As investors warmed to the life settlement industry over the past decade, the growth presented both opportunity and risk to the life insurance industry.

A new report from Conning Research & Consulting, “Life Settlements: An Asset Class Resets 2011,” examines the current state of the life settlement industry and says the factors underlying the rapid growth that occurred during the middle of the past decade are likely not sustainable and, from an underwriting perspective, not desirable.

The report notes that much of the growth in annual sales was attributable to STOLI (stranger-originated life insurance), which many insurers regard as schemes to evade their underwriting efforts.

“In 2005 and 2006, an influx of capital, primarily from German investors seeking a tax-advantaged investment and the development of STOLI significantly increased annual sales,” the report states. “In 2007 and 2008, an influx of capital combined with growing awareness of life settlements among brokers and policy owners (and the continued sale of STOLI policies) increased annual volumes to a high point of $12 billion. This created a seller’s market as investors sought more policies to build portfolios.”

Now, in the wake of the credit crisis and economic crunch, Conning says market dynamics have inverted and a buyer’s market for policies exists and capital has yet to return to the levels of a few years ago. “As the life settlement industry adjusts to a prolonged buyer’s market, its participants find themselves operating in a changing landscape in terms of acceptable policy criteria, expected returns, regulation and competition,” the report states.

The report credits a new vigilance among insurers regarding STOLI for the diminishing demand, noting that in 2010 that insurers had filed more than 200 civil law suits in various states over alleged STOLI transactions. Moreover, states are also taking an active role in combating STOLI sales by implementing anti-STOLI legislation as well as filing charges in cases of suspected fraud.

“Insurers are making efforts to monitor policies for STOLI. In some cases, this monitoring has led to rescission of the policy or the contestation of claims. This monitoring has also led some insurers to report suspected STOLI cases to legal authorities, which in turn, has led to criminal charges brought against the individuals involved in the STOLI scheme.”

Nonetheless, the report predicts the new rules may eventually induce more consumers, and subsequently investors, into the market.

“The sell-side is no longer the wild west of 2005,” the report states. “Consumer and agent awareness of life settlements has increased. Once the existing pool of settled policies has been repurchased, lapsed or had death claims filed, those investors that remain will return to buying policies. As investors return to life settlements, they will find clearer, and more stable, regulation.”

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