Securitization Of Life Insurance Settlements

This article was originally published in the July 2009 Life Settlements Review

Life insurance settlements ("LIS") constitute a potentially attractive candidate asset class for the issuance of rated securitized paper. The most recent longevity and demographic statistical information suggest that there will be a significant increase in supply of assets over the next 20 years. In 2007, there was approximately $9.2 trillion of life insurance in force in the United States. Of that amount, $416 billion in life insurance is owned by individuals over the age of 65. Only a small fraction of that amount, $15 billion in face amount, was sold or traded in 2007 in the secondary market. The number of 65 year olds is projected to increase dramatically over the next two decades from 37 million individuals to 72 million by 2030. Based on this increase in the number of persons eligible for life settlement transactions and assuming the same percentage of seniors with life insurance, by 2030 there will be roughly $800 billion in life insurance owned by seniors 65 years of age or older with $161 billion eligible for life settlements.

What is an LIS?

A life insurance settlement involves the sale of the rights to the death benefits associated with a life insurance policy ("Policy") from the policyholder ("Policyholder") to a third party investor or investors ("Investor"). Such third party Investor pays the Holder a lump sum payment reflecting the net present value of the policy's death benefit after deducting the premium payments and other costs over the estimated life of the insured and factoring in a return to the third party purchaser. The amount paid to the Policyholder is nearly always in excess of the redemption value offered by the insurer. The third party Investor causes the policy to transferred into its name or into the name of a third party securities intermediary which acts for the Investor of the policy. The Investor must thereafter pay the insurance premiums during the insured's lifetime and upon the insured's death receives the lump sum death benefit. There are a number of reasons why the Policyholder may sell a policy rather than allow it to lapse, for no benefit to the Policyholder, or have the policy redeemed by the insurer for the embedded cash surrender value of the policy. The Policyholder may determine that the reason for the existence of the policy, income protection for example, is no longer relevant. Alternatively, the Policyholder may have a change in economic circumstances such that he or she may not be able to afford the increasing cost of insurance. The falling interest rates coupled with declining equity values over the past two years have limited growth in the cash values of Policies and further pushed up the cost of insurance. Whatever the reason, the Policyholder does and should have the right to realize value for this valuable financial asset above the surrender value.


Origination and True Sale of the Asset Pool

Origination of LIS assets presents challenges similar to those which arose in connection with the origination of residential mortgage backed securities (" RMBS"). There is a wide range of life insurance providers, which are licensed brokers of life settlement transactions, from regulated global banks to private individuals, currently actively originating LIS assets for investment purposes. A securitization structure involves the creation of a managed asset pool which meets certain performance ratios. Origination risk is managed by coherent and effective market diligence standards, as well as regulatory supervision of the originators of the life settlement assets. There are currently a number of best-practice guidelines published by industry bodies, such as LISA, which require that, among other things, an acquired Policy is properly documented and the Investor or the licensed life insurance provider (broker) provides and documents the fully informed consent of the Policyholder to the sale of such Policy. The authors also believe that there is a strong case for uniform federal legislation mandating minimum federal requirements for disclosures to Policyholders and other origination practices which will greatly facilitate securitization transactions and remove institutional Investor concerns. Assuming the asset pool is originated, there are a number of well-rehearsed legal requirements which must be met for its effective true sale to the securitization vehicle (the details of such requirements are beyond the scope of this paper). Attracting Investors The cost of life insurance is determined by a combination of actuarial tables and Policyholder risk factors. On the one hand, each Policy will generally require continued, periodic premium payments to remain valid. On the other hand, the Policy maturity value is contractually determined at the creation of the Policy. Hence, the risk-reward proposition can be modelled, including pricing in the on-going asset maintenance costs, with a higher degree of accuracy than may be the case with other asset classes. The lack of correlation to prevailing market or economic trends appeals to investors. Some potential investors may be disuaded because the average life of acquired Policies is currently between 7 and 10 years, with typical returns of between 10% and 14%, although delayed return on investment could be mitigated by a blended securitization including shorter term front-end assets. Structuring A number of tax efficient jurisdictions would be appropriate domiciles for the securitization vehicle. The authors have structured transactions in European Union ("EU") jurisdictions which have quasi-offshore characteristics, such as the Republic of Ireland. An issuance of securitized LIS paper could meet the requirements of EU listing rules, thereby enhancing investor appeal and qualifying the Notes for purchase by certain types of regulated investors, such as pension funds. Structuring the transaction is fundamentally driven by tax considerations. The authors will address such considerations, as well as two recent U.S. Treasury revenue Rulings, in a subsequent article. Currently, double taxation treaties ("DTTs") exist between the United States of America and a number of securitization jurisdictions. DTTs permit the payment of interest on the Notes to be made free and clear of withholding tax, subject to compliance with treaty requirements, such as with respect to the amount of domestic and overseas ownership of the Notes. In addition, the parties need to ensure that there is no backup withholding tax on Policy maturity payments, as well as preserve the issuer's control over investment management decisions relating to cashflow. We will address these and other tax related issues in this subsequent article. Conclusions The mechanisms exist to facilitate successful securitization of the LIS asset class. These include the creation and transfer of an asset pool, accurate modelling methodology and the availability of DTTs. The issued paper could be listed and potentially rated. Managing origination risk is perhaps the key challenge. In this regard, investors will benefit from a focus on best practice guidelines and the adoption of uniform federal requirements, in the post-RMBS securitization landscape.

To read more on the taxation issues surrounding life insurance settlements, visit: http://www.dorsey.com/life_settlements_taxation

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

Mr Thomas Gallagher Dorsey & Whitney LLP 50 South Sixth Street Suite 1500 Minneapolis MN 55402 1498 UNITED STATES Tel: 6123402600 Fax: 6123402868 E-mail: marketing@dorsey.com URL: www.dorsey.com