How to determine fair value for life insurance policies in a secondary market

Abstract: In this study a methodological approach is presented on how transactions in the secondary market for life insurance policies can be fairly priced for both policyholders and life settlement companies. Monte Carlo simulation of mortality on a pool constructed based on actual data of 85 life settlement transactions shows that a realistic assumption for the range of offered prices is limited to 15% and 20% of the face amount of the policy, given a required return of 7%. The power of the proffered pricing approach is ensured by assessing and managing mortality risk along with the other pertinent risks using stress testing, where mortality risk appears to be analogous to some extent with systematic risk on other markets of assets.