Securitization of life insurance policies -- The life settlement market

     In recent years, a secondary market for life insurance policies has grown rapidly, accompanied by similarly exponential growth in the securitization of life insurance policies. The market is supported by a group of organizers who purchase eligible policies from the original owners, re-package them, and then sell interests in these policies to investors. (See here or NY Times 12/17/2006 article "Late in Life, Finding a Bonanza in Life Insurance" for more details.)

     Based on the numbers I was able to gather, the size of the market has grown from ~$1B in 1999 to over $10B in 2005. (See chart below.) This rapid growth was fueled mostly by institutional investors, such as hedge funds and Wall Street firms. Even Warren Buffet's Berkshire Hathaway has invested in life settlements. It has been estimated that the market can exceed $150B in terms of the face value of insurance policies involved.

     There are occasions when a senior (or a company) might want to dispose of his/her life insurance policy. For example, emergency need for cash, changed goals in health care & estate planning, overly expensive premiums, dissolution of company requiring disposal of company-owned insurances, key employee leaving company, etc. In these occasions, the policy owner can sell the insurance back to the insurance company for the cash value. Or, he/she can sell the policy in the secondary market if it offers a better deal. Such competition between the primary and secondary markets should benefit consumers as a whole.

     To continue its current pace of growth, however, the market must address several legal concerns. First, most state regulations require that the beneficiary of a life insurance police possess an "insurable interest" in the life and health of the insured. If a stranger without an "insurable interest" becomes the beneficiary of a life insurance covering the life of another person, the stranger has the monetary incentive to accelerate the death of the insured person. That is not a desirable public policy! Many states (including New York), however, have allowed a stranger to become the beneficiary if the insured person voluntarily agrees to the arrangement. Even with this exception, the risk of abuse can be real. It is important for all transactions to incorporate some safe guards. (E.g., not permitting the investors to know the identity of the insured.)

     Second, the investment interests on the re-packaged insurances sold to investors may be "securities" under the federal Securities Act of 1933 and Securities Exchange Act of 1934, and thus may be subject to the registration, disclosure, anti-fraud, and other requirements under these federal laws. In 1996, the Appeals Court of the District of Columbia held in SEC v. Life Partners that such type of investment contracts are not "securities". The Appeals Court of the 11th Circuit, however, reached the opposite conclusion in 2006 in SEC v. Mutual Benefits. In these cases, the defendants, Life Partner Inc. and Mutual Benefits Corp., were organizers in the life settlement markets. Both of them employed hundreds of agents and brokers to purchase policies from seniors and sold fractional interests on these pools of policies to investors. Because of this split between the two courts, any issuance of life settlement interests under the jurisdiction of the 11th Circuit (Alabama, Georgia, Florida) will now be subject to the federal securities laws, but not those under the jurisdiction of D.C. Such discrepancy will have to be resolved by the Supreme Court.

     Finally, as more and more organizers enter the market, competition to obtain eligible policies from seniors will increase. Potentials for fraud will rise. In fact, in October last year, the then attorney general of New York, Eliot Spitzer, brought suit against Coventry First, one of the large life settlement organizers, for allegedly rigging the bid process in buying the policies. Like many other states, New York currently does not have a law regulating the life settlement market. A model regulation, however, was released back in 2001 by the National Association of Insurance Commissioners. The model regulation was adopted by some states and contributed (at least partially) to the rapid growth of the industry. As this market grows, more and more states will eventually enact laws and regulations governing the industry. That should bring more clarity to the regulatory frameworks and sustain continued growth.