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May 1, 2008updated 13 Apr 2017 8:59am

Insurers face life settlements dilemma

Insurers face life settlements dilemma They may not like it, but life insurers have no alternative but to acknowledge that the life settlements market is here to stay and will continue to grow rapidly

By LII editorial

Insurers face life settlements dilemma

They may not like it, but life insurers have no alternative but to acknowledge that the life settlements market is here to stay and will continue to grow rapidly. Driving the market are significant inflows of capital from global investors lured by a unique alternative asset class. Charles Davis reports.

 

A decade ago, life settlements were insignificant in the US investment business. Today, investment managers worldwide are channelling capital into life settlements, creating a booming market expected to top $6.1 billion in policy face value when 2006 totals are tallied. The result is an increasing number and value of life insurance settlements to meet growing demand, despite lingering obstacles hampering channel capacity and product availability, according to a new study by consultancy Conning Research and Consulting.

Conning estimates that $6.1 billion in face value was transferred in 2006, up from $5.5 billion in 2005 and $2 billion in 2002.

Conning identified growth drivers and limitations in the market and explored infrastructure supporting life settlement investors. Conning painted a picture of a market shifting from one that was capital constrained to one in which a lot of capital is chasing a limited number of policies available for purchase.

Secondary market alternative

Life settlements provide a secondary market alternative to seniors who hold policies they no longer want or need. As the market grows, it can provide an attractive alternative to surrender, assuming that the trend towards increased transparency and disclosure continues, the study said.

“With the amount of capital available to this market, life settlements are here to stay,” said Stephan Christiansen, director of research at Conning, in a release. “While the settlements market still carries some baggage from the earlier viaticals market from which it originated, it is now clearly separate, with signs that it is maturing as it grows. Life insurers need to anticipate the growing impact of life settlements in their ongoing product development and pricing.”

In the life settlements market, Conning sees convergence of several trends confronting life insurers. First, policy owners increasingly demand products and services that provide flexibility. This increasing consumer flexibility creates the second thread, an accompanying increase in the level of risk in accurately pricing products. Finally, life settlements represent the continuation of third-party providers assisting and influencing policy owner behaviour, without concern for the best interest of the insurer.

Successful use of capital

To address the third-party provider issue, insurers and the broader investment management sector are turning increasingly to life settlements. Supporting these investors is an emerging infrastructure that helps them effectively apply their capital in this new market. However, this new infrastructure does more than increase the supply of capital flowing into life settlements.

“Its need for an ever-larger supply of policies, and the amount of capital it could potentially generate, is becoming a catalyst for fundamental changes in life insurance,” the report said. “While life settlements are young, as an asset class, and participants and insurers are still struggling to understand the implications of its growth, one conclusion is beginning to emerge. The global capital market has identified life insurance policies as an attractive investment, and a potentially valuable addition to an investment portfolio. As a result, life insurers will need to adapt to markets where policies will be traded.”

Conning expects global capital to continue flowing into life settlements and “conservatively estimates” that between 2007 and 2010 the US life settlement market could range between $90 billion and $140 billion in policy face value per year.

This staggering growth rate is even more amazing given the obstacles facing the life settlements industry in the US. As Conning noted in the study, the life settlement marketplace is built on a structural inefficiency. Insurers are unable to reprice policies once they are issued. Life insurers, even if made aware of the new information, are unable to adjust their surrender value; in essence, they are locked into the status of always offering the lowest policy value.

Allowing life insurers to offer their own life settlement would increase competition, and policy owner choice, the study said.

“The strategic advantage shifts towards the life insurers because they have economies of scale, along with internal financial and knowledge resources, often lacking among life settlement investors,” the report said. “These advantages, all other factors being equal, should translate into a higher life settlement offer from the insurer than from the life settlement investor.”

Reducing risk

Investors are attracted to life settlements because insurance is seen as a non-correlated alternative asset. Life settlements provide non-correlated diversification because insurance policies are independent of factors contributing to economic downturns, such as interest rate fluctuations and increasing fuel costs.

As a result, life settlements are one way to reduce a portfolio’s exposure to sudden downturns in equity or bond markets.

The result, the study found, is that investors worldwide are creating a secondary market for life insurance. This will create added pressure on insurers to broaden the supply of available policies for transfer, either by opening new markets or by expanding product offerings in existing markets.

The report shows that while life settlements are young, as an asset class, and participants and insurers are still struggling to understand the implications of its growth, one conclusion is beginning to emerge: the global capital market has identified life insurance policies as an attractive investment, and a potentially valuable addition to an investment portfolio. As a result, life insurers will need to adapt to markets where policies will be traded. The insurer’s strategic challenge is identifying what the best adaptation is.

The US, the UK and Germany are three of the largest markets in terms of the amount of life insurance in force, the study said. However, it continued: “Insurance is truly a global product and investors could seek new markets to find a sufficient supply of policies. Insurers in these markets may find themselves facing a developing life settlement market if investors decide the combination of potential supply and regulatory infrastructure is attractive.”

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