The potential of pooling and then securitizing life settlement transactions will never be fully realized unless the market figures out a way to properly fund the deals, according to industry professionals.
Having the cash to purchase hundreds of policies — and the operational wherewithal to review and service them — is not yet realistic despite continued efforts to structure the deals.
“Very few people can do these transactions,” said Emmanuel Modu, managing director and global head of structured finance at A.M. Best. “The pipeline is big, but I know that 99 percent of them will never happen.”
During the recent Life Settlements and Longevity Summit sponsored by IQPC, Modu and other industry players said that the ability of managers to create large pools of life settlements and securitize them is hampered by a number of problems.
Firstly, a manager would need a significant amount of capital to purchase the number of policies needed to achieve a proper spread of risk and the economics of scale for execution.
Scott Willkomm, senior vice president of Coventry Capital, explained that while the minimum number of policies often cited by rating agencies for a life settlement securitization to work is 300, the more likely number is 500 polices since not every policy would be “a diversifying asset” to the pool.
“It you don’t have that number you don’t have a meaningful spread of risk,” Willkomm said.
That would mean a manager would need a great deal of cash on hand in order to purchase the policies needed, said Wai-Keung Tang, managing partner of Kappa-Life.
“The average [face value] of a policy is $1.2 million, so that means you need $500 million to $1 billion face in order to fund the policies,” Tang explained.
Not all managers realized the scale needed to support a life settlement securitization and often waste their time attempting to put together a deal that will not work, Modu added.
“Since 2005 I say we’ve received 200 phone calls [about life settlement securitizations]. Maybe 20 have a chance of becoming being done. Out of that 20 maybe three of four are realistic possibilities,” he said.
One solution could be to creating “warehouse lending” facilities where a lender would extend credit to the manager in order to purchase the policies. Warehouse lending was a popular tool in the expansion of the mortgage banking market until its implosion last year.
“Securitization requires you to own the stuff,” Willkomm said. “We have lacked sufficient warehousing in order to own the asset.”
While many people cite the recent AIG deal to securitize $8.4 billion in life settlements as a positive sign. However, Willkomm explained that since those polices were already owned by AIG and on their balance sheet they did not need to finance and purchase them on the open market.
Another key challenge of financing life settlement securitizations is liquidity since institutional investors that traditionally invest in securitized assets require a current coupon.
“If the investor is expecting a coupon along the way you really need to budget that in the the reserve account [of the fund],” Tan said. “That means you will have a huge negative carry on the cash you put aside.”
Even if a manager was able to finance the purchase of hundreds of life settlement policies, they would need the infrastructure to conduct the due diligence and servicing required not to run afoul of regulators, said Rachel Coan, a partner with Katten Muchin Rosenman in New York.
“The origination risk is really get it critical,” she said. “We had a client that h had to discard many policies because of those issues.”
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