Have you heard of “death pools”? They’re games, of perhaps questionable taste, in which participants pick, say, 10 famous people they think might die within the next year. The contestant whose tally is the highest wins.
Of course, there is an entire, very large industry — life insurance — whose economics are based in large part on predicting when people will die. Unlike death pools, there is no hint of ghoulishness at play. Unless a policyholder ceases paying the premiums or surrenders the policy to the insurer in exchange for a cash payment (normally a tiny fraction of what the eventual death benefit would be), the longer the policyholder lives, the better the insurer’s return.
And then there is a related industry, which is barely a blip on the radar compared with the mainstream life insurance business. “Life settlement” companies buy life insurance policies directly from seniors (generally age 65 and up) or indirectly through life settlement brokers, or in some cases through other channels. They pay exponentially more than the policies’ cash surrender values, and then, upon owning a policy, they make the premium payments and collect the eventual death benefit.
For such companies, the return on investment is better the sooner the former insured dies. Yikes!
All kidding aside, the life settlements business isn’t anything like a game, nor is it ghoulish. Rather, there is a bona fide market that’s in need of its services, as the economics make a great deal of sense for policy sellers and buyers alike.
Still, given an opportunity to interview the finance chief of GWG Holdings, the parent of life settlement company GWG Life, we can’t resist asking: Does anyone ever question the morality of such an enterprise?
“Our customers certainly don’t question it, which is the key answer to the question,” says the CFO, Bill Acheson. “Since 2006, we’ve paid seniors roughly $315 million for their policies. That’s on the order of $300 million more than they would have received had they surrendered the policies [to life insurers].”
A Beckoning Market?
Here’s a fairly sobering fact: nearly 88% of universal life insurance policies don’t result in a payment or claim. In 2014, $602 billion of individually owned insurance benefits lapsed or were surrendered, according to the “American Council of Life Insurers Fact Book 2015.” And in 2015, $182 billion of such benefits were in policies with the kind of profiles that might be fit for life settlements, according to research firm Conning.
The market for life settlements is similar in key respects to the market for reverse mortgages, a more widely known financial instrument that allows cash-strapped seniors to sell their homes to reverse mortgage firms and keep living there for the rest of their lives.
“We believe that life settlements are going to be very common consumer transactions in the future,” says Acheson, noting that “reverse mortgages were not well-understood or widely accepted 15 years ago.”
Acheson, who’s had a long career in specialty finance sectors, mainly mortgages and unsecured lending, says that “like many people,” he’d never even heard of life settlements until not long before joining GWG in mid-2014.
“As I looked under the hood and saw the emerging growth nature of this market, with the senior population expanding rapidly, and as I began to understand the transactions and what seniors get from them, I thought, ‘Wow.’ The business has some interesting math and also specialty finance characteristics, so it’s a good fit for me.”
While there is surely a lot of complicated math — of the actuarial sort — that underlies the business, one quite relevant equation is flat easy to comprehend. That $315 million GWG has paid out has brought in $1.8 billion worth of life insurance policy benefits, according to Acheson.
Despite the fact that GWG makes more money when an individual dies soon after the company purchased his or her policy (the weighted average age of people on whom GWG owns policies is 83), it does buy policies on people with longer life expectancies, as those are less expensive to acquire. “The best thing to do is grow a large portfolio of policies, so that there is actuarial stability,” Acheson says.
But GWG rarely buys policies on those with more than 10 years of life expectancy, “because the amount we could pay the owner would be negligible, if not zero,” he adds.
Managing risk is always a core element of running a business, but in the case of life settlement firms, buying the right types and mix of policies is particularly crucial from a risk management standpoint.
GWG employs three main risk management practices, says Acheson, two of which address the choice of policies purchased. First, it highly favors policies originated by life insurers with investment-grade or better credit ratings. Second, before purchasing a policy GWG re-underwrites it, getting a third-party medical opinion on the policyholder.
The third risk-containment strategy is borne out of the fact, unlike what happens when a life-insured person dies, that the families of people who have sold their policies have relatively little incentive to inform the life settlement company when their relative has died.
So, GWG runs monthly online searches for obituaries and employs a third party to run more sophisticated, algorithm-based searches. The third party also searches the Social Security Death Index and has contractual access to search for obituaries in certain state databases.
Finally, GWG reaches out to a designated point of contact for each living former policyholder, usually a family member or designated financial professional, every three months via email, phone, or regular mail.
Getting to the Source
On the acquisition side, the company, like its competitors, buys most policies not from individuals but from life settlement brokers, which find policies, gather required documentation, and auction them in a competitive bid environment, Acheson says.
The company also sources policies through its network of approximately 3,200 financial advisers. In addition to helping GWG purchase policies from their clients, the advisers sell GWG’s line of publicly registered, nontraded investment products, including fixed-income debt and preferred stock, as well as the company’s Nasdaq-listed common stock.
There is a circular flow of money: GWG uses the proceeds from these offerings to buy and service its portfolio of life insurance policies, and the investors earn returns or yield on their investments from the realized value of the underlying policies, notes Acheson.
Other sources of policies for GWG include life insurance agents and individual policyholders, although the company hasn’t devoted significant resources to the latter because direct advertising is expensive and the other source channels are effective, Acheson says.
The transactions are not always straight purchases. For example, GWG can pay the policyholder a lesser amount than it otherwise would, or nothing, instead giving the policyholder a portion of the death benefit.
Acheson says he and other GWG executives devote a great deal of time spreading awareness of life settlements and the company’s investment products among investors, analysts, and investment bankers.
But despite low awareness, the industry is hardly new. A close cousin, the viatical settlement industry, took off in the 1980s, when many AIDS victims faced short life expectancies and needed cash while they were still alive. In later years, as people with AIDS started living longer, demand for viatical settlements waned, but a path had been paved for the emergence of the life settlements industry.
A life settlement is similar to a viatical settlement, but the insured is typically at least 65 years old and is not chronically or terminally ill.
Prior to the credit crisis that began in 2007, investment banks and other institutional players poured significant capital into the life settlements industry, Acheson notes. This abundance of capital, a nascent regulatory environment, and the actions of insurance carriers led to the creation of many life insurance policies specifically for resale in the secondary market.
Some such policies, originated using falsified information regarding the applicant, became known as STOLI (stranger-originated life insurance). The practice contributed to a public perception that the life settlements industry’s ethics were questionable.
However, the credit crisis caused a pullback in secondary-market investments and served as a catalyst for a more robust regulatory environment. Today, 42 U.S. states regulate the life settlements industry, although capital has been slow to return.
“Our contracts, other documents, and transactions with consumers are very highly regulated,” says Acheson. “This has gone from an unregulated, fast-money market to one that is very safe for consumers and for investors in us or in life settlements.”