The recently published post, “Life settlements in Canada: Right or Wrong?” by Richard Proteauc, considers the ethical objections in life settlements and discusses the moral consideration for this asset class. The nature of ethically investing in life settlements has been analysed in previous literature along with the opportunities for both investors and consumers.
The conclusion of many cases is that provided that there is full transparency with the product and processes between all parties there appears to be no ethical issues in investing in this asset class. Richard’s post was very intriguing and inspired us to examine some of the ethical objections raised in the article and review some others.
Why the Debate?
Without an understanding of the full process, the ethical nature of investing in the mortality of others can be questioned. However, life settlements are an ethically and morally responsible investment that facilitates a valued service for Americans who have an unneeded or unwanted life insurance policy.
Ethical objections may arise for several reasons. The first is the connection between death and profit. Another ethical consideration is the potential disparity which can exist between the profit made by the investor and the cash paid to the policy seller.
It is important to remember that the US Life Settlement market exists because it corrects a market inefficiency which arose due to a lack of liquidity in the life insurance product. Grounded in the same financial modelling as life insurance, a secondary market has bloomed for life insurance policies holders where there was previously none.
For investors who might question the ethical investment of the secondary market in life insurance, it is important to understand that life settlements provide policyholders with access to fair market value for their policies.
From the investor’s point of view, they have no interest in any particular person’s death, they are investing in statistical averages. From the ageing insurance policy owner’s point of view, they were stuck in a payment structure they do no longer need, and the existence of life settlements gives them the flexibility and an ability to change that structure.
Investors who are considering this asset class need to be aware that the we don’t add or subtract a single day of life from an individual by buying their policy. Yet there is no denying that the Fund, and its investors, adds to the quality of an insured’s life by purchasing their policy.
From a business perspective, a life settlements investment offers numerous opportunities, and from the personal perspective of the insured, it is a valuable service.
Below we have analysed some of the ethical objections that arise when considering an investment in the asset class.
What are the Ethical Objections in Life Settlements?
One of the key issues explored is the question whether it is ethical to profit from the speculative nature of the asset class.
Mortality projections are a critical feature of life insurance, defined benefit pension plans, annuities and equity release plans among other financial products. Pension plan sponsors gain from the early deaths of plan members and pensioners, as do annuity providers.
So relying on mortality projections as part of a financial product is nothing unusual. It’s not just the insurance companies speculating on their death, anyone who takes out a life insurance policy is in essence speculating on the end of their life. They do this because they want to protect their dependants in the event of their death.
Furthermore, it is evident that when investing in the life settlement asset class an investor is not projecting on the mortality of a single life but on the transactions linked to the realised mortality of a large pool of anonymous life policies.
In 1911, the U.S. Supreme Court ruled that life insurance policies were freely assignable for value. The Court found that a life insurance policy is a form of property and that policy owners are free to sell and transfer ownership to other parties
It is ethical for the insured to sell their policies back to the issuing company in exchange for the cash surrender value of the policy, so why should they be prevented from selling the same policy to a life settlement company for a fairer market value price? If the insured is restricted to only selling their policy at a price dictated by the issuing company, it would appear that their property rights would be illegitimately and unethically limited.
From this perspective, individuals have a fair discretion choose what to do with their own life insurance policy. The life settlements market simply provides a mechanism for those who want to buy or sell a life insurance policy in a fair and regulated investment market.
This argument relates to the size of the policy normally considered for a life settlement. Many investment managers look at a minimum face value of US$1 million, and it can range to $20 million or higher. Obviously if they are that wealthy to own a policy of that size, then they are not necessarily selling in a distressed situation. Plus, many transactions are done via someone with a fiduciary duty to the client, such as their attorney.
To some people life insurance is more commonly viewed as tool in prudential financial or estate planning, thus treated like any other financial product. For estate planning purposes many of them own more than one life insurance policy, so the attitude to life insurance in the US is different to other countries.
Insurance companies make money because a massive amount of all life insurance coverage lapses, with some media reports suggesting as high as 90% of all life policies are lapsed before a claim is payable.1 Lapsed polices provide windfall profits to insurance companies. It is pointless to think that an insurance company can only solely make profits on lapses.
Furthermore, U.S. insurance regulators have taken notice of these lapses and surrender rates with subsequent loss to consumers. A few years ago the National Council of Life Insurance Legislators decided to do something about it and passed The Life Insurance Consumer Disclosure Act with the goal of helping consumers understand the alternatives to lapsing a policy.
This objection has been questioned in past literature including in 2002 the Financial Institutions Center at Wharton published a comprehensive evaluation to weigh in on the argument and concluded that,
“Although some increase in cost can be expected the issue of cost is tangential to the issue of consumer welfare, and an increase in cost does not imply any negative effect on consumer welfare. We conclude that the incumbent life insurance carriers’ efforts to deter entry by life settlement firms are motivated by the anti-competitive desire to maintain monopoly power over policyholders.”2
The effects of the life settlements market will continue to be seen. Until US insurance companies become competitive and concentrate on the welfare of the policy holder and design polices with a surrender value which reflects its economic market value, policy holders will continue to see the life settlements market as a valuable alternative.
In the United States, insurance is regulated at State level, although State regulators have a national body known as the National Association of Insurance Commissioners (NAIC).
The regulatory framework, which protects both the policy holder and the investor, is robust and continuing to strengthen. Not only does this provide protection but it also enhances market transparency and reputation. The regulation of the life insurance secondary market now exists in forty-five of the fifty states.3
Also a growing number of American states include Life Settlements under their definition of securities, while many states have adopted the consumer protection approach, or both. Some states have used existing insurance regulations to control potential fraud.
Well-publicized abuses within the industry have led to action by the federal government and state agencies. Laws regulating licensing of the older viatical and newer Life Settlement companies vary from state to state. Efforts to establish uniform guidelines have been moderately successful. A small number of states still have no licensing requirements while some states such as Florida, Ohio, and Texas, have more stringent licensing requirements.
The regulatory changes over the last few years are encouraging and continue to grow and attract reputable players to the industry giving investor’s greater confidence
If an investor is looking at investing in the asset class they should also consider partnering with life settlements fund manager which demonstrates a significant amount of experience in the industry.
Conclusion
While there is a bountiful amount of literature available on the asset class is clear that there are not particular ethical issues which should prevent you from investing; provided that the products and processes is stays fully transparent to all parties.
A life settlement offers a win-win outcome for both parties as an unwanted policy becomes a valuable, tradeable asset. The policy purchase is simply a negotiated financial transaction between a willing seller and a willing buyer.
“We believe investors should continue to investigate the use of investments such as life settlements to gain exposure to real alternative risk premia.” 4
As always we wish you well in your endeavours in this interesting and valuable asset.
Please feel free to contact us if you have further questions.
[1] KPMG, 2013, Walking a Thin Line: Opportunities and Hidden Dangers of Life Settlements
[2] Neil A. Doherty and Hal J. Singer, 2002, “The Benefits of a Secondary Market For Life Insurance Policies”, Wharton Financial Institutions Center
[3] Edward S. Adams, 1 May 2013, “The Emerging Alternative Investment – Life Insurance Assets”, Insurance Studies Institute
[4] Mercer, April 2010, “Insurance Linked Strategies: Life Settlements”
Disclaimer: This information is intended for qualifying investors only and was correct at the time of preparation. It has been prepared to provide general information only and should not be considered as a “securities recommendation” or an “invitation to invest” in any jurisdiction. Potential investors should consider the relevance of this information to their particular circumstances. Before proceeding investors must obtain the prospectus and take their own legal and taxation advice. If you acquire or hold one of our products we will receive fees and other benefits as disclosed in the prospectus and relevant offering documents.
