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Avoiding the arbitrage trap: some life insurance companies are being targeted by investment firms that attempt to create blocks of policies that will be candidates for life settlements a year or two after issue.

Article Excerpt
Life insurance professionals must constantly remind themselves to focus on sound, fundamental business practices. In the game of football, the most fundamental focus is on blocking and tackling. Similarly, for those running a life insurance company, a primary focus must be on issuing profitable new business.

Executives typically receive periodic reports showing the amount of new business produced compared with a corresponding, preceding period. Likewise, the persistency of new business is a metric used by some to monitor the ultimate profitability of that new business. Certainly, writing new policies that lapse soon after issue typically results in the company losing the initial investment required to produce that business.

The question insurers should ask themselves is, "Can good fundamentals be deceiving?" Specifically, can increased production with better-than-expected persistency, sometimes be bad? Unfortunately, the answer may be "yes." It appears that some life insurance companies are being targeted by investment firms that wish to make money by creating a "mortality arbitrage." Typically, this is accomplished by taking advantage of the targeted company's underwriting procedures, which are constrained by legal and economic forces. This arbitrage most often takes the form of a...

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