Wall Street plays death card in securitization market

A trader works on the floor of the New York Stock Exchange, July 15, 2009. Betting on a person's mortality may be the safest bet on Wall Street these days as investors shun shaky financial markets and opt for securities backed by the certainty of death.

NEW YORK (Reuters) - Betting on a person's mortality may be the safest bet on Wall Street these days as investors shun shaky financial markets and opt for securities backed by the certainty of death.

Life settlement securitizations are growing as increasing financial stress leads buyers and sellers to seek shorter and safer windows for returns. Strapped consumers are cashing in life insurance policies ahead of time to stay above water, while investors are buying to eliminate risks.

The securities are sold in the U.S. asset-backed market after hundreds of life insurance policies are carefully screened by life expectancy experts. The insured is paid a partial benefit, while the investor payoff comes with death.

"Life Settlement securitizations should be attractive to investors as they are uncorrelated to everything else as far as the underlying expected cash flows are concerned," said Ron D'Vari, Chief Executive Officer at NewOak Capital LLC.

Other asset types, such as subprime mortgage securities that are linked to interest rates and home values, suffered a major collapse in the last few years as loan defaults soared, home values sank, lenders folded and billions of dollars were lost.

But "these securities are solely tied to mortality, a natural occurring phenomenon. The marketplace is asking for an asset that has these characteristics," said Jan Buckler, analyst at Dominion Bond Rating Service. Several life settlement transactions are currently being reviewed by credit rating agency DBRS.

Still, legal and life expectancy risks associated with the complicated asset type need to be considered, said D'Vari.

"Given the off-the-run nature of the asset type, the market tends to be private and much less transparent. Hence, investors should do a fair amount of due diligence upfront and monitor the underlying performance over time," said D'Vari.

MANAGING RISK

The hardest part of an analysis is trying to assess how long the individuals will live, as premiums and interest on the bonds must be paid until death allows retirement of principal.

Buckler said some earlier transactions did not accurately assess for longevity risks. In those cases, an average insured may have been expected to live for another five years but passed away after 10 years.

"Some of the estimates on mortality were incorrect and investors didn't get their money as soon as they had expected. That meant their yield went down or that they potentially lost money," said Buckler.

However, newer tools have helped to reduce those risks.

"In the industry, now there are different category assessments of mortality. There's also an active hedging market in longevity swaps, as well as other determinants that help put the risk of mortality in better perspective," said Buckler.

Driving the early sales of insurance policies may be the strained economic environment consumers find themselves in.

"A person may have been paying on the policy for a while, but may no longer be able to keep up with the premiums during hard economic times. It may be that the kids are going off to college or that they need food in the house," said Buckler.

While the policyholder can obtain a cash settlement from the insurance company, those tend to be much smaller, he said.

"The life settlement market will give them a higher dollar value for the sale," said Buckler.

Portfolios tend to reflect the insurance policies of those 70 years of age and above, but more commonly contain those aged 80 and higher.

Expectations for future growth are high given the mere size of the multi-trillion dollar life insurance market.

Earlier this year, Risk Finance, a unit of troubled insurer American International Group (AIG.N), arranged a securitization of life settlement policies with a face value of $8.4 billion. Securities issued totaled over $2 billion, according to A.M. Best, who rated the transaction.

"The securities have uncorrelated risks to the market and certain investors find it attractive," said Dan Castro, chief risk officer at Huxley Capital Management. He said the securities may also be used as a means to hedge risks.

"If you're an investor in an insurance company and you're long or short insurance, this could be something that balances the other side," said Castro.

(Reporting by Nancy Leinfuss)