Life Settlements Industry Next on the Chopping Block

If you thought you could escape the global financial crisis by crossing to the great beyond, think again. The $6.4 billion life-settlement industry -– where firms purchase life insurance policies for a lump sum and then collect when the policyholder dies — has been thrown into turmoil over the past several months.

Earlier this month, one of the largest U.S. life settlement firms, J.G. Wentworth, filed for bankruptcy protection after the credit markets seized and it could no longer borrow to buy additional policies. According to InvestmentNews, additional bankruptcies are expected for life settlement firms as a result of tightening credit.

And to make matters worse, people are living longer.

Late last year several of the firms that calculate mortality tables for life settlement firms rocked the industry by increasing the life expectancies for most groups. That’s good news for people’s health, but bad news for life settlement firms that did not see the change coming.

Life settlements firms profit from razor thin margins on the difference between what they pay in the lump sum to the policyholder and the premiums they must pay out until they collect when the policyholder dies. So the longer people live beyond their expected mortality, the more is costs life settlement investors.

As life settlement firms rack up losses — and sometimes collapse — expect the industry to come under attack from all sides. The broader life insurance industry as historically had a tenuous relationship with life settlement business since it blossomed in the 1990s. Insurers fear that the process of selling a policy to a third party as an investment is confusing to consumers and could create thousands of lawsuits as policyholders dispute the “insurable interest” of the contract.

Regulators are also chomping at the bit to reign in the life settlement industry. Many states have already created laws to prevent abusive sales practices, usually under the moniker of stranger/investors originated life insurance (STOLI) laws. New York State is currently considering its own set of STOLI laws.

In the meantime, don’t be surprised to see life-settlement losses crop up in some unusual places. Losses from life settlements reportedly are what initially brought down financier Danny Pang, who reportedly tried to cover up the life settlement losses with investor assets.

Even the Federal Reserve could be on the hook. AIG used assets from the largest life-settlement securitization to date — $2 billion –- to pay back a portion of its government loan.