Life Insurance Settlements and the Secondary Market

Photo: Shutterstock/Fida Olga

Individual life insurance policies come in all shapes and sizes—from sophisticated universal life and asset-linked policies with myriad features and complex cash values to simple term insurance. This article focuses on the secondary market for “lapse-supported” policies, which would require materially higher premiums if priced with lower long-term lapse rate assumptions.

The most common of these lapse-supported policies, based on the number of policies, are term policies, which can range from a five-year term all the way up to age 100 and typically have no cash surrender values. In 2019, roughly 58% of all insured Americans had term life insurance.¹

Background: Secondary Market for Term Life Insurance

Going back to the late 1980s, a secondary market for term life insurance appeared in the United States. It started with “viatical settlements,” which involved purchasing policies from terminally ill insureds.² Insureds with significantly reduced life expectancies would sell their policy to an investor in exchange for a fraction of the policy’s face value. The investor would typically also start paying the ongoing premium payments. In exchange, the investor would be named the policy’s beneficiary, allowing them to collect the entire face amount when the insured died. The sale price was typically based on individual life expectancy calculations performed by third-party experts.

These transactions were profitable for investors, so the buying market quickly progressed from smaller and private investors to larger and more sophisticated institutional investors. Unfortunately, some investors used high-pressure tactics to buy policies for unfairly low amounts from terminally ill individuals and others. Additional disturbing practices also emerged. However, over time, the secondary market in the United States matured through a combination of factors including involvement by the National Association of Insurance Commissioners (NAIC), improved insurance company standards, consumer education and regulatory protections. Today, the industry has evolved to focus mainly on “life settlements,” which involve policies originally purchased for genuine purposes and sold later due to the insured’s changing circumstances. In the United States, the life settlement industry has grown from $200 million of face amount in 1993³ to $4.6 billion in 2020.⁴

In Canada, on the other hand, since 1933, such activity has been illegal in most provinces. For example, the Ontario Insurance Act says that a policyholder can only sell their policy back to the insurance company for its stipulated cash surrender value. The cash surrender value is a formulaic and contractual amount at which the original issuer of the policy would be required to repurchase it from the insured. However, this could differ widely from the policy’s true market value (i.e., what an external third party might be willing to pay for the policy), especially if the insured’s life expectancy has since been unexpectedly reduced.

In 2000, 2017 and 2018, various bills would have allowed seniors to sell their existing life policies (subject to certain regulations), but none made it into law. As it stands, the only sizeable Canadian province that regulates and allows life settlements is Quebec.

Currently, 54%⁵ of Canadian seniors own a life insurance policy, and those with term life policies generally have few (if any) options in terms of settlement compared to their American neighbors.

Asset or Subscription?

A fundamental question is whether term life insurance policies should be considered an asset. Arguments for this include the long-term nature of life insurance and the fact that Ontario law already recognizes policyholders’ rights to use cash surrender values as collateral for a loan from a third party.

If considered an asset (as is the case in most U.S. jurisdictions), then the concept of life settlements is philosophically not much different from reverse mortgages, which also had a painful start but now have become a well-regulated asset class that provides Canadian seniors additional financial flexibility.

Alternatively, term policies also have characteristics more akin to a service or “subscription.” For example, with the exception of term-to-100 policies, shorter-term policies typically terminate as soon as the policyholder stops paying the premium. As such, it could be argued that the provider of this “service” can impose restrictions on its transfer or sale.

Considerations for Life Settlements in Canada

Allowing life settlements in more Canadian jurisdictions could potentially benefit policyholders in several ways:

• For seriously or terminally ill policyholders, it could help fund medical expenses. While Canada has broad public-sponsored health care, there are still many cases where patients need money for faster access to treatments abroad or new and specialty drugs that may not be covered by government formularies.
• For working-age insureds, life settlements could help protect against the financial impact of a chronic disability.
• For seniors, it could help fund long-term care costs, especially since some insurers have exited the long-term care insurance business and the remaining ones offer significantly more expensive policies with much lower benefit levels than in the past.⁶

At the same time, some areas of concern and risks would need to be addressed:

• An external entity would have a financial interest in the policyholder’s early death. Not only could this entity collect the face amount sooner, but they also could stop paying premiums sooner. Furthermore, if the policy is then resold to a third party, the insured may have no say or knowledge over who has become the new beneficiary upon their death.
• Most policyholders would need more education or professional fiduciary advice to evaluate a settlement offer properly. Without proper regulatory oversight and consumer education, companies might take advantage of policyholders.
• The Canadian life insurance industry has already underwritten many “lapse-supported” products. As such, there might be fear that opening the floodgates could cause catastrophic industrywide losses.

Conclusion

In an era of massive demographic shifts, increased inflation and health care costs—coupled with diminishing sources of retirement income—there is a real need for more financial support for Canadian seniors.

However, compromises would be needed to balance all stakeholders’ needs. Here are several ideas to that effect:

• Lump-sum settlements could be implemented on a go-forward basis only, giving life insurance company actuaries enough time to adjust their pricing assumptions for future policies to take this new development into account. In this case, another consideration would be whether to require insurers to allow life settlements on all newly issued term policies or simply remove the regulatory ban on life settlements and give insurers the choice. With the latter, some insurers may decide to retain the status quo, while others may see it as an opportunity to gain market share by offering term policies that can eventually be sold to a third party.
• Regulations could continue to ban large lump-sum settlements and only allow annuity-like periodic payments. Periodic payments could still be used to offset things like long-term care costs but would eliminate some of the potential moral hazard.
• Alternatively, what if only the originating companies were permitted to offer lump-sum settlements? This would require regulation to ensure fairness for consumers, and the actuarial profession in Canada would need to develop standards for calculating “health-adjusted cash values.”
• Lastly, while it might benefit consumers to have a more competitive market, a centralized solution might be appropriate. This could take the form of a nonprofit, government-backed organization with sole authority to offer life settlements.

I believe it’s part of our duty as actuaries to look out for the consumer. This is a space where Canadian actuaries could investigate and advocate for workable compromises that wouldn’t necessarily emulate the U.S. approach.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2023 by the Society of Actuaries, Chicago, Illinois.