Securitization poised to bring life to death bonds

Pension fund executives might turn to securitized life-settlement policies for their liability-driven investment strategies, filling the gap in the market for long-duration bonds, experts say.

Currently, life-settlement policies — which are pools of life insurance policies sold by the holders at a discount to the policy amount and purchased by investors who hope to collect the full policy amount when the insured dies — offer an opportunity for pension executives to invest assets in line with their liabilities. But the prospect of securitizing the policies — delayed at least until next year by credit-market woes — might make the assets more attractive to pension executives.

“Securitization will allow for tradability of life settlements and more choices in the marketplace, and when you securitize these assets it will force people to place rules and standardization in place,” said Jay Vadiveloo, head of insurance and financial services at Watson Wyatt Worldwide in Hartford, Conn. ”As a result of this, we’ll see improved analytics as well. This asset class could use some standardization in practices.”

“It’s clearly not overtrafficked investment space,” he said. “It has potential for pretty decent returns and is not a highly volatile investment — a plus for pension funds and endowments. Pension funds and endowments that use an LDI strategy would see the biggest benefits as these bonds would offer them diversification. This asset class is highly uncorrelated to anything else, thus making it very attractive.”

Added David Fishbaum, Chicago-based head of the actuarial unit at Oliver Wyman: “This is an interesting class that provides high returns and as an alternate asset class would provide LDI investors with a good return and diversification to their portfolios.” He estimated that returns could be 9% a year.

Growth in life settlement policies is skyrocketing. In a report, analysts at Sanford C. Bernstein & Co., New York, wrote this market is expected to grow to $160 billion in 2030, up from $30 billion at the end of 2007.

Pension funds such as the $232.1 billion California Public Employees’ Retirement System, Sacramento, and C$115.5 billion (US$108 billion) Ontario Teachers’ Pension Plan own pools of the polices., said Lawrence Simon, chairman and chief executive officer of Life Settlement Solutions, San Diego.

Robert Bertram, executive vice president of investments at Ontario Teachers Pension Plan in Toronto, said the fund doesn’t directly invest in life settlements, and if they become securitized, the securities could be used as a potential hedge for the pension plan’s liabilities.

Clark McKinley, spokesman for CalPERs, confirmed the plan owns $200 million in life settlements but declined further comment.

Life-settlement industry sources say investment banks are chafing at the bit to securitize these assets, but are hampered by difficult credit markets.

Life Settlement Solutions’ Mr. Simon and Zohar Elhanani, chief operating officer at Legacy Benefits LLC, New York, said Wall Street investment banks such as Goldman Sachs Group Inc., Deutsche Bank AG, UBS Securities LLC, Morgan Stanley and Suisse Securities LLC are either buying pools of life settlements or independently working to make securitization a reality.

Michael DuVally, spokesman for Goldman Sachs in New York, declined to comment on the specifics, but said the firm worked with National Financial Partners Corp., New York, and Genworth Financial Inc. of Richmond, Va., creating the Institutional Life Services LLC, a marketplace for life-settlement policies, and Institutional Life Administration LLC, a clearinghouse for these policies.

Furthermore, Goldman Sachs launched the first index tracking longevity and mortality risks. The index, QxX.LS, is the first in an expected series of life insurance policy indexes, Mr. DuVally said.

Spokesmen at UBS, Morgan Stanley and Credit Suisse declined to comment.

However, Forrest Gilman, global head of longevity derivatives at Deutsche Bank in New York, said life settlements would not be securitized in the same way as have credit cards, automobile and home loans.

“The negative cash flow nature of life insurance policies doesn’t lend itself to traditional securitization,” Mr. Gilman said. “Also, it has been difficult to accumulate a pool of policies to fit the rating agencies’ model for ratings — there’s little historical data available to measure past performance to gauge future performance and assign a rating. Life settlements as a market is only 8 years old.”

Securitization of life-settlement policies will make them more attractive to a broader institutional audience, experts say.

Mr. Simon said institutional investors looking for investment options and exposure to these alternative investments would boost demand for securitized instruments. What’s more, securitized deals would offer larger size and greater liquidity than what’s now available from being whole policies.

“I think we are maybe only one or two years away from fully securitized life-settlement deals,” Mr. Simon said. “The credit markets right now are a big problem.”

The ratings agencies also present another hurdle to the life-settlement securitization.

“The ratings agencies are a major problem as I think their credibility has been hurt dramatically and do they want to launch into a new asset class given the unknowns in this market,” Mr. Simon said. “The only one close to rating these investments is Moody’s.”

Mr. Simon cited a statement from Moody’s Investors Service statement indicating the company would probably rate at least one life-settlement securitization within the next 12 months.

Moody’s did rate one life-settlement structured deal in 2004, the Legacy Benefits Life Insurance Settlements Class A and B notes. The deal was not a true securitization because it had an annuity tied to it acting as a hedge and insurance against default. A true securitization relies on the underlying collateral’s performance to guarantee cash flow payment — not insurance or an annuity.

Legacy Benefits’ Mr. Elhanani said his company was banking on growth via securitization and issuing future securities without annuities, thus being the first pure securitization.

“If you build a big enough diversified pool of life settlements, there’s no reason to not get a (good) credit rating and distribute bonds,” Mr. Elhanani said. “In last few years, we became a warehouse to build a diversified pool of life settlements, which takes time. We’re definitely looking at securitization and or a fund to bring to investors.”

Watson Wyatt’s Mr. Vadiveloo, said despite the lack of pure securitized life settlements, there is “a lot of activity going on” as institutional investors are buying and selling life settlements and policies outright.

“There is a lot of informal securitization — life settlement portfolios being bought and sold or being structured in a non-rated manner, using lines of credit or open pools,” he said. “The market has created its own liquidity in this fashion.” He declined to provide client names.

Contact John D'Antona at [email protected]