Securitization of Senior Life Settlements

Abstract

Securitization has been an extremely important technique for managing exposure to a variety of financial risks. It allows the undesired risk to be concentrated in a small proportion of the newly created securities while largely eliminating its impact for most investors. Securitization had its very successful debut with mortgages, as a way to tap into funding from the bond market with mortgage-backed securities that were largely insulated from the inherent exposure of the underlying mortgages to prepayment risk. Since then, it has been extended to a wide range of securities and categories of risk. In this issue's Innovations section, Stone and Zissu describe a new kind of securitization, in which the risk to be managed is the risk of death. Or the opposite, actually: It is “longevity risk,” the risk that an insured person will live too long, i.e., longer than their actuarial expected life span. A senior life settlement contract provides a way for a terminally ill, or very old, holder of a life insurance policy to liquidate it and obtain cash prior to death. The article describes how a portfolio of life settlement contracts may be securitized and tranched, and discusses pricing and risk management for the new securities.