Securitization Of Life Settlements: A Pivotal Phase In The
Product Life Cycle
By Boris Ziser and Craig Seitel
Few of us would have predicted several years ago that the increased interest
from both foreign and domestic institutional funders
in the life settlement marketplace would help to redefine the industry and
bolster its credibility within the financial services arena.
Although life settlements evolved from the viatical
settlement market in the 1980s, which was dominated by individual investors
who purchased policies from terminally ill AIDS patients, the industry has
undergone a metamorphosis resulting in a shift in the product’s demographic
With this shift in focus from terminally ill insureds
to high-net-worth seniors generally over age 70 seeking an exit strategy from
unwanted policies, the industry entered a new era of sophistication and a new
stage of the product life cycle that brought greater credibility and a
clearly defined value proposition for all players in the life settlement
In spite of the structural complexities in securitizing life settlements, it
is a growing asset class that has captured the interest of investors from
around the world—particularly in the
last two years, investors from Germany. Clearly, we are seeing
an increasing number of parties interested in entering the industry, whether
as originators, brokers or funders.
According to the Viatical & Life Settlement
Association of America, the number of industry players has doubled over the
past five years—a good sign for this
asset class that will help the segment grow.
Although money managers consider a portfolio of life settlements a
great asset class because it diversifies investment, the classification of
life settlement transactions has been difficult, as they contain elements of
a loan, a sale, an equity investment and securitization. Life settlement
transactions do not fall into any single category, as various structures are
available for these deals.
One of the interesting but also most challenging aspects of life settlement
transactions is that they require intensive structuring, particularly with
respect to tax considerations. While favorable yields attract investors to
participate in life settlement transactions, tax considerations drive the
structures. In fact, special tax advantages afforded to German investment
funds under the U.S.-German Taxation Treaty have helped drive the influx of
significant amounts of German capital into the marketplace.
Similar to other types of corporate deals, a tax-efficient structure is a
central goal. Any inefficiency in the tax aspects of the transactions has a
rippling effect on the entire outcome, as the tax liabilities reduce the
yield, often forcing the investor to underbid for policies (risking losing
such policies), in an effort to maintain certain levels of return on
Many of the transactions completed to date have involved investment funds
located outside of the United
States. Since the life settlements and the
payments they produce originate in the U.S., a tax-efficient structure
will permit such payments to reach the fund, and ultimately the investors in
the fund, in a tax-efficient manner. The extent to which tax consequences can
be minimized will, in most cases, depend on whether a tax treaty is in effect
between the U.S.
and the country of which the investors in the fund are tax residents, and the
specific provisions of the tax treaty.
Under the tax laws of the U.S.,
absent a tax treaty and a proper tax structure, withholding tax will be
applied to life settlement payouts leaving the U.S., thereby reducing the yield
on the investment and creating a less favorable outcome. If the tax laws of
the offshore jurisdiction are not favorable or the tax treaty is not
favorable, it may be more tax efficient to structure a transaction in which
some level of taxation will be applied in the U.S. The transactions that fall
into that category are usually the most difficult from a tax perspective and
require significantly more tax analysis and guidance.
In addition to tax laws, U.S.
securities laws apply to life settlement transactions as well. Regardless of
whether life settlements are determined to be "securities" for
purposes of the Securities Act of 1933, the structure itself may involve the
issuance of securities, such as trust certificates. Transactions can be
structured as private placements, thereby avoiding the registration
requirements under the Securities Act that would otherwise be triggered.
Additionally, when offshore funds are involved, Regulation S can offer an
exemption from registration under the Securities Act as well. Life settlement
transactions must also be structured to avoid triggering compliance
requirements under the Investment Company Act of 1940. Depending on the
nature of the fund and its ownership structure, other statutes may apply.
When structuring a transaction, in addition to legal considerations,
practical considerations and client objectives must also be taken into
account. Various structures are available for life settlement transactions,
such as trust arrangements, custodial arrangements and Delaware Statutory
Trusts or other similar arrangements. Generally, each structure has certain
benefits and limitations. Depending on the flexibility and ownership status
required by the fund, one or more structures may be available. Various forms
of entity are available for life settlement transactions, such as a
corporation, limited liability company or a partnership. Given the available
alternatives, it is likely that many requirements and preferences of a fund
can be addressed.
A while back, the Wall Street Journal reported on a major milestone in
the industry with a bond sale involving a large domestic investment banking
institution that handled the private placement for $70 million in bonds backed
by life insurance policies rated by Moody’s Investors Services. Additionally,
A.M. Best assigned a debt rating to one securities transaction where
asset-backed bonds were collateralized with $195 million in face value of
life policies purchased from people with life expectancies from 48 to 84
Traditional investment grade securitizations are popular investments for
pension funds and insurance companies. However, there are more
"non-traditional" structured products that are engineered to meet specific
investment objectives. The capital sources for these investments are coming
from several sources, including various European funds and domestic hedge
Hedge funds are effective sources of capital because, unlike pension funds
and the insurance industry, hedge funds are not subject to the numerous
regulations that apply to these sectors. As a result, the hedge fund
community has much more flexibility with the type and structure of
investments it pursues. Because structured products can facilitate the
liquidity of investment portfolios with greater efficiency than unstructured
whole assets, such as individual life settlements, we predict the investments
in life settlements will be concentrated more in non-traditional securities.
Although interest from European investors (particularly those in Germany, Austria
and the U.K.)
has been strong until now, we are keeping a close eye on the impact a weak
dollar might have on prospective foreign investments in the life settlement
marketplace. Hedging against a weak dollar will add another element to the
structural complexity of life settlement securitization.
Boris Ziser is a securitization expert and
partner in the international law firm of Brown Rudnick Berlack
LLP located in New York City.
Craig Seitel is an investment banker and CEO of
Abacus Settlements, LLC, a life settlement provider located in New York City.