Insurers face life settlements risks

Adding its weight to the ongoing controversy surrounding the US
life settlements industry, rating agency Fitch has warned that life
settlements expose life insurers and their reinsurers to a variety
of risks in their core individual life segment.

The primary risk, believes Fitch, is that policymakers will
ultimately challenge the tax-advantaged status of life insurance
products if they are viewed more as an investment security that can
be bought and sold than as a vehicle that provides financial
protection to beneficiaries from the premature death of the
insured. The life insurance industry greatly benefits from the
tax-advantaged nature of its products and a change in the tax
status of life insurance products would have negative consequences
for the industry, including possibly adverse rating actions, said
Fitch.

Legitimate vs illegitimate settlements

Reputational and litigation risk was also significant, it said,
given that a settlement transaction often combines complexity,
substantial compensation for brokers and others arranging the
transaction, product replacement, little regulation, potential
fraud and the possibility of confusion on the part of elderly
policyholders and their heirs. Fitch added that while it recognises
that there are differences between what the life industry refers to
as legitimate versus illegitimate life settlements, it believes
that the emergence of the illegitimate market is a predictable
outgrowth of the legitimate secondary market. “It may also be
difficult for insurers to distinguish between the two,” said
Fitch.

Direct financial risk to insurers must also be considered and stems
primarily from actual lapse and mortality experience diverging from
pricing assumptions. Fitch said policies sold into the settlement
market will not lapse because the investors are reliant on the
death benefit to achieve their returns, while mortality on
settlement policies may also differ from expectations as many
settlement originators target people with substandard health.

Fitch said it believed lapse and mortality risks are manageable
given the relatively small amount of life insurance in force that
is estimated to be in life settlements, but that view could change
if the market grows rapidly.