A call by the American Council
of Life Insurers for a ban on life settlement securitisation has
met with vigorous opposition from the life settlement industry and
the Insurance Studies Institute. As matters now stand, the council
will be hard-pressed to refute arguments put forward by
securitisation proponents.
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What has long been a strained
relationship between US life insurers and the life settlement
industry has deteriorated significantly following a call by the
American Council of Life Insurers (ACLI) for legislation or
regulation to prohibit securitisation of life settlements. In its
call, the ACLI labeled life settlements securitisation as placing
senior citizens and investors at increased risk of fraud.
Unsurprisingly, the two major life settlement
industry bodies in the US, the Life Insurance Settlement
Association (LISA) and the Institutional Life Markets Association
(ILMA) have refuted the ACLI’s allegation in the strongest
terms.
Russel Dorsett, president of the Life Insurance
Settlement Association (LISA), described the ACLI’s call as “an
extraordinary pronouncement from an industry that has consistently
asserted that there is a valuable place for legitimate life
settlements”.
ILMA’s executive director, Jack Kelly,
commented: “The recent policy statement issued by ACLI concerning
securitisation of life settlements is misplaced and incorrect.”
LISA represents about 150 providers, brokers,
and financing entities in the life and viatical settlement industry
as well as service providers to the industry. ILMA represents
institutional participants in the life settlements industry and
includes as it members Credit Suisse, Goldman Sachs, JPMorgan Chase
and UBS.
The ACLI puts its case
Central to the ACLI’s argument is
stranger-originated life insurance (STOLI), in essence, a situation
where a stranger initiates a life policy against someone’s life and
funds the premium payments. The stranger may do this as an
investment for himself, on behalf of an investor or with the
intention of reselling the policy to an investor.
The ACLI has always argued that STOLI
undermines the principal that life insurance policies be supported
by insurable interest at their inception. STOLI transactions have
been outlawed in 28 US states and most other states are considering
anti-STOLI legislation.
The ACLI argued that because there are only a
limited number of insured individuals who want or need to sell
their existing insurance policies and are of an age and expected
mortality profile to be of interest to settlement providers,
promoters of life settlement artificially manufacture new life
insurance sales to generate an inventory of policies for
investors.
“Securitisation of life settlements will
exacerbate the STOLI problem,” stressed the ACLI.
Indicative of the size of the US life
settlements market, research firm Aite Group estimates that about
$13bn was transacted annually from 2010 to 2013.
The ACLI continued that securitisation is a
very effective means of market-making and encouraging rapid
expansion of a product, in this case, life settlement
contracts.
“Promoters will use capital generated from
securitisation to create larger inventories of life settlement
contracts which, in turn, will fuel more securitisations and more
STOLI,” the ACLI said.
Inevitably, continued the ACLI, life
settlement-backed securities will be “contaminated” with STOLI
policies, which will then be passed on to unsuspecting pension
funds and other far-removed investors.
Life settlement securitisation also poses risks
for investors purchasing settlement securities, added the ACLI,
which went on to highlight some derogatory names given to life
settlement securitisations. These include, death bonds, blood pools
and collateralised death obligations.
The ACLI noted that there were a number of
reasons securitisation poses risks for investors, one of which is
that it divorces the life settlement provider from the ultimate
risk associated with the purchase. This, asserted the ACLI, is
comparable to what happened with the US residential mortgage
securitisation market, which “facilitated and fueled the
proliferation of subprime mortgages.”
The ACLI noted that a major risk investors face
in STOLI investments is that those insured will live longer than
expected as a result, for example, of medical innovation, cures for
disease and better care.
The ACLI continued: “Investors in life
settlement securitisations will have no hard assets as security for
the inevitable default and fraud losses that attach to these
investments with alarming regularity. This is unlike mortgage
securitisations, where there is at least some tangible asset base
guaranteeing some value.”
Adding weight to its argument, the ACLI said
rating agencies advise that there is no standard method and no
common set of assumptions used by life settlement providers to
predict the life expectancies of the insured seniors whose policies
are being purchased.
The ACLI added that rating agencies also advise
that if there are no restrictions on the pooling and securitisation
of life settlement contracts there is little incentive for life
settlement providers to “get it right” in terms of medical
underwriting and respect for insurable interest requirements.
There is also a lack of transparency for
investors in securitisations because they are not permitted to
perform due diligence by examining the settlement underwriting
files, noted the ACLI. It added that the amount and quality of
information that will be made available to investors in life
settlement securitisations is insufficient for any “respectable”
securitisation and was a factor in some rating agencies declining
the opportunity to rate life settlement pools.
In its conclusion the ACLI stressed: “The fact
that there are now over 200 lawsuits involving life settlements –
many filed by disgruntled investors – sounds a warning.”
Industry bodies fight
back
Launching his response to the ACLI,
Dorsett termed the ACLI’s position an affront to the principal of
free and open capital markets.
“It cynically portrays [the ACLI] as a
protector of consumers, when in fact, their objective is to deprive
consumers of their right to receive a true market value from a
financial asset, a life insurance policy which is no longer needed,
wanted or affordable,” Dorsett said.
“This recommendation [to ban settlement
securitisation] is sensationalistic nonsense, larded with
half-truths leavened by outright lies. The ACLI knowingly attempts
to confuse not only the public but public policymakers by equating
legitimate life settlements with STOLI while characterising the
licensed and regulated intermediaries involved in the life
settlement industry as STOLI promoters preying upon seniors.”
Dorsett went on to term STOLI “a primary market
problem”.
“The real STOLI promoters are unscrupulous life
insurance agents appointed by the very companies that constitute
the membership base of the ACLI,” he said. “As well as the life
insurance companies themselves when they fail in their most
fundamental underwriting responsibility to establish a clear and
valid insurable interest at the inception of the policy.”
LISA, Dorsett stressed, has supported
legislation which makes clear to all parties that improper
origination will result in a permanently invalid policy.
Making a particularly strong point against the
ACLI, Dorsett said: “From a secondary market perspective,
stranger-originated life insurance simply does not make financial
sense. A newly issued life insurance policy which has been properly
priced and underwritten has no value as a life settlement. Nor will
it have any value in two years – or five years – unless the insured
undergoes a substantial change in health. The notion that the
securitisation of life settlements would create a pool of capital
dedicated to creating worthless life insurance contracts flies in
the face of economic logic.”
Hammering home his case, Dorsett noted that the
ACLI itself has acknowledged that securitisation is a very
effective means of market-making and encouraging rapid expansion of
any industry. More capital in the settlement market, argued
Dorsett, makes it likely that prices paid to consumers in the
secondary market will increase, and more consumers will receive
more value for their unwanted and unneeded life insurance
policies.
Dorsett added that for investors, a properly
constructed portfolio of settled life insurance policies offers the
potential for steady returns over long durations with low credit
risk and relatively minimal correlation with other asset
classes.
It is not that LISA does not recognise that
there are a number of challenges securitisation must overcome, said
Dorsett. It also does not claim that securitisation is without risk
but to imply that the magnitude of risk associated with life
settlements as an asset class is so overwhelming that a ban is
required “is nothing short of astonishing”.
Dorsett’s countering of the ACLI’s assertions
received strong backing from Kelly.
“One of the objections to securitisations
raised by the ACLI is that the longevity risk associated with the
transactions cannot be underwritten,” Kelly said. “This risk,
however, is the exact same risk that the members of the ACLI
underwrite when they issue life insurance policies and annuities.
By issuing life insurance policies and annuities, carriers believe
that this risk is capable of being adequately underwritten.”
Kelly also stressed that the ACLI has
repeatedly acknowledged the validity of life settlements and
underscored Dorsett’s point that securitisation would increase
liquidity and demand and, hence, prices in the life settlements
market.
In similar vein to Dorsett, Kelly also
highlighted ILMA’s view that there are a number of issues that need
to be considered and resolved before life settlements become
suitable for securitisation.
“This asset class is relatively new, with a
limited record,” said Kelly. “It traditionally takes a number of
years for an asset class to mature such that a securitisation is
viable.”
Another perspective
Some could argue that views on the
issue of life settlements securitisation is likely to be tinged
with the self-interest of the ACLI on one hand and LISA and ILMA on
the other. However, providing what can be viewed as a balanced
opinion is the Insurance Studies Institute (ISI), which has
published a critique of the ACLI’s call to ban settlement
securitisations.
The ISI is a non-profit organisation that has
as one of its key objectives to “provide or enhance understanding
of the insurance industry’s economic impact on society”.
The ISI took a strong stance against the ACLI
and in the opening gambit of its critique stated: “Policymakers
need to realise the true intention of ACLI and the life insurance
industry appears to be destruction of a vibrant secondary market
for life insurance, thereby denying seniors the option and right to
realise full market value for their unwanted, unneeded and
unaffordable life insurance policies.”
In support of its view, the ISI pointed to data
published by the ACLI that shows that between1995 and 2008, life
insurance sold to individuals totalled $20.9trn and the lapsed and
surrendered life insurance over that same period totalled $9.2trn,
or about 45 percent of the total sales.
“Clearly, the life insurance industry is
motivated to protect their revenues from lapses and surrenders,”
noted the ISI.
Continuing, the ISI referred to Conning
Research & Consulting’s 2009 report Life Settlements, It’s
A Buyer’s Market for Now, in which the consultancy stated that
total outstanding life insurance policies held as settlements
approximated $31bn as of 2008. The ISI pointed out that is a mere
0.3 percent of a total of $10.2trn of individual in-force life
insurance and only 0.34 percent of total lapses and surrenders
between 1995 and 2008.
“Clearly, the life insurance secondary market
does not represent a threat to the life insurance industry,” noted
the ISI.
Insurance securitisations
The ISI turned its attention to the
life insurance industry’s own use of securitisations, stressing:
“Of course the insurance industry welcomes investments from
individuals for insurance based securitisations and life insurance
policies, but the industry now says it does not want individuals to
realise full market value for their unwanted, unneeded and
unaffordable policies.”
The insurance industry has “relied heavily” on
securitisations for financing their risk by using securitisations
covering reserve requirements, embedded value securitisations and
annuity arbitrage securitisations, noted the ISI.
Continuing this line of argument, the ISI
asked: “Is the securitisation by a life insurer of expected future
profits of a closed block of business with massive lapse and
surrender assumptions not disingenuous to investors in the
securitisation? But now, when those same tools and techniques are
available for the consumers’ benefit, the ACLI asks policymakers
for an outright ban to the practice.”
Rather than curtail seniors’ options, the ISI
argued that the correct approach to adopt is educating and
informing consumers of their options with respect to the ownership
of life insurance. This, noted the ISI, was the central theme of a
report published in December 2009 by the University of Minnesota’s
Carlson School of Management titled Increasing Awareness of
Life Settlements.
“ACLI’s statement simply plays into what
researchers at the University of Minnesota found to be confusing
and uninformed messaging being communicated to consumers and
policymakers,” stressed the ISI.
“For the life insurance secondary market to
stay vibrant for seniors, capital is needed, and capital markets
require liquidity, thus the need for securitisations.”
