An Exploration of Mortality Risk Mitigation

Abstract

Investors transacting in life settlement policies face many risks. But the most often raised concern from any life settlement investor surrounds extension risk, which is the probability that an insured individual lives well beyond his or her life expectancy. The risk presents two problems: 1) that the death benefit arrives later but does not grow with time and 2) that the ongoing premiums drain the investment returns. However, with the consumer market pressing to cash in their insurance policies, equity investors expanding the life settlement market may find emerging mortality solutions will bring bankers to the table. This article explores several solutions that mitigate the mortality uncertainty and enable the successful execution of financial transactions. A life-contingent, single-premium annuity structure combines a single-premium immediate annuity with a settled life insurance policy, incorporating debt-like characteristics of principal protection while providing the necessary mortality hedge. Residual value insurance has been developed to insure a policy's future value, making premium finance programs that use traditional lending more efficient. Mortality index swaps, which utilize recently developed mortality indices, allow life settlement providers and life insurance companies to indirectly hedge each others' risks. Principal protection insurance protects a life settlement portfolio manager from extended life expectancy over an entire portfolio. Now with the innovative risk mitigation solutions emerging, investors are able to combine traditional lending facilities with mortality risk transfer products and thus deploy capital more efficiently towards life settlements.

TOPICS: Credit risk management, private equity, asset-backed securities (ABS)