Life settlement securitisations reviewed

The launch of a true life settlement securitisation market continues to edge nearer (see STORM issue 47) as two firms are believed to be closing in on completing the first ever deal before the end of the year. At the same time, concerns being raised about such deals, including a new report from S&P, appear to be misplaced for some potential deals at least.

Those prepping the leading deals argue that comparisons of life settlement securitisations with failed mortgage-backed securitisations in newspaper articles and now in Congress are like comparing apples to oranges. They say that the life settlement deals they are involved with are very transparent and are not highly leveraged.

"In one case we expect that the issuer will be issuing equity and the rated debt component to be less than 1/3 of the total death benefits. Additionally, we expect that more than half of the total raised will be held in reserves," says one structurer. "Equally, the life expectancy stresses being put on transactions could actually be regarded as overly conservative, with the single-A rated stresses being more conservative than 70% VBT 2008. The stresses also include block out periods where no deaths are allowed to occur."

Further, the structurer says: "In our transactions every life settlement is reviewed and receives a legal opinion from a top-tier law firm and is reviewed by a second law firm during the rating process to ensure the origination was in order and there are no insurable interest issues. Other standards are used to prevent improper or predatory life settlement business practices from benefiting from the rated securitisations. Overall, we believe the standard is way in excess of securitisations done in the mortgage market. It is also possible to follow the securitisations and mark-to-actual as opposed to mark-to-model."

S&P says its new report on life settlement securitisations follows what it describes as renewed interest in the instruments being expressed by various institutions. Although it notes that both investors and originators see the potential benefits in this asset class, the rating agency believes there are inherent risks in, and obstacles to, securitising life settlements.

Nevertheless, the structurer says: "It looks like the investors for our first rated bond will consist of one or two investors with first-hand expertise and understanding of life settlements. They will also be conducting their own risk assessment and due diligence process. These are sophisticated institutional investors - ideally placed for life settlement securitisation investment."

While S&P has not rated any life settlement securitisations, the agency provides in its new report its view on the attendant risks and difficulties in such transactions. The report lists a number of major concerns, which include: the actuarial assumptions underlying a transaction; that noteholders who do not have insurable interest in the lives covered by the pool of policies become the ultimate beneficiaries of the policies; the accuracy of independent medical reviews; that most life settlement originators have either limited or no track record; and the timing of the cashflows.

However, S&P notes that some investors believe that these bonds offer portfolio diversification and that those already immersed in more traditional fixed income investments can use these bonds to balance their holdings. "For example, similar to how some investors perceive natural peril catastrophe bonds, investors do not believe there is a significant correlation between mortality and the condition of the economy - though there is correlation between the condition of the economy and the credit quality of the insurance providers," the agency explains.

In conclusion, S&P says that in order for it to rate its first life settlement transaction, the concerns it outlines would need to be addressed. In addition, it would first need to create and publish criteria for rating securitisations of this asset class.

MP