – 2007 we collected 200,000 evaluations on 60,000 individuals with a peak age between 72-85. Unlike life insurers, we see some cases several times because an insured may try to sell the same policy repeatedly or have multiple policies to sell. Such cases are included once for each year in which they were evaluated, giving us 80,000 data points. Since the medical history and underwriting methodology change over time, how past data is incorporated into the current evaluation can have a significant impact on the A/E result.

 

Back in 2004, we lacked the data to break results out into specific impairments. Today we have enough data to really start developing particular table considerations. Overall, I think that the study validates what we have been doing all along. We respond to the actual data and make appropriate changes to our processes. The most accurate results possible given available information benefits our clients going forward.

 

I’ve proposed for some time that the industry needs a mechanism for a standardized A/E, at least using one specific table and one analytical format. This would be hard to do, just as it would be hard to get insurers to use the same format.

 

However, A/E analysis is more than the life expectancy assumption and the mortality table that’s being used; a host of other factors come into play. That is why we actually give the data to our clients so they can calculate the A/E themselves. The investors are very sophisticated today. Many of them understand the mechanics of the business well enough to analyze past experience on their own.

Given your findings that life expectancy evaluations are 15 to 20 percent too short, how do you expect the industry will respond to this emerging experience?
For the most part, the actual life expectancy will be about four to six months longer than the AVS evaluation. However, there is significant variation depending on the specific impairment, so some will be a year or more too short. We aim for accuracy and are just getting enough data to get there. Shifting life expectancy assumptions upward will reduce IRR. However, I don’t see companies making any major changes in how they conduct and analyze their business.

 

Our experience study is based on cases presented to AVS for evaluation, not what the provider used for the transaction. The provider may well have used a life expectancy purchased from a different underwriter or developed their own. Our assumptions tend to be more conservative, so if the provider did use a different assumption from ours, their actual experience probably had an even greater effect on their IRR.

How do you anticipate that the mortality experience adjustment will play out, and is it analogous to the current credit crisis underway?
I expect to see some churning in the tertiary market, but most participants in today’s market possess sufficient wherewithal to support their business and adjust their expectations. It’s not a scenario where the portfolio becomes valueless. It just shifts the performance. In that respect, it’s an IRR-type of problem and not analogous to the credit default troubles elsewhere in the financial arena.

Do you have any closing thoughts on the industry in general?
The genesis of this business was viatical settlements, where we were that last source of money that was desperately needed by people who were terminally ill. These people may have had health insurance but no longer had jobs for income, and life settlements provided that critical social need. The industry’s use of life settlements has broadened significantly since the early days and there have been abuses. I am concerned that negative perceptions of our industry obscure the legitimate value that life settlements offer to policyholders.

 

In these current tough economic times we again are seeing life settlements provide people with an alternative source of money when other assets have failed to retain their value. Yesterday we filled a social need for the ill; today it’s the elderly. I believe that this market in its more simplified form has a great opportunity to thrive.