A secondary market for life insurance using blockchain
August 28, 2018 by Nicky Morris
Many policyholders are unaware that they can sell their life policies. Depending on location, secondary markets currently are at best opaque and obscure and at worst non-existent. Singapore-based startup fidentiaX plans to change that.
The demand
Seniors often wish to exit their life insurance commitments for various reasons. They may need the money for care or medical expenses, they may no longer be able to afford the premiums, or perhaps the beneficiary doesn’t need the money.
In the US, 250,000 policies a year with a face value of more than $57 billion are lapsed and surrendered back to life carriers. The average face value of a surrendered policy is approximately $225,000 as of 2010 (Source: Welcome Funds). Another study showed that only 50% of seniors are aware they can sell their policies.
Nonetheless, there’s a small industry focused on “Life settlements” which involves buying the policies from the insured. The ultimate investors are wealthy individuals, Alternative Investment Funds, hedge funds and some institutions.
The type of life insurance varies by country. In the US the focus is on universal and variable life policies. Hence policy valuation primarily uses life expectancy.
However, in other jurisdictions such as Germany and Asia, the emphasis is on endowments. As a result, the investment aspect plays a more prominent role in valuation than life expectancy. And people of all ages have changes in circumstances which mean they want to reduce outgoings or sell investments.
FidentiaX’s co-founder Alvin Ang explains: “We are focused on the cash value of the policy. We are not trying to be a death merchant. So we don’t want the investor to buy the policy for the potential payout for death. We can’t stop them from doing that. We have an actuary within the company that will make price recommendations based on the surrender cash values.”
“We’ll be looking at endowment, universal life, whole life. Plans that have inherent cash values – participating plans. Cash value is something that is guaranteed that is yours.”
The benefits
For the policyholder, a secondary market provides greater flexibility and could encourage more people to take out insurance. For example, in the US there is currently very low growth of only 1% a year.
For the insurers, the broadened consumer options could be a boon for sales. Though with greater consumer knowledge, that $57 billion (face value) of lapsed policies will decline.
Ang reckons there’s a secondary benefit to insurers. “During the Lehman crisis, there was a lot of surrendering of insurance policies, because everybody was faced with a liquidity crunch. When there’s a sudden drawdown of funds due to surrendering of policies, they have to liquidate assets at a non-optimal value. Having a tradeable marketplace acts as a dampener to the whole crash. It reduces the volatility to some extent.” That said, there’s a good chance the secondary market could also freeze up during a major crisis.
For knowledgeable investors, it’s an attractive opportunity. The US market tends to offer returns that don’t correlate with other asset classes. Even in endowment markets, life insurer returns are smoother compared to other investments. According to BVZL, secondary market returns for US life settlements were 12-18% IRR annually as of December 2013. However, US settlements are relatively risky.
Ang explained: “The issue in the US is when you make a purchase from a 65-year-old there is this question mark over whether the guy knows what he’s actually selling.” What if the policyholder is a smoker but claimed he wasn’t and the insurer refuses to pay. There are tax risks and many others, hence the attractive returns.
According to Ang, currently some middlemen buy and re-sell tradeable policies at a significant markup. Whereas with fidentiaX’s marketplace, the middleman stands to lose the most.
Regulation
In Asia, this is a relatively under-regulated area. Asked if fidentiaX was in a sandbox, Ang said: “We do not see a need to be in a sandbox because in Singapore and the few countries that we are exploring, there are no prescribed regulations on tradeable insurance. This could be due to the lack of awareness in the market and the relatively low transaction volume. However, we are taking steps to address KYC and AML risk within the marketplace.”
FidentiaX’s trust structure
Initially, the startup plans to focus on Asia, starting in Singapore, then moving to Malaysia and Hong Kong. The marketplace will be live by the end of the year.
The business isn’t decentralized. In each jurisdiction, the policies will be held in a trust managed by a lawyer. Legally the policies will be owned by the trust. Ang’s reasoning is an investor could be in a different jurisdiction to the policyholder.
The beneficial owner will be recorded on the blockchain. The lawyers will have a blockchain node and a separate database with full policy details. The two will be connected using an oracle, which is a way for a blockchain to communicate with off-chain data.
This structure also ensures the privacy of the policyholder whose name will not be revealed to buyers. Typical information will include the policy, the insurer, the policy tenure, the policy surrender value, projected return, and some basic information about the life assured’s age and gender. They don’t plan to disclose health conditions.
When it was pointed out that the trust structure could raise concerns about fraud as buyers have to ‘trust’ both fidentiaX and the lawyers as custodians, Ang acknowledged that this trust structure is a pragmatic solution in the short term. In future when insurance companies enter policies on blockchains, the need for trustees should diminish.
Novel features
Another novel aspect is fidentiaX plans to have a private blockchain network using the lesser-known Nxt platform.
They did a small ICO last year, but they have three different tokens including a stable coin to minimize the impact of token fluctuations.
The primary business models are a membership fee and transaction fees. For larger investors, they will offer additional services with associated fees.
The future: tokenisation and securitization
FidentiaX is creating a model fund which involves buying some policies directly from the market. The idea is to tokenize the fund in the future, enabling fractional ownership of a policy.
The longer-term plan will involve securitization. But to do so, fidentiaX will need a larger capital structure and to comply with complex regulations.
The massive benefit for securitization is the visibility into the underlying assets that blockchain enables. Contrast this with the opaque nature of mortgage-backed securities during the financial crisis. Recently a Chinese bank securitized trade finance receivables which are stored on a blockchain.
Conclusion
The potential for a disruptive secondary market in life insurance seems promising. For fidentiaX there’s a big opportunity, but it will face the same challenges that all startups face: successful execution.
