Mortality Considerations of Life Settlements

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1 Mortality Considerations of Life Settlements David Cook Principal and Consulting Actuary Actuaries Club of the Southwest November 13, 2008

2 Profile of Life Settlements Mortality issues Insurer responses 2

3 Life settlement sale into the secondary market for life insurance policies Viable settlement opportunities may exist when the market value of a life insurance policy exceeds the cash surrender value, if any Insurers are usually unwilling participants in settlement transactions, the ultimate guarantors of the cash flows traded and the expected net loser 3

4 Life Settlement Characteristics and Mortality Experience for Two Providers Cook, Ezell Data filed in Texas for Life Partners Inc. and Coventry First LLC Experience years 2004, 2005 and senior settlements Representative of other portfolios 4

5 Settlements by Face Amount >$2.5 million 18% $1 to $2.5 million 30% <$0.5 million 31% $0.5 to $1 million 21% Average = $1.8 million 5

6 Age at Settlement 90+ <1% % % % Average Age

7 Life Expectancy at Settlement % of Settlements LE in Years Average LE in Yrs

8 Life Expectancy at Settlement % of Settlements <5 Yrs 5 to 10 Yrs 10 to 15 Yrs 15+ Yrs LE in Years 8

9 Policy Year at Settlement % of Settlements Average PY LE in Years 9

10 Actual-to-expected mortality 60% Deaths during on settlements during Expected mortality based on underwriter LEs and 2001 VBT 10

11 Life Settlement Mortality Considerations and Their Effect of Portfolio Valuation Mohoric, Kinney White paper covering life settlement industry practices, underwriting techniques and mortality issues Includes illustrative calculations for a hypothetical portfolio 11

12 LE estimators generally use life insurance underwriting approaches Assessments are usually based on a review of medical records provided by the insured and no additional tests or documents are ordered Reinsurer underwriting manuals are a typical starting point, with adjustments made by an estimator s medical director LE estimators handle ages and load levels not typically encountered by life insurance companies 12

13 LE estimates are derived amounts Mortality loads (debits and credits) are the direct results of an estimator s underwriting process LEs are typically calculated using a mortality multiplier and a mortality table to derive mortality rates Characteristics of the underlying mortality table significantly affect the LEs calculated 13

14 t = 1 e = p x t x Slightly more than half of the individuals in a cohort are expected to die by their life expectancies, an effect magnified by high mortality rates 14

15 LE estimators have little applicable mortality experience data Life settlements are relatively new Experience data is typically treated as proprietary and not shared Actual life settlement select and ultimate period characteristics are unknown 15

16 2001 VBT has been the mortality table most commonly used by estimators, sometimes with adjustments Recent experience by life insurers has been significantly better than the 2001 VBT perhaps 75% in aggregate and 65% for important life settlement ages and classes Life settlement mortality experience does not deteriorate due to lapses of healthier lives Mortality improvement factors may be used by estimators 16

17 It is generally believed that LE quotes have steadily lengthened in the market 21 st Services Chief Actuary -- With some proprietary adjustments removing inappropriate elements in the underlying data and including other elements that were excluded by its authors 21 st Services will base its proprietary mortality tables on the 2008 VBT. Example: Age 70 MNS, 150% mortality multiplier Old LE yrs New LE yrs (+29%) 17

18 The Life Settlement Report Market Rocked as 21 st Services Changes Mortality Tables It is definitely causing deals not to get done. News of portfolios changing hands at cents on the dollar based on presumption of optimistic LEs in valuations Other estimators are in the process of changing to the 2008 VBT as a base 18

19 Hypothetical Portfolio Policies: 250 policies with 272 lives Face amount: $464 million portfolio $1.9 million average policy size Minimum = $100,000 Maximum = $17.2 million Ages at settlement: 52 to 97 Average 81 Smoking: 94% nonsmoker LEs at settlement: 14 to 161 months Average 89 by amount 19

20 Hypothetical Portfolio PV Future Cash Flows at 10% (millions) IRR Expected 90 th Percentile Expected 90 th Percentile 2001 VBT $170 $ % 8.1% 70% of 2001 VBT $125 $ % 3.7% 110% LEs $147 $ % 5.8% 120% LEs $126 $ % 3.7% 20

21 Stranger-Owned Life Insurance (STOLI) Life insurance purchased with the expectation of transfer to an investor at the end of the contestable period Avoids insurable interest laws at issue Investor loans premiums and may pay a bonus up front At the end of two years, the insured may typically: 1) repay the loan and keep the policy, 2) sell the policy and repay the loan, or 3) transfer the policy to the investor and pay nothing for the loan 21

22 STOLI Insurer Responses Change marketing and underwriting to detect STOLI business Review specific policy changes post-issue, particularly change of ownership, and monitor amounts of older-age business written Discontinue agents that repeatedly write STOLI policies 22

23 STOLI Insurer Responses Before issue: New required forms, including a statement of client intent, premium financing disclosure form, and agent certification form New application questions related to the source of premiums, intent to sell or transfer, and past sales to third parties Financial underwriting related to need, policy premiums relative to income, creation of trusts and premium loan agreements 23

24 STOLI Insurer Responses After issue: Reviews of requests for verification and changes in premium payment pattern Reviews of large contestable claims for STOLI issues and misrepresentations Review of changes in ownership, payor or address for known life settlement companies 24

25 STOLI Insurer Responses Actions with agents: Warning letters and counseling Special care with business submitted and disciplinary actions short of termination Termination Problem: Premium financed sales volumes may be very high. How do companies replace those sales? 25