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Trade Report May 09

Trade Report May 09

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Published by David Dorr
This was our sixth issue.
This was our sixth issue.

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Published by: David Dorr on Mar 15, 2010
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Trade Report
 
Longevity MarketsCommentary 1Yield to LE 4Purchase Parame-ters5IRS Clarifications 7Longevity MarketSpreads9
May 18, 2009
Volume I, Issue 6Inside this issue:
Since we published last month’s Trade Report there have been some impor-tant developments in the life settlement sec-tor and chief among them is the new guid-ance from the IRS regarding the tax implica-tions when conducting a life settlementtransaction. The recent ruling changed what was previously believed to be a pretty cutand dry understanding of the tax conse-quences of a life settlement. It is also of particular importance to foreign investorsand offshore based investment vehicles. Todelve further into this issue we have in-cluded a reprint of an O’Melveny & Meyersinterpretation of the ruling on pg 7. Thoseinterested in learning more about this issuecan contact us for further information andresources. The week before last was the 15
th
 LISA life settlement conference in New  York and while membership to the associa-tion was down significantly from last yearthe industry is showing that it is still strong and here to stay. Several market players thathave been relatively quiet in their purchasing over the last six months appear to now beloaded up with new capital and in the very first stages of deploying it in the month of May. These groups include Peachtree, Ma-ple Financial, and Senior Settlements. All of these providers have been participants in thelife settlement market for some time and it isnot surprising to see capital flow to firmsthat have longer histories.Following our discussion of the AIG securitization from last month we haveobserved recently that a few hedge fundsand private equity funds that have partici-pated with the Treasury’s TALF program arelooking very closely at life settlements. Thiscould prove to be an exciting developmentfor our market, albeit with longer term ramifi-cations. For those not familiar with TALFhere is an explanation below.
 The Fed explained the reasoning behindthe TALF as follows:
“New issuance of ABS declinedprecipitously in September and came to a haltin October. At the same time, interest ratespreads on AAA-rated tranches of ABSsoared to levels well outside the range of his-torical experience, reflecting unusually highrisk premiums. The ABS markets historically have funded a substantial share of consumercredit and SBA-guaranteed small businessloans. Continued disruption of these marketscould significantly limit the availability of credit to households and small businesses andthereby contribute to further weakening of U.S. economic activity. The TALF is designedto increase credit availability and support eco-nomic activity by facilitating renewed issuanceof consumer and small business ABS at morenormal interest rate spreads.”If pools of life settlements can besecuritized and sold or pledged as collateral tothe government under TALF, TARP or a new program not yet available it is certain that lifesettlements will experience a boom unprece-dented even from years past.
Continued on next page
 
Longevity Markets Commentary
Editor & Publisher
Brian C. Dorr
Contributing Editors
 
 Anne K. ZandCarline B. Gele 
Managing Editor and Writer
David C. Dorr
LIFE-EXCHANGE tradedata is published monthly on the fifteenth of eachmonth. Subscription rateis $250 per month or$2,750 for the whole year.No data herein should beconstrued to be recom-mendations to purchase,retain, or sell securities, orto provide investmentadvice of the companiesmentioned or advertised.No fees are accepted forpublishing any editorialinformation. LIFE-EXCHANGE, its subsidi-aries, and its employeesmay, from time to time,purchase, own, or sellsecurities or other invest-ment products of thecompanies discussed oradvertised in this publica-tion. 
Copyright @2009 Life-Exchange, Inc. All rights reserved.
 
Longevity Markets Commentary Cont.
 
Copyright @2009 Life-Exchange, Inc
2001 Biscayne Boulevard Suite 2102, Miami, Florida 33137
(866) 907-9766
 Japan’s currency credit rating twonotches from AAA to Aa2. The fullannouncement can be read herehttp://www.reuters.com/article/newsOne/idUSTRE54H2RW20090518. If thisjust happened to a country that has ahigh savings rate and over $1 trillionin foreign currency reserves what doyou think the implications are for theUnited States?How will this impact lifesettlement investments? It will raiseIRR’s back up and make credit facili-ties expensive and in many cases un-available. It will also coincide with adecline in the US Dollar as investorslook for alternative safe havens. Re-member, life settlements involve aone way long term directional betgoing long the US Dollar. Some may argue that higher interest rates in theUS Dollar will actually attract tradersand investors back into our currency but this overlooks the greater funda-mentals. Many novice FOREX trad-ers believe that trading currencies issimply a matter of buying the higherinterest debt of one developed coun-try and selling the lower yielding debtof another developed country. Anexample of this would be buying USDollars and selling Japanese Yen. This is also known as a carry tradebecause of the interest rate arbitrageearned by simply holding the twocurrencies. While this is a profitabletrade while currency pairs remain within a tight trading range, or evenbetter when the higher interest cur-rency is trending upwards (usually due to others jumping in on the sametrade) it can turn disastrous whencaught on the wrong side.
Continued on next page
 credit ratings of US based life insurersand how it may signal potential sol- vency issues that could impact lifesettlements as an investment. We’vealso begun to touch on credit ratingsand their impacts on IRR. We’ve beensuggesting for some time now theneed to model volatile changes in in-terest rates for portfolios. In lastmonth’s issue we cited the bubble inlong term treasuries that is beginning to burst and the impacts that it couldhave on our market. This month wecontinue that theme.David Walker, formerly thecomptroller of the Treasury wrote anop-ed in the Financial Times on May 12, 2009 titled
“America’s triple A rating is at risk” 
.
In the article hecites the growing off balance sheetliabilities of the US Government which are continuing to balloon atalarming rates. Currently those un-funded obligations, primarily for SocialSecurity and Medicare, are over $45trillion. According to Walker, SocialSecurity is going to start negative cashflowing in less than 10 years. BothMoody’s and S&P have signaled thatthey are carefully watching the US’scredit rating and if we’ve learned any-thing from the financial crisis over thelast 24 months, it’s that credit down-grades are a lagging rather than leading indicator. In our April Trade Report we highlighted the bubble that hadoccurred in long term US Treasuries. Just since that issue we have seen acontinued steeping of the US Govern-ment debt yield curve. Obviously if the US gets downgraded from its AAAstatus, which it has held since 1917,borrowing costs are going to go up – alot.Even as this publication goesto press Moody’s just downgraded
 
Page 2 
Continued from page 1
If this happens IRR’s willplummet by better than 300bpsfrom current levels (14.18%) inshort order. This would cause sellside volume to explode but not forthe reason that most people wouldthink. On the surface it is logical toconclude that considerably highersettlements would induce more pol-icy owners to sell and while this istrue and will certainly be a contribu-tor to higher volume the real con-tributor will be that more policies will qualify. Of policies currently submitted to the market we estimatethat roughly one in seven will pro-duce a price at current IRR’s that will exceed the CSV. In Q4 ‘08 withIRR’s almost approaching the 20’sless than one in ten policies submit-ted would price. TALF funding  would have the reverse effect mak-ing it possible for perhaps one infive or one in four policies to pricebecause of the low IRR created by anew low cost of capital funding source. This could lead to a 60% orgreater increase in industry volumeinstantly. While this may seem like adream come true to life settlementparticipants, particularly the seniors who are in desperate need of cashmore than ever to shore up theirfinances, it will be at the expense of every US tax payer. This potentially cannibalistic approach will likely have longer term repercussions thatmay not bode well for the life settle-ment market.
 
 A topic that we are moni-toring for almost every issue of ourtrade report is credit quality and itsimpacts on our market. Most of ourcommentary has centered on the
 
Longevity Markets Commentary Cont.
 
Copyright @2009 Life-Exchange, Inc
2001 Biscayne Boulevard Suite 2102, Miami, Florida 33137
(866) 907-9766
oped in the insurance industry it hasimportant applications throughoutthe financial universe. It is timely torevisit the various uses for ALM es-pecially since we are potentially enter-ing another period of volatility ininterest rates. Also ALM modeling isuseful if not critical in modeling lifesettlement securitizations or noteofferings collateralized by life settle-ments. We’ve seen note offerings with maturities in the 3-10yr range when the average life expectancy is well above 10 years. This poor mis-match inevitably causes problems andcould easily be solved with note issu-ances that better reflect the maturity and/or duration of a portfolio. While ALM originally fo-cused primarily on interest rate risk  we believe that longevity risk willcontinue to grow as a greater compo-nent for carriers and reinsurers whenmeasuring risk and looking at ways tobe more competitive. Most carriersand reinsurers are currently not wellbalanced when it comes to longevity risk. Typically they are over weightedin either their life books or their an-nuity books and even those few witha relatively even mix still have signifi-cant imbalances because of the vari-ances in the products they sell. Aproper series of indexes and the righttrading product will one day be thesolution. JP Morgan, Credit Suisseand Goldman Sachs have made early inroads into products and indexesthat will make this goal achievable,however, there is still much develop-ment needed to really find the rightfit. In future articles we will cover thechallenges related to creating the rightindex or product.
1. Wikipedia, TALF
 
2.
Swiss Re,
sigma
No. 6/2000
 
Continued from page 2
But even those caught on the wrong side quickly forget their lessonand view it simply as a short term cor-rection. What these novices have usu-ally never contemplated is whether ornot it is possible for a “developed”nation’s currency to simultaneously offer a very high interest rate and con-tinue to devalue over a period of years,rather than months vs. other curren-cies from both developed nations anddeveloping ones.
 
Lemons to Lemonade
Ok so all of this looks pretty daunting but this presents a huge op-portunity to emphasize the need forhedging longevity risk and there is nobetter means to accomplish this thanthrough free market mechanisms. Aliquid market for taking positions inlongevity risk would help govern-ments, pension funds, and insurers totransfer this risk in a way that is cur-rently not available. This could helppreserve Social Security (at least for afew more years) and help carriers’ bet-ter handle their asset-liability manage-ment (ALM). We will be hearing a lotmore about ALM over the next coupleof years. For those readers not famil-iar with ALM below is an explanationfrom Swiss Re
 
“Asset-liability management (ALM) for insurers examines the history, issues, and  prospects for ALM at life and non-life insur- ers. Developed in the 1970s in response to a sharp rise in the level and volatility of interest rates, ALM has evolved into a set of tech- niques that enable financial institutions tomanage a host of risks, of which interest rate uncertainty is just one.” 
 Although ALM was devel-
Page 3 
UPCOMING EVENTS
 
08.07.2009LISA Broker Summit inOrlando FL *Tentative Dates 08.28.2009LISA Industry Service Fo-rum in Orlando FL -*Tentative Dates 09.24.2009-09.25.2009LISA ComplianceConference *Tentative Dates 10.26.2009Fasano 6
th
Annual LifeSettlement Conference inWashington DC 11.08.2009-11.10.200915
th
Annual Fall Confer-ence LISA in NY, NY*Tentative Dates 11.12.2009-11.14.2009NAILBA 28 in HollywoodFL 

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