Testing for adverse selection of life settlements: the secondary market of life insurance policies

Januario, A V and Naik, N (2014) Testing for adverse selection of life settlements: the secondary market of life insurance policies. Working Paper. London Business School IFA Working Paper.

Abstract

This paper examines the secondary market for life insurance in the United States using a large and comprehensive dataset of 9,002 policies with aggregate death benefit of $24.14 billion purchased from their original owners between 2001 and 2011. We find that policyowners selling their policies collectively received more than four times the amount they would have received had they surrendered their policies to their respective life insurance companies. Using cashflow data for a subsample of 7,890 policies with aggregate death benefit of $21.08 billion, we find that the investors expected to make an average internal rate of return of 12.5% per annum, which is 8.4% in excess of treasury yields. Finally, we observe a systematic relation between life settlement contract characteristics and returns expected by investors. Our findings suggest that the primary determit of returns across different life settlement contracts is not adverse selection relative to underlying life expectancies, but other economic phenomenon such as costbenefit tradeoff, bequest motive, convexity of premiums, diversification of unique risks and mitigation of life expectancy estimation risk.