Buzz is building among financial firms about arranging life settlement securitizations, but experts question the structured products' viability as an investment amid a lengthy list of risks and a limited track record of successful transactions.
“There are transactions in the pipelines — a lot of them come to our desks — but many of them aren't doable,” said Emmanuel Modu, managing director of the insurance-linked securities group at A.M. Best Co. Inc. “Getting into this asset class isn't trivial, and that's discouraged people from entering the market and securitizing policies.”
Although private investors and investment banks recently have increasingly been analyzing life settlement securitizations as a new revenue source, the concept has been around for more than a decade. The first viatical securitization, which was provided by Dignity Partners Inc., took place in 1995, using policies belonging to the terminally ill.
To date, there has been just one successful life settlement securitization, which took place in January and involved American International Group Inc. More than 2,000 policies in that deal were provided by the Coventry Group, a life settlements firm.
Mr. Modu, who privately rated the AIG transaction, and those at other ratings agencies said that they have seen an uptick in interest about structuring similar deals. But arrangements that meet the agencies' standards for a rating have been scarce.
“What I've seen is that the interest is heating up, but the volumes aren't up,” said Jesse Schwartz, a consulting actuary at Watson Wyatt Worldwide. “Growth may be slow because the asset classes are new and complicated; investors need an extent of technical knowledge to participate.”
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.
Several hundred to 1,000 policies would be sufficient for a single securitized pool, though for many of these securitizations to exist, there would need to be a large influx of seniors who were ready to sell their policies, said Michael McLaughlin, head of the U.S. life actuarial practice for Deloitte Consulting LLP.
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.
AROUSING SUSPICION
“We are concerned about the market-making inventory for the life settlements industry. How many of these settlements are done within five years of issue?” asked James Avery, president of individual life insurance at Prudential Financial Inc.
“When we see policies being sold within two to five years of issue, that makes us suspicious of the intent of purchase,” he said.
Aside from policy origination, there is also the matter of legitimately selling the policy.
“There's the possibility for fraud and abuse if people would have to be persuaded to sell the policy,” Mr. McLaughlin said. “Will there be enough disclosure provided to individual policyholders to make sure they are they getting a fair deal?”
Another risk lies in in-vestors' receiving inaccurate in-formation about the health and life expectancies of the insured. Policyholders who are healthier than reported could result in lower returns for the owners of the securitized pools.
The settlements themselves aren't immune to problems in the credit markets. Investors can run into difficulties if a bank won't let them borrow the money to buy a book of policies on the secondary market, Mr. Schwartz said.
Industry observers wonder wheth-er the investment banks that are proposing the deals are sufficiently prepared for the level of due diligence that goes into preparing legitimate securitizations and whether investors — such as pension funds — deem the prospective returns on the investments worth the risk.
Although some institutional investors, including the California Public Employees' Retirement System, already own life settlements, pension plans have been quiet about whether they would participate in securitized versions of the investments, observers said.
“Depending on how they're structured, they can be attractive from a diversification perspective, conceptually,” said Bryan R. Decker, managing director and chief investment officer at Evaluation Associates LLC.
The consulting firm works with endowments, retirement plans and other institutional investors.
Mr. Decker said that he hasn't seen the firm's clients demonstrate interest in investing in the settlement securitizations.
“There are probably enough other investment opportunities that pension plans can invest in before they'd get into this,” he said. “If the investment banks are scrambling to create this, then it must be beneficial for them, so I'm skeptical.”
E-mail Darla Mercado at [email protected].
