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01 June 2017

Life expectancy – one size does not fit all

By Fred Bell; Actuarial Analyst, SL Investment Management

One of the fundamental attractions of investing in Life Settlements is that the return achieved is linked to the Life Expectancy (LE) of insured lives, which is naturally uncorrelated to mainstream investment markets. An understandable consequence of this fact is that the Fund Manager's approach to the derivation and application of LE and mortality is very important to the success of a Life Settlement Fund.

Typically, when a policy is brought to market (via either secondary or tertiary channels) the intermediary will typically obtain LE estimates from one or more specialist LE underwriters. This information allows potential investors to assess the mortality profile of the insured life underlying the policy. It informs the valuation placed on the Life Settlement and the relative risk/reward characteristics compared to other policies available in the market and the fund for which it is being purchased. Therefore, the LE is a vital piece of information in the pricing and valuation of a Life Settlement and consideration should be given to its use.

Currently, the industry standard mortality table for valuing Life Settlements is the 2015 Valuation Basic Table ("2015VBT") issued by the US Society of Actuaries (SOA). SL uses the full 2015VBT select mortality tables (i.e. gender and smoker specific) as a basis for valuation, in conjunction with corresponding gender-specific mortality improvement factors derived from those the SOA has recommended in subsequent reports.

SL's pricing methodology is to adjust the underlying 2015VBT mortality rates (combined with mortality improvement factors) by applying mortality factors unique to each life insured. The mortality factors are calculated such that the actuarial LE derived from the adjusted mortality rates is equal to a weighted average of the LEs obtained from the specialist LE underwriters. The adjusted mortality rates result in a unique mortality curve for each life insured, which takes account of their relative impairment compared with the underlying table.

The upshot of this is that it is difficult to encapsulate all of the pertinent information on an insured life into a single LE number. It takes a robust and sophisticated actuarial team to provide guidance through the LE maze and some Fund Managers simply do not have the resources to go that extra mile.