Life Settlements Market Holds New Opportunities

Life Settlements Market Holds New Opportunities

Conning, a thought leader in insurance since 1912, has recently shared an executive summary of its latest study on the Life Settlement market, revealing that there is increased investor interest and new opportunity for the aggregation of these policies by licensed agents and brokers.

As an asset class, life settlements continued to struggle to attract new capital in 2012. As 2013 developed, some indications of renewed interest in life settlements among investors surfaced. This renewal was driven in part by the prolonged low interest rate environment.

At the same time, a new market opportunity emerged in the form of long-term care funding opportunities. Yet, as life settlements enter 2014, and beyond, will the new market opportunity and continued low interest rate environment combine to reignite investor interest and help meet consumer demand?

Market Review and Forecast

In 2012, Conning estimates that life settlement sales increased over 2011. This increase reflects a change in the methodology we use to estimate life settlement annual volumes and, in our opinion, does not signal a change in broader market conditions. Capital continues to remain skittish about returning to this asset class, though anecdotal evidence suggests that there is renewed interest in life settlements driven by the prolonged low interest rate environment.

Looking ahead, because of the combination of fewer new policies settled with increased death claims and lapses on previously settled policies, the amount of in force life settlements decreased for the first time in our years of observing the market.

In the past, Conning based its estimate on a variety of sources, chief among these were annual reports and financial statements from life settlement funds and investors.

However, the decrease in the number of publically available financial statements and reports no longer makes that methodology practicable. As a result, with this issue we are changing our annual volume estimate methodology to use the annual reports providers file in some states. Providers are the companies that purchase life settlements on behalf of investors.

Based on our analysis of the life settlement market, we estimate that:

– Investors purchased approximately $2.0 billion worth of U.S. life insurance face values in 2012.

– Investors held just under $35 billion of in force U.S. life settlements at the end of 2012.

– Transactions continued in 2013, with several large portfolios being purchased.

2013 Transactions

Life settlement transactions continued in 2013. The first most noticed transaction was Berkshire Hathaway’s purchase of a portfolio with $300 million in face value from Coventry. This marked the return of Berkshire to the asset class it left in 2006. The decision by Fortress to sell its life settlement portfolio was the second largest transaction that drew attention. It marked a shift by the asset manager from an acquirer of portfolios in 2010 to a seller of them.

Based on information in the AAP Life Settlement Market Update, internal rates of returns for life settlement transactions remained in the high-teens in 2013. This attractive return is a key reason some investors may be reconsidering the asset class as an alternative to other long-term fixed investments such as bonds.

2013-2022 Annual Volume Forecast

Over the ten-year period from 2013 through 2022, Conning estimates the average annual amount of life settlements will be $2.2 billion. We estimate annual growth for face value settled will increase 1% to 2% per year over the forecast period. We base this on our analysis of broader investor and market conditions about this asset class.

First, supply will not be an issue. Unless life insurers develop a mortalityadjusted cash surrender value, life settlements will continue to provide an economically competitive alternative to lapsing or surrendering some policies. Second, and equally important, there will be ongoing demand from some alternative asset investors for the low correlation to equity and debt markets that life settlements can offer. Third, the issue around changes in life expectancy should lessen as investors become familiar with the variability of this risk. Fourth, the regulatory environment surrounding life settlements has settled. What we are less certain of, and have difficulty seeing develop, is a strong return of capital to 2007 and 2008 levels. As we look at investor concerns about investment, liquidity continues to be a hindrance to a strong return of capital to life settlements.

Without an efficient tertiary market where already settled policies can be sold, it will remain difficult for fund managers to provide a degree of liquidity to their investors. It is important to note that we view this as a hindrance, not a roadblock. There will always be some number of investors willing to commit capital for an extended period in a product with low, or no, liquidity. However, concerns about liquidity reduce the number of investors ready to make that commitment.

A New Long-Term Care Market Opportunity

The number of individuals who may need some form of LTC (long-term care) is increasing as Baby Boomers age. Life settlement investors may want to consider two distinct opportunities in the long-term care market. The first is an emerging opportunity to meet the financial needs of nursing home patients. This opportunity is emerging because of regulatory changes. The second opportunity is helping elderly individuals finance their stay in assisted living facilities and with home health care.

Growing Demand for Long- Term Care Funding Sources

The number of elderly individuals using some form of LTC is increasing. The cost to live in a long-term care facility continues to increase. According to the U.S. Census Bureau, just over 40 million Americans were 65 years of age or older in 2010. What is interesting is that the 85 and older age group had the highest growth from 2000 to 2010. Over this period, the number of individuals age 85 or older grew 30%, compared to 19% for the 65 to 74 age group and just 5% for the 75 to 84 age group. This is important because as a person ages, the need for some form of assisted living increases.

However, the sale of traditional longterm care insurance continues to fall. This creates an opportunity for life settlement investors to provide a source of LTC funding through the purchase of cash value policies

A State Encouraged Nursing Home Opportunity

States, through Medicaid, are a primary funder of nursing home care. In 2011 (the latest available), according to the Centers for Medicare and Medicaid Services, Medicare and Medicaid paid 56% of nursing home care. Medicare paid 25% of total nursing home expenditures in 2011. Medicaid covers a much larger portion of long-term care expenses, but only after applicants have exhausted the majority of their personal resources in order to qualify for Medicaid benefits. In 2011, Medicaid paid 31% of total nursing home expenditures.

Under Medicaid, if a cash value life insurance policy has more than a minimal amount of cash value (usually in the range of $2,000), the owner must liquidate it and apply any money received towards their LTC cost of care before qualifying for Medicaid. In 2013, several states began discussing legislation that would require the disclosure or recommendation of life settlements to people who might be considering lapsing or surrendering their policies in order to meet Medicaid eligibility requirements.

These proposals build on NCOIL’s (National Conference of Insurance Legislators) 2010 Life Insurance Consumer Disclosure Model Law. That model law would require that life insurance companies inform policy owners they have a number of options to consider instead of abandoning an in force policy.

The Assisted Living Care Funding Opportunity

Over the past two decades, a wider range of home and community-based services have become available to older Americans who need assistance with activities of daily living.

Assisted living in particular has rapidly emerged as a housing and long-term care option for older Americans. However, individuals need to rely on self-funding for assisted-care expenses. This creates an opportunity for life settlements to broaden its market and provide funding to these consumers.

A 2011 study by the National Center for Health Statistics reported that 733,300 persons were residents of assisted living facilities nationwide for each day in 2010. This is over 50% of the size of the nursing home population. Individuals in assisted living facilities are older. According to the 2010 National Survey of Residential Care Facilities more than one-half of residents were aged 85 and over.

Because the majority of individuals self-fund their assisted living care expenses, this creates an opportunity for life settlements. Many states have been cautious in expanding Medicaid coverage for services in assisted living facilities. Instead, these expenses typically are financed from a resident’s income, including Social Security, Supplemental Security Income, state supplements, private pensions, federal housing subsidies, and—in some states— family contributions.

The Long-Term Care Impact on Life Settlements

Currently, the life settlement industry is suffering from a lack of new capital flowing into the asset class. Concerns about longevity risk linger among investors. Adding to those concerns are the length of time capital is tied up in relatively illiquid investments. If the long-term care market represents a new opportunity for life settlements, would it help address these challenges? What new challenges would it create for investors?

A Positive Impact on Longevity Risk

Moving towards the long-term care market may help reduce the longevity risk facing life settlement investors. Longevity risk is the life settlement investor’s risk used by the life expectancy assumptions when purchasing policies that may no longer be valid. As payments continue beyond the life expectancy, the policy may become less profitable, or even unprofitable, to the investor.

Because many of the policies in the long-term care market have a smaller face value, it would be possible to accumulate a larger number of policies/lives in a portfolio, reducing the impact of any given policy exceeding its life expectancy.

At the same time, the variety of illnesses among nursing home and assisted living facility patients enable the construction of a diversified portfolio of illnesses. This reduces longevity risk caused by concentration among a limited number of illnesses.

Potentially Reduced Liquidity Risk

Life settlements are an illiquid asset class. Policies do not generate cash returns until the death claim is processed and the insurer pays the claim. If a fund manager needs to sell a policy to raise operating cash or pay client withdrawals, it may take time. This lack of liquidity, combined with the length of time an investor’s capital is tied up in a life settlement fund, has contributed to lower interest in life settlements. However, a shift to funding the long-term care market may reduce some of those concerns due to the shorter life expectancies among these patients.

The traditional life settlement transaction involves an insured with a life expectancy of close to eight years. For example, the AAP Life Settlement Market Update reported that the average life expectancies for new settlements were 98 months in August 2013, an increase from 91 months in June 2011. In comparison to life settlements, studies have reported that patients in nursing homes have much shorter life expectancies. One 2010 study published by the Journal of American Geriatric Society found that out of the 8,433 study participants who died between 1992 and 2006, 65% died within 1 year of nursing home admission. Care Market

The development of life settlements as a viable source of long-term care funding faces several key challenges. Transaction costs reduce the appeal of smaller face value policies for investors. Commissions paid to brokers can reduce the appeal to the owners of small face value policies.

Finally, insurers have been developing long-term care riders for life insurance products that are a significant challenge to the long-term development of life settlements in the long-term care funding market. The popularity of these products represents a challenge to the future development of life settlements as a funding source for LTC. In many of these combination products, LTC benefits are provided as accelerated benefits that reduce both the cash value and death benefits.

A More Complex Life Settlement Process

The life settlement process for longterm care funding is more complex than that used by traditional investors. The reason for increased complexity is the need to establish a Separate Account that makes monthly or periodic payments to a longterm care facility.

In addition, the need for life settlement investors to make a reduced death benefit payment to the insured’s beneficiaries increases the complexity. This complexity adds to the costs of managing a life settlement portfolio.

We cannot estimate the potential additional costs from this increased complexity for two reasons. First, there is simply not enough data to make this estimate. Second, a life settlement investor could decide to perform these tasks in-house or use a thirdparty provider in the same manner that they do to administer the premium payments. Given that many of the policies in the longterm care market are smaller in face value, this complexity would suggest that investors with efficient processes and the ability to achieve scale would generate a higher return than those without such processes or scale.

Seizing the Life Settlement LTC Funding Opportunity

As elderly individuals, and their families, look for ways to pay for LTC, life settlements offer an additional source of LTC funding. This creates a new opportunity for life settlement investors. Understanding the size of this opportunity begins by estimating the number of elderly people that own cash value life insurance. After sizing the market, understanding the distribution of the potential customers helps identify whether or not to pursue a state-specific or national marketing effort. With that understanding, life settlement investors also need to consider how to reach these customers.

Sizing the Nursing Home Funding Opportunity

Identifying the life settlement opportunity in nursing home funding requires understanding several trends. First, how many people are in long-term care, and is that number growing? How many individuals in nursing homes use Medicaid? Finally, an analysis of nursing home ownership is useful in identifying the potential ease of distribution. A state-level understanding of these questions further helps identify where investors might find the greatest opportunity.

Older American Own a Sizable Pool of Policies

There are a large number of cash value policies owned by older Americans. However, the rates of ownership and policy size vary by both age and product. This may have an impact on which types of products a life settlement investor might favor.

A State Specific Distribution Opportunity

Life insurance policies and the number of nursing home and assisted care facility patients are not divided evenly among the states. The ten largest states with the most in force life insurance policies, as of end of 2012, also are leading states in terms of face value. In addition, these states also have the majority of individuals aged 85 or older and the majority of the nursing home population. This concentration of policies, elderly individuals, and nursing homes enables life settlement groups to target selected states rather than pursue a national distribution strategy.

Reaching the Customers

The concentration of elderly customers in some states offers the potential to develop a targeted marketing strategy. The challenge is in finding an effective way to reach these potential consumers and introduce the life settlement option.

One avenue of approach would be using the care facility as an initial contact point with the policy owner. The facility already discusses payment options with the patient and his/her family. It would make sense, especially in states that have legislation regarding life settlements and Medicaid, for the facility to include life settlements as part of that discussion. The facility could not act as a broker or provider, unless it sought the appropriate licensure. It would instead be acting as a referral.

Conning (www.conning.com) is a leading investment management company for the global insurance industry. Conning is focused on the future, supporting the insurance industry with innovative financial solutions, investment experience, and proprietary research. The company’s unique combination of asset management, risk and capital management software, and advisory solutions, as well as insurance research, helps clients achieve their financial goals through customized business and investment strategies. The company is headquartered in Hartford, Connecticut, and serves its global client base from additional offices in Purchase,NY, London, Cologne, and Hong Kong.

Conning publishes a number of insurance industry research services, including its Insurance Segment Reports semiannual lineofbusiness reviews; its Forecast & Analysis service, which offers a forward look at the industry; and its well-known Strategic Study series of executive reports on key products and trends and issues of critical industry importance. All are available in print and online through Conning.