Life Settlement Underwriting

LIFE SETTLEMENT UNDERWRITING

Life Settlements are one of the fastest growing segments of the life insurance marketplace. Yet, many life insurance professionals have never completed a life settlement transaction. This is likely due to lack of product knowledge. Fortunately, the Life Insurance Settlement Association (LISA) and other organizations are doing an outstanding job of disseminating information about life settlements. In spite of this explosion of information, very little has been written regarding the underwriting process. It is critical that financial professionals understand the similarities and differences between underwriting practices for life settlements as opposed to traditional life insurance.

A life settlement occurs when an individual (typically age 65 or older) sells an existing life insurance contract for cash. The face amount of the policy is usually $250,000 to $30,000,000 and higher, is beyond the contestable period and the insured has a life expectancy of 15 years or less. The amount received for the policy is more than the cash value but less than the death benefit. The settlement amount is determined after calculating the present value of future benefits from the proceeds of the policy minus the present value of future expenses of the purchaser. Expenses of the purchaser include premium payments, administration expenses and profit. Since the purchaser is required to pay the policy premiums until the maturity of the policy, one can see how critical the life expectancy estimate is to the process. If a life expectancy assessment turns out to be too short, then the purchaser will pay too much for the policy. Conversely, if a life expectancy assessment turns out to be too long, then the seller will receive too little for the policy. Providers who specialize in purchasing life settlements usually obtain life expectancies from two or more independent Life Expectancy Providers. Some large Providers also maintain in-house underwriting staffs. Life expectancies may vary considerably depending on the interpretation of the medical information and the actuarial table used.

LIFE EXPECTANCY PROVIDERS

LISA defines Life Expectancy Providers as “actuarial and physician experts who apply probability theory, actuarial methodology and medical analysis using the records of the insured to calculate the probable life expectancy of an insured”. Many Life Expectancy Providers also utilize experienced life insurance underwriters to work with the actuarial and medical experts. There are currently 5 major Life Expectancy Providers whose assessments are generally accepted by purchasers: AVS, Fasano, 21st Services, ISC Services and EMSI. These companies specialize in underwriting the older age marketplace by developing proprietary methods, underwriting manuals and mortality tables. Some Life Expectancy Providers start with Reinsurance Underwriting Manuals as the basis for their ratings. These reinsurance manuals were written primarily for applicants up to age 65 and insurable impairments up to 500% since this has been the traditional market for life insurance. Life Settlement Underwriting generally begins at age 65 and impairment ratings can run much higher than 500%, so modifications are typically made based on extensive research of the most current older age mortality data combined with analysis of recent medical advances in the treatment of disease and any experience data accumulated in-house. In general, the underwriter begins with the traditional debit and credit methodology to determine an overall rating, either standard or substandard. This approach is an approximation since few impairments result in a uniform percentage increase in mortality. In most cases, this approach produces reasonable results. However, for some conditions, such as many forms of cancer, the debit approach does not produce reasonable results because the shape of the impaired mortality curve is significantly different than the standard curve. For these impairments, different approaches are used. Some Life Expectancy Providers continue with the debit/credit approach while others use extra deaths for a limited length of time, or a combination of these. The final assessment is then converted to a life expectancy through actuarial calculations. For a highly impaired life with a short life expectancy, clinical judgment may be used in lieu of an actuarial calculation. The life expectancy calculations combine the underwriting assessment with the appropriate mortality table. Each Life Expectancy Provider uses their own proprietary mortality tables that may be based on sex, smoking status, impairment and preferred class. While it is generally assumed that Life Expectancy Providers use the 2001 Valuation Basic Table (VBT), it appears that most, if not all, either use their own tables or a heavily modified version of the 2001 VBT.

Life settlement underwriters rarely decline to underwrite a case for medical reasons. For instance, medical conditions such as AIDS, Alzheimer’s disease and Congestive Heart Failure would most likely be declined for life insurance purposes. However, it is possible to estimate a life expectancy for these conditions. In addition to reviewing the medical history, Life Expectancy Providers often analyze factors that contribute to healthy aging, such as regular physical exercise, participation in social activities, positive mental attitude and commitment to a healthy lifestyle. For those insureds with a debilitating chronic disease, the availability of a caregiver and a support network become important. This adds a level of complexity to the underwriting analysis that could affect the life expectancy.

REQUIREMENTS

When submitting an application to a direct writing company on an older individual for a large life insurance policy, producers are required to submit current medical evidence as outlined in the insurance company’s medical underwriting requirements guide. The usual requirements would include an exam, blood profile, EKG and attending physician’s statement (APS). Many companies also require functional assessments on older age applicants which include the ability to carry out the activities of daily living such as bathing, dressing, eating, transferring and toileting. Large policies usually require financial underwriting.

The good news is that life settlement underwriting rarely requires medical exams, EKG’s or blood profiles. After receiving the completed application, attending physician’s statements are ordered from selected physicians. This information will be forwarded to a Life Expectancy Provider by the requestor, usually a Broker or Provider. After review of the supplied medical history, the Life Expectancy Provider will furnish a detailed life expectancy on the individual to the requestor. The Provider will then prepare a bid for the policy. Unlike traditional life insurance where applications can be declined, it is rare that a Life Expectancy Provider will not furnish a life expectancy. The Life Expectancy Provider must usually make a decision based on the information submitted. Occasionally, a life expectancy will be completed but the Life Expectancy Provider will indicate that their analysis may change if furnished with additional information from an attending physician. The Life Expectancy Provider will not order current medical requirements, such as an exam, EKG or blood work.

Rarely, a life expectancy cannot be provided when there is not enough medical information from the attending physician to make an informed judgment. It might seem favorable that an insured has not seen a doctor in two or three years. One might assume that there have been no medical problems during this time. However, under these circumstances the Life Expectancy Company has no basis to establish a life expectancy. A physician has not completed a thorough examination of the patient’s current health status. There are no laboratory studies to review or electrocardiogram results. Often serious medical conditions can be undiagnosed if there has been no regular follow-up by an attending physician. It is in the insured’s best interest to disclose all medical conditions so that the life expectancy can be as accurate as possible.

Among the factors that the Underwriter or Medical Professional looks for when reviewing the APS are smoking history, weight, cholesterol values, family history, blood pressure readings and medical history such as heart attack, stroke, pulmonary disease, diabetes, cancer, signs of frailty, Alzheimer’s disease and ability to perform the activities of daily living. From the insured’s viewpoint, if they are medically impaired in some way, the life expectancy will be shortened and they will receive a larger cash settlement for their policy.

DIFFERENCES BETWEEN LIFE SETTLEMENT UNDERWRITING AND TRADITIONAL LIFE UNDERWRITING

• Complexity: Since the applicants are older, the medical history is often more complex than is seen in traditional life underwriting. This requires underwriting professionals that work in life settlements to have extensive experience in impaired risk underwriting.
• Close working relationship among underwriters, physicians and actuaries: In traditional underwriting, the underwriters frequently make the final decision regarding the mortality assessment. In life settlements, underwriters, physicians and actuaries must work closely together because of the complexity of the medical conditions. The ratings must be converted into life expectancies. Thus, the life expectancy calculation is not simply a matter of adding together the debits on a case but making sure that the life expectancy is consistent with the medical history provided.
• Competitive Offers: A competitive offer in traditional life underwriting would mean as low a mortality rating as possible on a medically impaired risk or classification as a preferred risk. With life settlements, a competitive offer would mean a higher rating since this should result in a shorter life expectancy. Thus, the insured would receive a larger settlement for their policy.

CONCLUSION

The underwriting approach for life settlements is different than traditional life underwriting. When reviewing an application for life insurance, the major concern of the underwriter is avoiding anti-selection in early policy durations. A proposed insured may be classified as a preferred, standard or substandard risk. If substandard, they are charged an extra premium that is commensurate with the increased risk. In life settlement underwriting, a preferred, standard or substandard rating is determined but this is translated into a life expectancy rather than a premium. It is critical to obtain a thorough and complete medical history when completing a life settlement application. This includes a complete medical history, list of prescriptions medication taken and details regarding tobacco usage. A thorough knowledge of the life expectancy process will help producers obtain the highest return for their clients and result in more cases being placed.