The economic turmoil of the past few months has rocked the life insurance industry and caused upheaval in insurance planning. But it is less well-known that related hot markets such as premium finance and life settlements have also been particularly hard-hit, leaving many policyholders and insurance advisors wondering "What happened?" and "What now?"

The pain is especially acute in the life settlement, or secondary insurance, market, where life insurance policyholders sell their unwanted policies to investors. This market was previously prospering; it had grown exponentially in the past decade, with an estimated $12 billion of U.S. life insurance face value sold in 2007.  Life settlements typically involve policyholders aged 65 years or older, who seek immediate cash in excess of what they could obtain by surrendering a policy to the insurance company. Investors find the market attractive because secondary policies have no correlation with volatile stocks.

Growth in life settlements also fueled developments in the premium finance market by allowing policy owners to borrow using the market value of their policies as collateral. While premium financing has existed for some time, lenders have developed new programs that offer borrowers a variety of options for securing loans, including non-recourse financing (where the policy is the only security) and partial recourse or "hybrid" financing (where the borrower personally pledges some collateral in addition to the policy-for example, 25% of the loan amount).

For many older individuals, this access to credit and their ability to sell a policy in a life settlement made the acquisition of life insurance easier and more appealing, and it led to a boost in both the initial and secondary sales of life insurance policies.

In 2008, however, a perfect storm of economic, market and legal crises ripped through the industry, hobbling the operation of both the life settlement and premium finance markets and bringing many of these transactions to a halt.

Economic Collapse
The economic turmoil that began last October has hurt the life insurance industry on multiple levels. The credit crisis triggered by the collapse of the subprime mortgage market required a federal bailout of AIG, one of the world's largest insurance carriers. The resulting stock market decline reduced the investment account value of several other insurers as well, slashing their profitability and putting significant pressure on their capital reserves.

Rating agencies responded by downgrading several U.S. life and annuity companies. Other insurers were forced to seek out new capital, and several of them also applied to receive assistance from the federal bailout program. Life insurance policies issued by downgraded carriers declined in value, while the lack of available credit forced some investors and lenders to withdraw from the life settlement and premium finance markets altogether. All this significantly hampered policy owners wanting to sell. It also curbed premium financing, particularly the non-recourse and hybrid programs that relied on a policy's market value as the primary or only source of security.

Market Shake-up
The secondary insurance and premium finance markets were rocked again when 21st Services, one of the major independent companies offering life expectancy reports on policy holders for the life settlement market, announced that it would lengthen its life expectancy evaluations by up to 25%. Another major provider, AVS Underwriting, soon followed suit in November 2008, saying it would lengthen life expectancies by up to 10%.

Such reports are crucial in life settlements and premium financing because they project the longevity risk associated with a particular policy-in other words, how long an insured will live before the payout of the policy death benefit. Shorter life expectancies generally result in higher policy values, since the policy will require fewer premium payments for the buyer before maturity. If the reports have underestimated the insured's actual life expectancy, however, then the investor or lender will have overestimated the policy's investment return, and thus overvalued the policy.

The longer life expectancies have increased the longevity risk of many policies and forced a downward adjustment in the life settlement market. Some investors concerned about the accuracy of the reports have withdrawn from the secondary market or demanded that the reports be updated. Premium finance lenders, meanwhile, have found that the value of their collateral for outstanding loans-namely, the policies-has been impaired. As a result, many policy owners have found it difficult to finance or sell their policies, or they have received offers that were much lower than they expected.

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