Moderator Nicola Barrett

Transcription

1 Investment Symposium March 2009 A5: Life Settlements Investing in Physical Assets, Synthetics & Swaps Brian Tijan David Weinsier Ellen Gardner Moderator Nicola Barrett

2 Confidential Physical Life Settlements March 2009 These materials may not be used or relied upon for any purpose other than as specifically contemplated by a written agreement with Credit Suisse. Origination Confidential 1

3 Sourcing policies Advantages and disadvantages of traditional vs. direct model Traditional marketplace Ins ure d Pro duc er Gen eral age nt Bro ker Pro vide r Inve stor Direct model Insu red Pro duc er Pro vide r Inve stor A direct model has several distinct advantages over its competitors: Access to larger volumes of life settlement opportunities Ability to fill client orders more quickly and effectively Exposure to more extensive and reliable market intelligence Ability to pay more competitive prices to policy owners Greater control over the origination process Direct origination allows for enhancement of policy quality Confidential 2 Role of a life settlement provider Serves as the purchaser in a life settlement transaction Provides services to the purchasing investor Allow the investor to choose policies based on a specific view or appetite Assist the investor in sourcing a tailored and competitive portfolio across the market-based on their individual methodology Providers may offer multiple services to institutional investors, limiting operational risk and enhancing product quality, examples include: Documentation maintenance Policy management Mortality tracking Claims filing Premium optimization and monitoring Confidential 3

4 Diligence Confidential 4 Not all life settlements are created equal There are meaningful differences in the risk profiles of policies available in the secondary life insurance market An investor does not want to purchase policies acquired by an insured with the intent to re-sell in life settlement market When purchasing traditional life settlements and previously financed life insurance policies, Credit Suisse follows these risk guidelines: Category 1 Category 2 Category 3 Category 4 Category 5 Category 1: Consists of traditional premium finance programs which are full recourse and 100% collateralized. Category 2: Consists of policies where both the owner and insured reside in states with favorable insurable interest laws. Category 3: Consists of premium financed programs which have a straight loan component where the loan accrues a reasonable interest rate and where the lender (i) is not entitled to some predatory fee if the policy owner decides to terminate the loan and/or sell the policy via a life settlement transaction and (ii) does not have any interest, directly or indirectly through an affiliate, in brokering the settlement. Category 4: Consists of policies where insurable interest risk is increased by the presence of certain factors that are not typically seen in traditional lending arrangements, but there are mitigating factors present. Credit Suisse will not accept at this time. Category 5: Consists of all of the premium finance programs that Credit Suisse will not accept at this time. Confidential 5

5 Extensive diligence should be performed An investor should ensure that brokers / agents representing policy sellers are acting in the best interest of the insureds Life Settlements Every broker and/or general agent is: subject to a Credit Suisse due diligence review required to complete closing certificate All insureds: must have spouses/insureds consent to the transaction consents to all transactional fees paid to their intermediaries have a closing call with Credit Suisse to confirm his/her understanding of the transaction Comprehensive documentation to protect the rights of policy buyer Full review of policy and ownership history; receipt of VOC from carrier Complete insurable interest review (including counsel review of all entity-owned policies) Structured Premium Finance Products All Credit Suisse products are recognized by the participating insurance carriers Every broker and/or agent is: subject to a Credit Suisse due diligence review required to complete closing certificate All insureds: are advised by their own broker or agent are represented by their own legal counsel have a closing call with Credit Suisse to confirm his/her understanding of the transaction Obtain CPA compilation report in most cases Comprehensive documentation to protect the rights of the lender Confidential 6 Portfolio Development Confidential 7

6 Physical market versus synthetic market Advantages of Physical Policy Ownership mark to market is not subject to counterparty methodology gives the investor full ownership of policies allowing for resale at a later time investor maintains ownership of policies, rights, medical data and all supporting documentation Straightforward Transaction Structure High Net Worth Senior Individual Sells policy in open market Investor Premiums Insurance Carrier Cash Death Benefit Investment in individual policies Traditional cash flow structure Upfront cost: purchase price as percentage of death benefit based on life expectancies Premium schedule needed to keep the policy in force Death benefit received upon maturity Investment of a pool of policies Life settlement portfolio / block orders Target specific sectors of the market to acquire a specific portfolio Track success ratio on a regular basis so that you can compare your strategy with the activity in the market and realign as necessary Confidential 8 Investing in physical life settlements Partnership with a provider can alleviate infrastructure burdens of market place Documentation and servicing can be simplified, limiting operational risk and unnecessary paperwork Proper structuring of a transaction can eliminate certain unwanted risks Policy Risk Provider Residual Risk Investor FX Servicing Documentation Policy Distribution Leverage Cash Inefficiency with Premium Reduction in time between purchase and ownership allows for more efficient cash management Confidential 9

7 Transaction alternatives Settlements Certificates Annuities Format Policy Security Contract Underlying Reference Asset Single Reference Life Single Reference Life and Premium Financing Contract Single Reference Life and Annuity Contract Directional Risk Longevity Longevity Mortality Investor Counterparty Issuing Entity (Insurance carrier) Issuing Entity (Credit Suisse or other non-rated issuer) Issuing Entity (Annuity carrier) Liquidity vs. Investments in Longevity Derivatives Yes Yes Yes Customizable Portfolio No Yes No Counterparty Risk Mitigant None, payout is general obligation of issuer None, payout is general obligation of issuer None, payout is general obligation of issuer Standardized Documentation No Yes No Ownership of Medical Information Yes No Yes Typical Risks Passed to Investor Longevity, Cost of Insurance, Contestability, Rescission, Counterparty Credit (Carrier) Longevity, Cost of Insurance, Contestability, Rescission, Counterparty Credit (Carrier and Credit Suisse) Mortality, Cost of Annuity, Counterparty Credit (Carrier) Investors can gain exposure to the longevity market through products that best suit their needs Confidential 10 This presentation has been prepared by individual sales and/or trading personnel of Credit Suisse or its subsidiaries or affiliates (collectively "Credit Suisse") and not by Credit Suisse's research department. This presentation is provided for your information only and may not be distributed to anyone else without the express consent of Credit Suisse. It has been prepared solely for informational and illustrative purposes and is not to be used or considered as an offer to sell, or a solicitation of an offer to buy, any financial instrument or the provisions of an offer to provide investment services in any state or country where such an offer, solicitation or provision would be illegal. Any discussions or results based on hypothetical projections or past performance have certain inherent limitations and should not be taken as an indication of future results. There is no certainty that the parameters and assumptions used can be duplicated with actual trades. The information set forth above has been obtained from or based upon sources believed by Credit Suisse to be reliable, but Credit Suisse does not represent or warrant its accuracy or completeness. This material does not purport to contain all of the information that an interested party may desire. In all cases, interested parties should conduct their own investigation analysis of the transaction described in these materials and the data set forth in them. Any discussion of risk is not intended to be exhaustive. Interested parties must conduct their own assessment of risk and decision with regard to pursuing a transaction and should consult professional advisors where appropriate. Structured transactions are complex instruments, typically involve a high degree of risk and are intended for sale only to sophisticated investors who are capable of understanding and assuming the risks involved. The market value of any structured instrument may be affected by changes in economic, financial, and political factors (including, but not limited to, spot and forward interest and exchange rates), time to maturity, market conditions and volatility and the credit quality of any issuer or reference issuer. Any investor interested in purchasing a structured product should conduct its own investigation and analysis of the product and consult with its own professional advisors as to the risk involved in making such a purchase. Credit Suisse does not provide any tax advice. Any tax statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties. Any such statement herein was written to support the marketing or promotion of the transaction(s) or matter(s) to which the statement relates. Each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor. Confidential 11

8 Life Settlements Investing in Structures, Synthetics, and Swaps Investment Symposium David J. Weinsier March 31, Towers Perrin Agenda Introduction to the secondary market Valuing policies Impact on the life insurance industry 2009 Towers Perrin 2

9 INTRODUCTION TO THE SECONDARY MARKET Life Settlement Sale of an existing life insurance policy to a third party, typically an institutional investor, for an amount greater than the underlying cash value of the policy Traits of a typical candidate Impaired (but not terminal) Age 65 or older Life expectancy of 6 to 11 years Large face amount ($1 million+) 2009 Towers Perrin 3 INTRODUCTION TO THE SECONDARY MARKET Premium Financing Sometimes referred to as Investor Owned Life Insurance (IOLI) or Stranger Owned Life Insurance (STOLI) Inherent concept is similar to that of a life settlement, with the following general distinctions: Investor, via a broker or other third party, may initiate the application of a life insurance policy through a prospective insured A loan is made to cover the first two to five years of premiums After the loan period, the insured is given the following options: Retain the policy, after paying back the initial loan plus interest and fees Default on the loan, effectively putting the policy back to the lender 2009 Towers Perrin 4

10 INTRODUCTION TO THE SECONDARY MARKET Drivers of the market Life Settlements Insureds with reduced life expectancies may have a higher economic value than the policy s underlying cash value Individuals in the U.S. are living longer, thus potentially outliving the usefulness of their life insurance policies The target market for settlements (i.e., individuals above age 65) is expected to grow by 90% over the next 25 years Decline in interest rates has led to lower cash values than originally illustrated Broker commissions Continued Towers Perrin 5 INTRODUCTION TO THE SECONDARY MARKET Drivers of the market Premium Financing Free or low-cost insurance to insureds Lack of asset collateralization Broker commissions 2009 Towers Perrin 6

11 INTRODUCTION TO THE SECONDARY MARKET Products with appeal in the secondary market Universal life (80-90% of policies transacted) Single life or joint With or without extended no-lapse guarantees Convertible term ROP term Whole life 2009 Towers Perrin 7 INTRODUCTION TO THE SECONDARY MARKET Market participants Core participants Funding source Settlement provider Medical underwriter Secondary participants Reinsurer or hedge provider Rating agency Monoline Attorney Servicer & tracking agent Broker Policyholder 2009 Towers Perrin 8

12 VALUING POLICIES The key driver of policy value is the life expectancy estimate ( LE ) The LE is typically based on a mortality rating applied to a standard mortality basis The mortality rating is derived by the underwriter using life insurance underwriting processes Typically derived using a system of debits and credits Generally expressed as a percentage of standard where standard is 100% Continued Towers Perrin 9 VALUING POLICIES The key driver of policy value is the life expectancy estimate ( LE ) The table used for the standard mortality basis varies across underwriters Until recently, most underwriters used a table based on the 2001 Valuation Basic Table ( 2001 VBT ) Many major underwriters have moved to 2008 VBT Select/ultimate vs. ultimate - differing opinions exist as to the appropriate duration to move to ultimate mortality Some underwriters include a provision for future mortality improvement and/or selection factors in the early durations 2009 Towers Perrin 10

13 VALUING POLICIES Life expectancies (years): 2008 VBT vs VBT, non-smoker rated 100% Male Issue Ages VBT VBT % change 9.6% 8.0% 4.2% 3.1% (1.1)% Female Issue Ages VBT VBT % change 5.4% 3.8% 2.6% 0.0% (4.3)% Replacing 2001 VBT with 2008 VBT, all else being equal, can turn a 15% IRR into a 6-12% IRR 2009 Towers Perrin 11 VALUING POLICIES Generally, LE estimates continue to increase In 2008 a major underwriter acknowledged its prior LE estimates were inaccurate; its revised methodologies and assumptions resulted in LEs approximately 25% longer Three more major underwriters have revised methodologies or underlying tables in the last 6 months, leading to LEs approximately 5-15% longer These changes, combined with the credit crunch, caused the secondary market to come to a near complete halt in the second half of 2008 The evaluation criteria used by underwriters are proprietary, constantly evolving, and exposed to little formal industry scrutiny However, the underwriters are continually being evaluated by investor groups 2009 Towers Perrin 12

14 VALUING POLICIES Mortality variance can come from two general sources Sources of Mortality Variance Mortality Volatility Risk Mis-estimation Risk Standard random fluctuation in mortality Given the limited number of lives in a portfolio, this fluctuation may be material Fluctuation in population mortality due to various environmental factors Mis-estimation of mortality rating Mis-estimation of standard mortality basis Both initial level and mortality slope Fluctuation due to catastrophic events A cure for cancer would be a catastrophic mortality event for life settlements 2009 Towers Perrin 13 VALUING POLICIES There are two common approaches investors use to value policies A. Apply a fixed mortality rating received from an underwriter to an independent mortality curve The LE will vary based upon the chosen curve Assumes mortality rating and table are independent B. An alternative, but more common industry approach is to rely on the LE estimate provided from the underwriter, as opposed to the mortality rating The LE is then calibrated to a chosen mortality curve This approach results in a much tighter range of expected profit results across various curves, since only the timing of deaths is impacted We have recently observed investors IRR expectations between 15% and 20% 2009 Towers Perrin 14

15 IMPACT ON THE LIFE INSURANCE INDUSTRY The secondary market has impacted life insurance carriers in a variety of ways Increased sales at older ages Experience may differ from assumptions used in pricing Better persistency Mortality antiselection Reduced overfunding of UL policies Higher number of term conversions Potential for fraud 2009 Towers Perrin 15 IMPACT ON THE LIFE INSURANCE INDUSTRY Capital market influence In recent years the capital markets have been paying increased attention to the life insurance industry XXX/AXXX securitizations and similar structures Life settlements Investors are always seeking a new asset class especially one with a lack of correlation with existing investments Upside: Additional sources of capital (e.g., life insurance securitizations) Longevity indices allow investors to bet on mortality or potentially use as a hedging tool Significant basis risk exists Downside: arbitrage opportunities in pricing can be exploited 2009 Towers Perrin 16

16 IMPACT ON THE LIFE INSURANCE INDUSTRY The insurance industry is now well aware of the secondary market and many have taken action Increased focus on pricing at older ages Mortality Increased focus on mortality at older issues ages Lapse Lower levels of assumed lapses used in pricing However, recent concern around shock lapse due to failed premium finance structures Funding levels Increased focus on minimum funding scenarios Adoption of stronger underwriting procedures for older insureds More frequent reinsurance audits 2009 Towers Perrin 17 IMPACT ON THE LIFE INSURANCE INDUSTRY The insurance industry is now well aware of the secondary market and many have taken action Many have attempted to identify and deter investor-owned life insurance cases Closer monitoring of producers Include supplement with application asking both applicant and producer to sign confirmation that applied-for policy is not being purchased with intent to re-sell Restrict change of ownership Some direct carriers have recently taken an active role in the secondary market Anecdotal evidence shows that many carriers are still open to accepting premium financed cases, under certain conditions 2009 Towers Perrin 18

17 Life Settlements Investing in Structures, Synthetics, and Swaps Investment Symposium David J. Weinsier March 31, Towers Perrin Agenda Introduction to the secondary market Valuing policies Impact on the life insurance industry 2009 Towers Perrin 2

18 INTRODUCTION TO THE SECONDARY MARKET Life Settlement Sale of an existing life insurance policy to a third party, typically an institutional investor, for an amount greater than the underlying cash value of the policy Traits of a typical candidate Impaired (but not terminal) Age 65 or older Life expectancy of 6 to 11 years Large face amount ($1 million+) 2009 Towers Perrin 3 INTRODUCTION TO THE SECONDARY MARKET Premium Financing Sometimes referred to as Investor Owned Life Insurance (IOLI) or Stranger Owned Life Insurance (STOLI) Inherent concept is similar to that of a life settlement, with the following general distinctions: Investor, via a broker or other third party, may initiate the application of a life insurance policy through a prospective insured A loan is made to cover the first two to five years of premiums After the loan period, the insured is given the following options: Retain the policy, after paying back the initial loan plus interest and fees Default on the loan, effectively putting the policy back to the lender 2009 Towers Perrin 4

19 INTRODUCTION TO THE SECONDARY MARKET Drivers of the market Life Settlements Insureds with reduced life expectancies may have a higher economic value than the policy s underlying cash value Individuals in the U.S. are living longer, thus potentially outliving the usefulness of their life insurance policies The target market for settlements (i.e., individuals above age 65) is expected to grow by 90% over the next 25 years Decline in interest rates has led to lower cash values than originally illustrated Broker commissions Continued Towers Perrin 5 INTRODUCTION TO THE SECONDARY MARKET Drivers of the market Premium Financing Free or low-cost insurance to insureds Lack of asset collateralization Broker commissions 2009 Towers Perrin 6

20 INTRODUCTION TO THE SECONDARY MARKET Products with appeal in the secondary market Universal life (80-90% of policies transacted) Single life or joint With or without extended no-lapse guarantees Convertible term ROP term Whole life 2009 Towers Perrin 7 INTRODUCTION TO THE SECONDARY MARKET Market participants Core participants Funding source Settlement provider Medical underwriter Secondary participants Reinsurer or hedge provider Rating agency Monoline Attorney Servicer & tracking agent Broker Policyholder 2009 Towers Perrin 8

21 VALUING POLICIES The key driver of policy value is the life expectancy estimate ( LE ) The LE is typically based on a mortality rating applied to a standard mortality basis The mortality rating is derived by the underwriter using life insurance underwriting processes Typically derived using a system of debits and credits Generally expressed as a percentage of standard where standard is 100% Continued Towers Perrin 9 VALUING POLICIES The key driver of policy value is the life expectancy estimate ( LE ) The table used for the standard mortality basis varies across underwriters Until recently, most underwriters used a table based on the 2001 Valuation Basic Table ( 2001 VBT ) Many major underwriters have moved to 2008 VBT Select/ultimate vs. ultimate - differing opinions exist as to the appropriate duration to move to ultimate mortality Some underwriters include a provision for future mortality improvement and/or selection factors in the early durations 2009 Towers Perrin 10

22 VALUING POLICIES Life expectancies (years): 2008 VBT vs VBT, non-smoker rated 100% Male Issue Ages VBT VBT % change 9.6% 8.0% 4.2% 3.1% (1.1)% Female Issue Ages VBT VBT % change 5.4% 3.8% 2.6% 0.0% (4.3)% Replacing 2001 VBT with 2008 VBT, all else being equal, can turn a 15% IRR into a 6-12% IRR 2009 Towers Perrin 11 VALUING POLICIES Generally, LE estimates continue to increase In 2008 a major underwriter acknowledged its prior LE estimates were inaccurate; its revised methodologies and assumptions resulted in LEs approximately 25% longer Three more major underwriters have revised methodologies or underlying tables in the last 6 months, leading to LEs approximately 5-15% longer These changes, combined with the credit crunch, caused the secondary market to come to a near complete halt in the second half of 2008 The evaluation criteria used by underwriters are proprietary, constantly evolving, and exposed to little formal industry scrutiny However, the underwriters are continually being evaluated by investor groups 2009 Towers Perrin 12

23 VALUING POLICIES Mortality variance can come from two general sources Sources of Mortality Variance Mortality Volatility Risk Mis-estimation Risk Standard random fluctuation in mortality Given the limited number of lives in a portfolio, this fluctuation may be material Fluctuation in population mortality due to various environmental factors Mis-estimation of mortality rating Mis-estimation of standard mortality basis Both initial level and mortality slope Fluctuation due to catastrophic events A cure for cancer would be a catastrophic mortality event for life settlements 2009 Towers Perrin 13 VALUING POLICIES There are two common approaches investors use to value policies A. Apply a fixed mortality rating received from an underwriter to an independent mortality curve The LE will vary based upon the chosen curve Assumes mortality rating and table are independent B. An alternative, but more common industry approach is to rely on the LE estimate provided from the underwriter, as opposed to the mortality rating The LE is then calibrated to a chosen mortality curve This approach results in a much tighter range of expected profit results across various curves, since only the timing of deaths is impacted We have recently observed investors IRR expectations between 15% and 20% 2009 Towers Perrin 14

24 IMPACT ON THE LIFE INSURANCE INDUSTRY The secondary market has impacted life insurance carriers in a variety of ways Increased sales at older ages Experience may differ from assumptions used in pricing Better persistency Mortality antiselection Reduced overfunding of UL policies Higher number of term conversions Potential for fraud 2009 Towers Perrin 15 IMPACT ON THE LIFE INSURANCE INDUSTRY Capital market influence In recent years the capital markets have been paying increased attention to the life insurance industry XXX/AXXX securitizations and similar structures Life settlements Investors are always seeking a new asset class especially one with a lack of correlation with existing investments Upside: Additional sources of capital (e.g., life insurance securitizations) Longevity indices allow investors to bet on mortality or potentially use as a hedging tool Significant basis risk exists Downside: arbitrage opportunities in pricing can be exploited 2009 Towers Perrin 16

25 IMPACT ON THE LIFE INSURANCE INDUSTRY The insurance industry is now well aware of the secondary market and many have taken action Increased focus on pricing at older ages Mortality Increased focus on mortality at older issues ages Lapse Lower levels of assumed lapses used in pricing However, recent concern around shock lapse due to failed premium finance structures Funding levels Increased focus on minimum funding scenarios Adoption of stronger underwriting procedures for older insureds More frequent reinsurance audits 2009 Towers Perrin 17 IMPACT ON THE LIFE INSURANCE INDUSTRY The insurance industry is now well aware of the secondary market and many have taken action Many have attempted to identify and deter investor-owned life insurance cases Closer monitoring of producers Include supplement with application asking both applicant and producer to sign confirmation that applied-for policy is not being purchased with intent to re-sell Restrict change of ownership Some direct carriers have recently taken an active role in the secondary market Anecdotal evidence shows that many carriers are still open to accepting premium financed cases, under certain conditions 2009 Towers Perrin 18