Introduction to Methodologies Used to Price Life Insurance Policies in Life Settlement Transactions

Abstract

Project Description: The purpose of this paper is to provide a general overview of the deterministic and probabilistic pricing methodologies, and the application of the common contributing factors in determining the price of life insurance policies for life settlements in the secondary market. This paper does not venture into an analysis or review of the internal economics provided by life insurance policies. Scope of Research/Methodology: The life settlement market has grown exponentially from its roots in the 1980’s as a viatical industry, to today’s multi-billion dollar life insurance secondary market. One of the principal facilitators of this expanding asset class is the evolution of more accurate and reliable pricing models used by institutional investors to value life insurance policies. Understanding the basics of these pricing models also helps policy owners and their advisors to be informed market participants. This paper underscores the two fundamental methodologies that are used today, Deterministic Pricing and Probabilistic Pricing, and examines the fundamental similarities and differences in these methods, and how those factors impact investors. In particular, this report scrutinizes the importance of the underlying mortality assumptions, and the internal rate of return that is calculated based upon those assumptions. Target Results/Benefits: Concisely describe the primary pricing methodologies that are utilized to value life insurance policies for life settlements. Timeline: Research/draft report from January, 2008 through March, 2008. Appendix, Data Sources: Insurance Industry Research Bernstein Research Call, Life Insurance Longview: Life Settlements Need Not be Unsettling (2005) Life Settlement Industry Resources The Art of the Deal: Pricing Life Settlements, Contingencies, Zollars, Grossfeld & Day (2003)