Settlement Industry Expects “Perfect Storm”

Changes in mortality tables and a general lack of liquidity have pushed the portfolios of several life settlement firms underwater, and could force a flood of policies into the secondary market later this year.

“Some people are going to need to stop the cash burn, so there could be an avalanche of product coming onto the market that will have a dramatic effect on valuations and pricing,” said Zoran Fotak, president of Luxembourg-based Inscap Management. “The credit crunch combined with mortality changes by medical underwriters created a perfect storm.”

Zotak and other life settlement professionals made their comments at the Insurance Linked Securities Summit sponsored by FinanceIQ last week.

Last year, the life settlement industry was thrown into turmoil when several providers of life expectancy estimates — including 21st Services and EMSI — revised mortality tables for most groups.

The resulting estimates for increased longevity was bad news for settlement firms that now need to put aside additional capital to continue premium payments on the underlying policies.

The extension of the mortality tables has undermined the value of many portfolios, while also eroding lenders’ willingness to commit capital to an industry that made such a fundamental mistake, said Fotak.

“The extensions shouldn’t have been a disruptive as they were, but the valuations to price the policies were wrong” Fotak explained. “Rather than exercising a healthy degree of skepticism, we were dragged along and [we] bought into the Kool Aid.”

The worst damage will likely occur for managers that have created synthetic products out of life settlements because the leverage will only compound losses coming out of the underlying policies.

“Adding leverage on that trade makes it potentially very toxic unless you have a great understanding of the risk involved,” Fotak added. “Until the cash market stabilizes, the synthetic market would continue to have issues.”

The losses in life settlement funds is already leading to increased due diligence on the part of investors, said Michael Byl, president of Strategic Directions Management.

Byl said investors are looking for greater transparency in life settlements funds and sometimes pushing for greater communication by managers during the life cycle of the fund.

“Transparency stands all the way at the top and if you don’t have that, you are not going to the next level,” Byl said.

He added that some investors are even pushing for separate accounts, rather than having their assets sit in a commingled fund, — to exert greater control and oversight.

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