As some readers are aware, Toomre Capital Markets LLC ("TCM") is one of the few Capital Markets consultancies with considerable experience in one arcane sector of the securitization markets called insurance-linked securities. Lars Toomre was originally retained in 1997 by what is now known as Munich Re America, Inc. to help that subsidiary of Munich Re thrash out what strategies to pursue in the convergence of the capital markets and more traditional insurance markets driven by fortuitous loss. Partly as a result of that initial strategy work, American Re Financial Products was established to pursue three major initiatives:

• Finite reinsurance (now much discredited after the abuses exposed by the AIG/General Re finite reinsurance abuse scandal)
• Reinsurance of credit enhancement mono-line insurance companies and other credit enhancement opportunities primarily originating from world-wide project finance needs (now shut down due to Munich Re's downgrade from AAA to A in 2001), and
• Creation of American Re Capital Markets to create, underwrite and trade in various insurance-related opportunities such as future film production securitizations, weather derivatives, insurance-linked securities, guarantees of index total rates of return, insurance swaps, the hedging of Enterprise Risk Management exposures and the secondary trading of various property and casualty, health and life insurance policies (now part of Munich Re Capital Markets operation in New York City).

  Lars Toomre ended up joining Munich Re to help establish American Re Capital Markets where he focused on weather derivatives, enterprise risk management

  and other odd-ball initiatives with "hair on them". One of the odd-ball type of requests that periodically would come across the Capital Markets desk concerned "What would Munich Re want to pay for a particular insurance policy (or sometimes portfolio of insurance policies) in the secondary market?" Some of these requests concerned structured settlements, some concerned viatical insurance and some were marketed as "life settlements". Generally, the insurance broker was looking for a better price than what the leading aggregators of the day (generally JG Wentworth or General Re Financial Products) were willing to pay. The type of policy and details within caused the valuations from various sources to often vary considerably.

  Some people have asked why bother with all the complications of acquiring a portfolio of life insurance policies in the secondary market or a diversified portfolio of P&C risks? In short, the answer is that the returns from such diversified portfolios do not correlate with the returns from more traditional investment sectors such as equity, fixed-income, currencies or commodities. Hence, some of the smartest diversified investment companies (like Berkshire Hathaway, PIMCO, Citadel Investments and Greenlight Capital) have made some very significant allocations to insurance, insurance derivatives and insurance-linked securities, particularly because of how this sector risk increases their risk-adjusted returns (as calculated by such measures as the Sharpe Ratio).

  On Monday, November 26th 2007, The Wall Street Journal published a front-page article entitled An Insurance Man Builds A Lively Business in Death written by Liam Pleven and Rachel Emma Silverman. This article describes in quite some detail how life settlement contracts are acquired and some of the pratfalls of dealing with retail clientele that have primary life insurers and regulators warily circling this rapidly expanding industry.

  The article starts by describing Alan Buerger, the former insurance salesman who runs Coventry First LLC, "which lets investors bet on – and profit from – other people's demise. His company is in the business of buying rights to life-insurance policies. In an arrangement known as a 'life settlement', Coventry pays the holder a lump sum for the policy now, takes over paying the premiums for as long as the insured person lives, then collects the benefits -- generally worth far more -- when the person dies. Coventry keeps some of the policies in its own portfolio. It sells others to institutional investors. From an investor's standpoint, as a general rule, the sooner these people die, the better."

  To better understand, consider the case of the generic 45 year-old American. A sample life insurance policy may pay-off to designated beneficiaries say a million dollar face amount plus any account value at the time of the insured person's death. In return, the insured party agrees to make one or more series of periodic payment to the life insurance company to keep the policy in force throughout the agreed upon term. With generic life expectancy now close to eighty years, the value of this life insurance policy (assuming that the insured person lives exactly to eighty years of age) is the present value of the million dollar face amount (brought back 35 years [e.g. 80-45]) less the present value of all of the periodic premium payments that will be expected to be made over the next 35 years.

  Remember that a million dollar, 35 year zero discounted at say a 10% bond-equivalent discount rate is only worth $35,584 in present dollars. When the present value of the future insurance premiums are subtracted from this value, many times the current economic value of such a policy is negative from the prospective of a potential acquirer (and positive from the perspective of the primary life insurance company to the extent that its investment return exceeds the 10% discount rate). The value to a secondary market acquirer comes in the event that the insured person dies earlier than expected. The present values of that million dollar zero after five and ten years (again using the same 10% corporate bond equivalent discount factor) are $620,921 and $385,543. The offsetting present value of policy premiums is also reduced since there is no reason to keep the policy in force after the death of the insured party.

  The WSJ article continues with by describing how the industry trade group, The Life Insurance Settlement Association, has grown from some sixteen members in 2000 to more than 165 presently including major firms such as Deutsche Bank AG. "Now banks including Goldman Sachs Group Inc., Credit Suisse Group and Bear Stearns Cos. want to expand the industry further. In April, these banks helped form the Institutional Life Markets Association to lobby against efforts to restrict the business. Some Wall Street firms are also seeking to buy policies more directly, trying to cut out parties such as Coventry. This year, Cantor Fitzgerald LP set up an Internet-based exchange for those who want to sell or buy policy rights."

  Life settlements, however, stir objections and not only because they make some people squeamish. Apparently, some state regulators have called life-settlement terms unfavorable in some cases to policyholders. These regulators also charged that certain arrangements flout the spirit of laws designed to keep speculators from taking out policies on strangers. "Policyholders, too, have lodged complaints. Television talk-show host Larry King filed a lawsuit in October against a Maryland insurance brokerage, claiming he got a raw deal when he sold two policies on his life, with face values totaling $15 million, for $1.4 million. Among his complaints: With one of the policies, Mr. King says he doesn't know who has a financial interest in seeing him dead."

  The article goes on to explain that among the biggest critics of life settlements are the primary life insurers that issue the policies that constitute the actual property that is conveyed in the life-settlement trade. "Some, such as MetLife Inc., say the [life settlement] concept turns what they say should be protection for surviving family members into a vehicle for speculators. Insurers don't generally protest when people sell policies they've held for a long time. But many, such as AXA Equitable Life Insurance Co., [the former Equitable and] a unit of AXA SA, oppose deals in which the policy is purchased with the intent of transferring it quickly to an investor, a phenomenon some call stranger-originated life insurance."

  As the article correctly explains, life settlements threaten the business model for life insurers. "Each year, about 6% of life-insurance policies lapse, according to the Insurance Information Institute, a trade group, as people forget about them or decide they don't need them anymore." Coventry First, Toomre Capital Markets LLC client, Q Capital Strategies, and their rivals raise the prospect that fewer policies will be abandoned, leaving insurers to pay out more in death benefits. Currently, many insurers already offer to pay an often-small sum to policyholders who cancel coverage. However, the amounts that the secondary market life insurance acquirers are willing to pay often exceed what the primary insurers offer.

  Hence, the primary life insurers will have to find a way to pay more to compete with life-settlement firms' payouts. 'That would drive the premiums through the roof,' says MetLife's chief executive, Rob Henrikson. Mr. Henrikson ironically is the same executive at MetLife who in 1996 oversaw the demise of one of Lars Toomre's former employers, MetLife Investment Management Company Inc. ("MIMCO") with the purchase of The New England and its many investment management subsidiaries. The WSJ article suggests that the "battle between the nascent life-settlement industry and insurers is expected to play out over the coming year in individual states, where insurance is regulated and laws covering life settlements are spotty and varied."

  The article continues with a detailed description of Mr. Alan Buerger and Coventry First LLC. This section reads as follows:

  At the core of the battle is Mr. Buerger. His firm, based in Fort Washington, Pa., has bought the rights to life-insurance policies with face values of $12 billion since 2001, he says. That puts Coventry among the industry's top players: Overall in the U.S., life-insurance policies worth $19.5 billion were traded from 2002 to 2006, estimates Conning Research & Consulting Inc., a Hartford, Conn., firm that tracks the insurance industry. Others believe the figure is higher.

  Mr. Buerger won't disclose his privately held company's revenues, though he says they increased fivefold from 2002 to 2006. This year, for the fourth year in a row, he treated Coventry employees and their family members -- 270 people in all -- to an all-expenses-paid trip to Paradise Island in the Bahamas. Coventry gave each traveler a $500 credit to spend on things like fishing trips and restaurants, he says. Mr. Buerger grew up in the Philadelphia area, the son of a ham-radio equipment salesman who was nicknamed "Ham" Buerger. The younger Buerger first tried selling life insurance in his early 20s, eventually joining the former Shearson firm, where he catered to wealthy clients. He left in 1984 to start running his own life-insurance agency, called Coventry Group.

  Now 60 years old, Mr. Buerger has the optimistic demeanor of a polished salesman. In an interview at Coventry's headquarters in this leafy Philadelphia suburb, he invokes the movie "Field of Dreams," known for the line, "If you build it, he will come." He says: "That's how we see this business." In the early 1990s, Mr. Buerger sold a controversial product called corporate-owned life insurance (sometimes called janitor's insurance) in which firms took out policies on their employees and collected when they died. In 1996, Congress pared some tax breaks associated with those policies.

  He sought new opportunities. He attended a seminar on "viaticals," a strategy popular in the early 1990s that was tailored to terminally ill AIDS patients wanting to sell their life-insurance policies. The development of life-extending AIDS drugs largely put an end to the business. Mr. Buerger never sold viaticals, but he concluded that the idea of buying life-insurance payouts could be applied to a much larger pool. He reasoned that relatively healthy, wealthy seniors often no longer need policies they may have purchased years earlier, for instance, to benefit now-grown children. "I felt like I was struck by lightning," he says. He formed Coventry First in 2000, taking out an $850,000 home-equity loan to make early purchases. It remains a family business: Mr. Buerger is chief executive officer, while his wife, son and daughter-in-law hold senior positions.

  Life settlements resonated with older Americans, whose retirement years were stretching longer than many had anticipated. The deals also appealed to policyholders who wanted ready cash for a valuable asset -- much like reverse mortgages, which let older homeowners turn their home equity into income that doesn't have to be repaid until they sell their homes or die. Stephen Ellis needed cash, quickly, when he went over budget on a new house he was building. So the 48-year-old mortgage banker from Annapolis, Md., started shopping two policies, with a combined death benefit of $2 million, that he had taken out on his 75-year-old mother. Mr. Ellis had been paying $35,000 a year for the policies, he says, but the insurer would have paid him virtually nothing to cash them out. He fielded bids through a life-settlement broker, Chesapeake Financial Settlements LLC, in Rockville, Md. A small firm offered $205,000. He accepted.

  "I didn't really look at it as morbid," says Mr. Ellis, who supports his mother financially. "I thought, 'Wow what an incredible way to put a value on this.'" His mother has been in poor health but approved of the sale to benefit him now rather than later, he says. She was unavailable for comment. Some critics say families would generally benefit more by hanging on to the policies.

  In the Larry King lawsuit, filed in U.S. District Court in Los Angeles, the 74-year-old talk-show host alleges that the Meltzer Group Inc., an insurance brokerage in Bethesda, Md., breached its fiduciary duties. The complaint alleges that, in 2004, the brokerage advised Mr. King to set up a trust that would buy and then immediately resell a $10 million policy for $550,000. Given Mr. King's age, health and finances, the suit says, he would have been better off keeping the policy to benefit his estate. In part, that's because the sale of the policy generated income taxes. His heirs likely would have taken no income-tax hit, because life-insurance payouts are typically exempt. The suit also alleges the broker didn't fully disclose commissions and other fees on this transaction and a second one involving a $5 million policy. The suit alleges these charges totaled at least $700,000. That's equivalent to the after-tax proceeds from the $1.4 million Mr. King received for the two policies, says his lawyer, Marshall Grossman.

  The suit also alleges that the defendants refused to name the buyer of one of the policies. "The insured never knows if the guy barreling down the highway in a large truck coming in the opposite direction holds the insurance policy on his life," says Mr. Grossman. "We don't know whether the owner is a Wall Street hedge fund or a Mafia don." In court papers filed this month, the Meltzer Group and its chief executive, Alan Meltzer, said the King complaint "is fraught with misstatements of fact and law" and that Mr. King had full knowledge of any risks. In the filing, the group identified the trust that purchased the policy, but said it is "unaware of the identities of the trust beneficiaries." A spokeswoman for the group, which is a member firm of National Financial Partners Corp., declined to comment further.

  Coventry is identified in the lawsuit as the end buyer of the $5 million policy, but isn't a defendant. "Life insurance is a valuable asset and policyowners should keep their policies," Coventry said in a statement. Life settlements, it says, are for people who for some reason want to drop policies. Mr. Buerger says the company protects the privacy of its policyholders and sells an interest in policies only to institutional investors. Such parties are generally considered diversified and less desperate to avoid losses on any individual policy should the holder live an unexpectedly long life.

  The balance of the article explains that the life-insurance market once was even more freewheeling. For instance,

  in 18th-century England, people took out policies on prominent figures in ill health. The practice was eventually deemed gambling. It led to laws like those in U.S. states today, which generally require that the person who takes out a policy have an established relationship at the time with the insured.

  Once purchased, however, the policy is considered property of the policyholder, who is free within certain limits to use it at will. That includes selling to someone else the rights to collect the benefits. Coventry and other firms controlled by the Buerger family make money by buying up policies and collecting the death benefits, collecting fees on policies they manage for others, and arranging loans to people who want to finance their premiums. The firm says it pays policyholders on average about three times what insurers pay people who want out of their policies while still alive, the so-called cash-surrender value. Coventry has paid holders more than $2 billion for policies, or nearly 17% of these policies' face value. The cash-surrender values of the policies amounted to $650 million, Coventry says.

  Hedge funds and investors, including insurance giant American International Group Inc., have invested in policies Coventry has purchased. Rates of return vary largely depending on when people die, but Mr. Buerger says the compounded rate for the end investor on a portfolio of policies is typically 9% or 10%. Life settlements appeal to investors' appetite for "uncorrelated" investments -- ones that generate steady returns largely independent of the forces swaying stocks and bonds. People die with relative consistency, whether markets are rising or falling. In conferences in recent years, investment banks and ratings agencies have discussed bundling life-insurance policies into securities they can sell to pensions or hedge funds, much as mortgages have been packaged for years.

  Life insurers, meanwhile, are on the defensive. Many are lashing out at cases in which investors encourage seniors to take out policies with the chief intent of transferring them to investors as soon as possible. A number of life-settlement firms drum up business by arranging to lend holders money to pay premiums. Some insurers are increasingly scrutinizing applications before policies are sold, or canceling them before they can be resold. Typically, insurers can rescind a policy unilaterally within the first two years. Insurers are also giving their own policyholders new ways to get upfront cash. New York Life Insurance Co., for one, is offering to lend policyholders money against their future payout, an arrangement akin to a reverse mortgage.

  Only about half of U.S. states have life-settlement laws, among them Maryland, Florida and Texas. Most that have the laws require individuals to wait two years before selling a policy to a third party. State officials are sharply divided about whether to keep the two-year rule, or switch to a five-year ban if the insured person is using an outside party's assets to buy the policy. A longer waiting period could make the bet riskier for investors: Though investors may be paying the premiums, if a policyholder dies during that period, the family, not the investors, would get the bulk of the payout.

  Authorities have challenged some deals as well. A civil suit by the New York attorney general's office last year alleged that Coventry made secret payments to brokers to lure business away from other life-settlement companies. Florida's Office of Insurance Regulation made similar allegations in an investigation against Coventry announced in May. A judge threw out much of the New York case this fall, in part because much of the suit didn't involve New York transactions. Coventry says it believes the few remaining claims "have no merit." Coventry settled the Florida investigation, paying no fines but agreeing to cover the investigation's $1.5 million in administrative costs.

  Mr. Buerger portrays life settlements as too attractive to policyholders to be significantly curtailed. And he says his firm will thrive amid competition from banks because Coventry has life-insurance expertise that Wall Street lacks. "They've got the money," he says. "We've got the policies."

  Toomre Capital Markets LLC agrees that the life settlement firms offer too attractive a value to policyholders to be significantly curtailed. For years, the primary life insurers have grown fat and happy by being the only market for the surrender of life insurance policies. When the life insurance surrender values are as low as a third of what the life settlement market will pay for an individual policy, one must remember that the implied yields that the life insurers are willing to pay greatly exceed the current market rates of 10% or so set by the life settlement firms and other institutional investors. Hence, in some form, life settlement firms and the secondary market for life insurance policies are likely to continue to grow.

  The key impediment to the life settlement industry growth will be what shenanigans, games and false inducements insurance brokers and life settlement firms use to get the most attractive product -- that from elderly retail clientele who sell their life insurance policies in the secondary market. This is an inconsistently regulated market and falls somewhat into both the spheres of insurance and securities regulation. The relatively wealthy elderly are some of the most vulnerable retail clientele. With their infirmities and failing health and/or judgment, are they really able to handle a smooth, somewhat aggressive and/or pushy salesman who says that their policy is worth X and make an informed judgment that it should not be worth something significantly more?

  Hence, Toomre Capital Markets LLC would argue that it is incredibly important to deal with life settlement firms with the highest integrity and approach to this business. TCM is proud to recommend our client, Q Capital Strategies LLC, and suggest that you contact them directly should the reader have interest in selling a life insurance policy in the secondary market. Toomre Capital Markets LLC is happy to explain further to institutional investors how insurance-linked securities are a key component in creating portfolios with more consistent, lower risk-adjusted returns. Please feel to speak with us directly at the contact information listed at the bottom of this web page. Reader thoughts and comments are welcome.