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09 August 2012

“Life expectancy – one size does not fit all”

LouiseBy Louise Witts, Senior Actuary, SL Investment Management

One of the key attractions of investing in Life Settlements is that the return achieved is linked to the Life Expectancy of insurance policyholders, which is something uncorrelated to mainstream investment markets. An obvious consequence of this is that one of the corner stones of a successful Life Settlement fund is the manager's approach to Life Expectancy and mortality, which are key factors in pricing a Life Settlement policy.

When a policyholder brings a policy into the secondary market, typically the intermediary will obtain an estimate of their Life Expectancy (LE) from one or more specialist LE Providers.  This helps the potential investors to assess whether or not the policy is one which will fit in their portfolio and match the risk/reward profile of their fund.  The LE becomes a vital piece of information in the pricing of the Life Settlement and it is worth considering how it is used.

Currently, the standard mortality table used across the market for pricing Life Settlements is the 2008 Valuation Basic Table ("2008VBT") issued by the Society of Actuaries.  SL uses the gender- and smoker-specific 2008VBT mortality tables as a basis for pricing, in conjunction with corresponding gender-specific mortality improvement factors derived from those used by the Society of Actuaries in the 2008VBT report.

SL's pricing methodology is to adjust these underlying 2008VBT mortality rates (combined with mortality improvement factors) by applying a mortality factor unique to each life insured.  The mortality factor is calculated such that the actuarial LE derived from the adjusted mortality rates is equal to an average of the LEs obtained from the LE Providers.  The adjusted mortality rates result in a unique mortality curve for each life insured, which takes account of their relative impairment compared with the underlying table.

The bottom line is that it is difficult to encapsulate all the information on a policyholder in a single LE number. It takes a robust and sophisticated actuarial team to steer through the LE maze and some fund managers simply do not have the resources to go that extra mile.