The Asset and Liability Sides of Senior Life Settlements

Abstract

In this article the authors define a reference time called t ₀, in longevity/value space, as the longevity that drives a life settlement contract to a zero value. They develop the t ₀ metric to show how the “longevity gap” collapses and expands as actual longevity of the pool of insured deviates from the forecasted longevity upon which the pricing of the life settlement contracts is based. The “longevity gap” or “gap” measures the value of the asset component of a life settlement contract (the death benefits), relative to the value of the liability component (the required premium payments). The longevity gap metric can be used by investors and creditors to measure the solvency of individual life settlement contracts or portfolios of life settlement contracts. Because the value of the asset side of a life settlement contract expands and declines at a different rate than the liability side when longevity changes, t ₀ becomes a threshold that investors can use to gauge and compare the longevity risk embedded in life settlement contracts that are being offered. The authors show that policies valued by simply discounting the stream of cash flows of life settlement contracts based on an expected longevity of the underlying population of insured can be misleading. Knowing at what longevity of the insured the policy will hit t ₀ offers valuable information.

TOPICS: Other real assets, legal and regulatory issues for structured finance