Handbook of Finance: Financial Markets and Instruments

Chapter 59. Investing in Life Settlements

ANTHONY F. L. PECORE

Research Analyst, Franklin Templeton Investments

Abstract: Life insurance is an asset and can be sold into a willing market. For years, life insurance companies served as the only market, paying cash surrender value. In recent years, the life-settlement market has developed to give competitive market pricing, rather than cash surrender value, to policyholders for their unneeded insurance. Development of a risk framework for life settlements requires an understanding of the mortality risk and expected cash flows.

Keywords: life settlement, life expectancy (LE), mortality risk

Life settlements are a new asset class for the investor. We believe life settlements possess investment characteristics that will be very attractive to those in search of investment-grade credit quality, long duration, assets priced at attractive spreads, with low correlation to other capital markets. The purpose of the chapter is to introduce the life settlement cash flow to asset managers, survey the driving valuation factors, and provide a first-order analytical framework for risk management.

INVESTMENT CHARACTERISTICS

After a policy owner has made the economic decision that their life insurance policy is no longer needed, they may seek to sell the policy or lapse the policy and accept the cash surrender value, if any, from the issuing insurance company. If the policy owner sells the policy to an investor, the investor will pay all future premiums and ...