In this paper, we comprehensively analyze open-end funds dedicated to investing in U.S. senior life settlements. We begin by explaining their business model and the roles of institutions involved in the transactions of such funds. Next, we conduct the first empirical analysis of life settlement fund return distributions as well as a performance measurement, including a comparison to other asset classes. Since the funds contained in our dataset cover a large fraction of this relatively young segment of the capital markets, representative conclusions can be derived. Even though the empirical results suggest that life settlement funds offer attractive returns paired with low volatility and are virtually uncorrelated with other asset classes, we find latent risk factors such as liquidity, longevity and valuation risks. Since these risks did generally not materialize in the past and are hence largely not reflected by the historical data, they cannot be captured by classical performance measures. Thus, caution is advised in order not to overestimate the performance of this asset class.
We analyse the prevailing valuation practices in the settlement industry based on a sample of eleven funds that cover a large fraction of the current market. The most striking result is that a majority of asset managers seems to substantially overvalue their portfolios relative to the prices of recently closed comparable transactions. Drawing on market-consistent estimates with regard to medical underwriting, it is possible to trace back the observed discrepancies to inadequately low model inputs for life expectancies and discount rates. The consequences are a dissimilar treatment of investor groups in open-end fund structures as well as an unduly high compensation for managers and third parties. To address this predicament, we suggest defining life settlements as level 2 assets in the fair value hierarchy of IFRS 13, improving transparency and disclosure requirements, and developing new incentive compatible fee structures.
Incentivizing unobservable effort in risky environments, such as in insurance, credit, and labor markets, is vital as moral hazard may otherwise cause significant welfare losses including the outright failure of markets. Ensuring incentive-compatibility through state-contingent contracts between principal and agent, however, is undesirable for risk-averse agents. We provide a theoretical intuition on how pro-social preferences between agents in a joint liability group con-tract can ensure incentive-compatibility. Two independent large-scale behavioral experiments framed in an insurance context support the hypotheses derived from our theory. In particular, effort decreases when making agents’ payoff less state-dependent, but this effect is mitigated with joint liability in a group scheme where agents are additionally motivated by pro-social concerns. Activating strategic motives slightly increases effort further; particularly in non-anonymous groups with high network strength. The results support existing evidence on joint liability groups and further suggest that even if peer pressure to ensure effort provision is absent, such group policies can improve efficiency when agents are pro-social.
We estimate economies of scale and scope as well as cost and revenue efficiency to explain the structure of the global reinsurance market, where large reinsurers dominate but both diversified and specialized reinsurers are competitive. The costs and benefits of size and product diversification are particularly relevant to the reinsurance industry, as risk diversification is central to the industry's business model. We find that reinsurers with total assets less than USD 2.9 billion exhibit scale economies, while those with total assets greater than USD 15.5 billion do not. Large reinsurers are characterized by high cost efficiency, while small reinsurers exhibit superior efficiency only when specialized. Large reinsurers also exhibit revenue scope economies when operating both life and nonlife reinsurance. Moreover, the evidence is in line with the efficient structure hypothesis: cost-efficient reinsurers can charge lower prices without sacrificing profitability.
