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23 November 2011

Life Expectancy is not an off the shelf component for Life Settlements success, advises SL

Global specialist asset manager, SL, is advising that investors in Life Settlement funds should look closely at that fund's approach to life expectancy (LE). Current Industry methodologies need to be adapted in order to aid liquidity and therefore potential returns.

When investing in Life Settlements, the two factors that are crucial to the achievable return are the price to value relationship for the individual policies that make up the portfolio and anticipation of the cash-flow needs of the resulting portfolio.

In order to manage these factors, an appropriate assessment of life expectancies is of key importance. The specific LE factors relevant to individual policies, when viewed collectively, become smoothed out, allowing overall life expectancies to become more predictable. The life assurance industry's standard method of predicting the mortality of groups is to use the 2008 Valuation Basic Table Report & Tables ("2008VBT") issued by the Society of Actuaries. However, the Life Settlements industry is looking specifically at the portion of individual life insurance products that are sold in to the secondary market and these may not be fully representative of the whole population.

When a policyholder brings a policy into the secondary market, typically the intermediary will obtain an LE from one or more specialist Life Settlement underwriters. A fund manager may take this updated LE, reconcile it with the 2008VBT and base their calculations purely on that. However, SL warns this method may be too simplistic as the 2008VBT was designed for insured populations whereas actual experience within the life settlement market points to early-years mortality being lighter than within the wider population, which could lead to assets being overvalued and liquidity requirements being underestimated.  In short, only healthy people who are unlikely to die imminently tend to sell their policies. 

Other additional factors that could lead to policies being unrealistically priced are where an individual's medical records are not available or are out of date; this could lead to the fund manager being selected1 against if the individual has a longer life expectancy than their medical records suggest.

SL believes that, by applying further adjustments to the provided LE reports and current methodologies, a fund manager is able to add an additional layer of caution into any policy that is bought. This aids liquidity planning within the fund, with the simple aim of enhancing the returns the fund is able to achieve.

Louise Witts, Senior Actuary at SL and Fellow of the Institute and Faculty of Actuaries, said:

"Life Settlement funds are attracting a lot of attention due to their potential to provide steady returns in volatile times. But it is an emerging industry in which the importance of applying a robust assessment to the quoted life expectancies is becoming increasingly evident. A "best practice" approach is vital to success." 

1 - (Adverse) Selection occurs when two parties have asymmetric information and as a consequence the less favourable outcome is more likely to be selected.