A recent front page New York Times article, from September 6, 2009, highlighted an emerging trend by Wall Street bankers towards large scale securitizing of life settlements of life insurance policies.
The effect on average customers for life insurance of this new business model by Wall Street will likely be to increase the cost of life insurance. Life insurance premiums are set by life insurance companies based on the assumption of a certain amount of policy lapses before payment of the insurance’s death benefit. Therefore, a large scale movement to securitize life settlements would change the analysis of lapse ratios since all policies subject to securitization would be held to maturity, or the payment of the death benefit. Life insurance premiums would need to rise to account for a significant reduction in policy lapses, otherwise there will be a negative impact on life insurers required capital reserves.
Life settlements (which have existed on a relatively small scale for quite a while now) involve ill or dying holders of life insurance policies who sell their life insurance policy to an investor who pays less than the death benefit’s value in cash to the policy holder. The ill or dying policyholder gets a lump sum of cash that they can immediately use before they die, and the investor gets an assignment of the life insurance policy from the insured policyholder. The investor will continue to pay the life insurance premiums with the hope that their investment (of cash paid to the original policyholder and the ongoing payment of the insurance premiums) will yield a high rate of return when the insured dies and the death benefit is paid to the investor. In essence, this is a bet by the investor on the longevity of the insured life; the sooner the insured dies, the higher the rate of return. In order for the investor to have a return on their investment, they must continue to pay the insurance premium so that the policy will pay the death benefit upon the insured’s death. If tens, and hundreds, of thousands of life insurance policies are subject to securitization then it will affect the overall lapse ratios since they will all continue to maturity.
Wall Street is planning on packaging large groups of life settlements into bonds then selling them to investors for fees, and also earning fees on the trading of these bonds. Wall Street’s involvement in securitizing life settlements would change the scale, and breadth, of the life settlement business. It may also bring future, unanticipated problems to life settlements similar to those created by the securitization of mortgages, and other types of debt obligations.
To see the full New York Times article, click here