The Securitization of Life Settlements: Opportunities and Risks

From Individual Policies to Tradable Securities

One of the most significant developments in the life settlement market has been the securitization of policies. This process involves bundling a large number of individual life settlement policies into a trust and then selling notes or bonds to investors that are backed by the death benefits from the policies. This has transformed life settlements from a niche alternative investment into a more mainstream asset class.

The Mechanics of Securitization

The securitization process typically involves the following steps:

1. Origination: A life settlement provider purchases a large number of policies from individual sellers.
2. Warehousing: The policies are held in a "warehouse" facility, often financed by a bank, while a sufficiently large and diversified portfolio is assembled.
3. Creation of a Special Purpose Vehicle (SPV): The policies are sold to an SPV, which is a legal entity created specifically for the purpose of the securitization.
4. Issuance of Notes: The SPV issues notes to investors, which are rated by a credit rating agency.
5. Servicing: A servicing agent is appointed to manage the portfolio, including paying premiums and collecting death benefits.

Benefits of Securitization

Securitization offers several benefits to investors:

• Diversification: It allows investors to gain exposure to a large and diversified portfolio of policies with a relatively small investment.
• Liquidity: The notes are often tradable, providing a degree of liquidity that is not available with individual policies.
• Professional Management: The portfolio is managed by a professional servicing agent.

Risks of Securitization

However, securitization also introduces new risks:

• Complexity: The structure of a life settlement securitization can be highly complex, making it difficult for investors to understand the underlying risks.
• Counterparty Risk: The performance of the investment depends on the solvency and performance of the originator, the servicer, and other parties to the transaction.
• Model Risk: The ratings assigned to the notes are based on complex financial models, which may not accurately reflect the true risks of the portfolio.

The Role of the Rating Agencies

Credit rating agencies play a important role in the securitization market. They analyze the portfolio of policies and the structure of the transaction to assign a rating to the notes. This rating is a key factor for many investors in their decision to invest. However, the financial crisis of 2008 demonstrated that rating agencies can make mistakes, and investors should not rely solely on the rating in their analysis.

The Future of Life Settlement Securitization

Despite the risks, securitization is likely to remain an important part of the life settlement market. As the market matures and becomes more transparent, the risks associated with securitization are likely to decline. For institutional investors, securitized life settlements can be an attractive way to gain exposure to an asset class with low correlation to traditional financial markets.