A colleague sent me this question. I’m not real sure how to respond, as I don’t deal with too many settlements. Thought you guys might know how to comment upon this thought:
"I am not saying it is a poor investment! What I am saying is this; “Do
the dynamics of changing the lapse rates on polices, (because of the
sale of these polices through life settlement options where they will
no longer lapse) change the underlying financial integrity of the
Insurance companies do not keep dollar for dollar
assets on all their policies because a large percentage lapse.
Policies being bought up in life settlement options where sold based on
underwriting guideline available at the time they were written. These
guidelines included lapse rates.
If the policies being bought today
are not going to lapse what does that do to the underlying financial
viability of the insurance company and take it a step further the
When a few banks wrote a few sub prime mortgages we had no
problems. When it become a wide spread business practice that included
the securitization and sale of these mortgaged back
securities as an investment we know what happened. Real estate dropped
in value and the house of cards tumbled.
Will billions or trillions of
dollars (I do not know the scope of life settlement option sales) in
life insurance polices that have been sold for these life insurance
settlement investments cause the insurance industry to falter or lose
value as the banks have? What will be the effect on our economy if
insurance companies do not have the assets to cover all policies? Is
the insurance industry increasing reserves to handle this changing
It was my belief that life settlements occurred on but a small % of outstanding policies.
Life settlements do have the potential to be very dangerous to the industry. I see two big dangers. The first is exactly what you are mentioning. They will lead to less lapses which means more death claims which ultimately leads to insurance costing more. The second is that it really turns life insurance into an investment which increases the chances of less favorable tax treatment.
Notice that applications now ask questions pertaining to this practice and policies are intended to be sold won't get approved.
If they proliferate, life settlements will force the insurance companies to raise the rates as fewer policies lapse.
Not only will life settlements mess up lapse rates and potentially affect the tax treament of benefits, you ignore the concept of ‘insurable interest’. Now, a third party has an interest in seeing the insured die earlier than they normally would. That by itself gives me pause to recommend life settlements in ANY case. I don’t want to sound like an alarmist, but in this tough economic environment, it’s not too unrealistic to think that some of these institutional investors will ‘call’ in their investment earlier than expected.