Testing for Adverse Selection in Life Settlements: The Secondary Market for Life Insurance Policies

Abstract

Using a large and comprehensive dataset of 9,002 life insurance policies with aggregate death benefit of $24.14 billion purchased from their original owners between 2001 and 2011, we compute the expected return on individual policies. We find that the primary determinant of the expected return on these life settlement contracts is not adverse selection relative to underlying life expectancies. Instead, we find that other economic phenomenon such as demand for insurance, increasing premium schedules, diversification of unique risks and mitigation of life expectancy estimation risk help explain the cross-sectional variation in expected returns across life settlements contracts.

Keywords: life settlements, secondary market for life insurance, adverse selection, longevity risk

JEL Classification: G20, G22, G23