When discussing what’s in store for life settlements funds, it’s important to consider what’s come before. In 2022, public equity and bond markets both suffered double-digit losses as investors reacted to a triple-whammy of the Russian invasion of Ukraine, higher inflation in part driven by higher commodity prices, and a rising interest rate environment designed to rein in price rise pressures.
Selling pressures in the public / liquid markets translated to the private markets. Private equity and venture capital funds had to endure valuation write-downs in line with their public market equivalents. Alternative credit investments like private debt also started raising red flags as portfolio companies began to feel the strain of consumers tightening their belts.
Life settlements fit into the alternative credit bucket. But we didn’t see plummeting values in life insurance policies owned by life settlement investment funds because that’s not how these instruments work; we didn’t see life settlement funds deviating too much from the typical discount rates they use to bid for policies; and we didn’t see many forced sellers in the tertiary market. Indeed, the underlying drivers of return in the space and the lack of correlation to both public and private markets are exactly what attracts investors to them in the first place.
The impact of macroeconomic events and trends in the life settlement market comes in the form of the risk/return trade-off versus other options. Demand for life settlement policies has been increasing in recent years as more investors realise the benefits of adding exposure to this asset class to a diversified portfolio; this has had the effect of dampening the discount rate at which life settlements are purchased, a classic case of increasing demand causing price pressures on the existing supply. If interest rates keep rising, and demand continues to increase, a cross-over point could be reached where the life settlement asset class offers very little risk premium over risk-free returns despite the lack of reduction of the longevity risk exposure inherent to these products.
What’s different here is that investors are re-evaluating whether the classic 60/40 stock/bond portfolio is right for them. They’re increasingly looking to alternative credit solutions to replace some of their government bond exposure so they can access less volatile, longer term return streams. We’ve seen some investors look to the life settlement market in 2022 for this exact reason and we’d expect that to continue in 2023, provided that the discount rate gap doesn’t close too much.
Another factor that affects the life settlement market is the activities of life insurance companies themselves. It’s important to remember that the life settlement market is a negative contributor to life insurance company performance because what the insurance company pays out to life settlement investors is higher than the surrender value they would pay to the original policyholder.
The post-Global Financial Crisis ZIRP era impacted life insurance companies’ profits because they were unable to access yield from government bond investments whilst simultaneously being on the hook for higher interest rate promises to policyholders who took out coverage well before the GFC. Raising the Cost of Insurance component of a life insurance policy was one action taken by some carriers to increase revenues to address the shortfall. Another issue is that of ‘carrier encroachment’ – where life insurance companies buy the policies back from the insured themselves at higher values than the surrender value (but lower than what the policy holder would get from the life settlement market).
A rising interest rate environment might be beneficial to the life settlement industry, however, because life insurance companies can access higher yielding investments which might mitigate the need for additional COI increases. Additionally, the National Council of Insurance Legislators (NCOIL) passed a resolution last year which, in theory, should negate the carrier encroachment issue.
Other things to look out for in 2023 – and beyond – include the widening of the net used to model life expectancy. The industry has traditionally relied on medical reports, which vary wildly in comprehensiveness and consistency, to support their decision to purchase a life settlement. We’re seeing developments in the underwriting process ranging all the way from life insurance based insurtech to the hiring of internal life expectancy underwriters to either replace external providers or provide a second opinion to them. The other main topic that we feel is one to watch in 2023 is one of the levels of deal flow in the secondary market. Life settlement funds say there isn’t enough supply in the market but what’s also true is that the market isn’t set up to absorb a significant increase in the supply of policies in the secondary market due to operational challenges and the cumbersome nature of the bidding process.
Like many sub-sectors of the alternative credit industry, the life settlement market is set for an interesting 2023, but for different reasons. Where private debt investors see concern about inflation causing consumers to tighten their belts, thus affecting their portfolio companies, life settlement investors see concern from potential further interest rate rises eating into the risk premium that life settlements offer and dampening demand, for example. But life settlements have proven their ability to adapt in the past two decades and the industry is arguably in ruder health than ever before. It’s going to be interesting to see how life settlements performs from an absolute and relative perspective in 2023.
Corwin (Cory) Zass is Founder and Principal of Actuarial Risk Management