Until the Keydata collapse not much was written about Life Settlements, which is odd given that the underlying problems with the Keydata issue are nothing to do with the asset class itself.
Life settlements are not new and have actually been around for a while – nearly 100 years to be precise. What is new is the number of recent market entrants trying to promote something perceived as new, with relatively little substance behind them.
A recent article by Hargreaves Lansdown said: “Until one of the mainstream investment groups or insurance companies come into the market and backs a professionally-run fund with their reputation… stay clear”.
I agree, as a mainstream professional investment manager in this market for 20 years dealing largely with institutional investors. Be cautious of too good to be true promises – that is why the European Life settlements Association was formed last year.
Life settlements offer an excellent investment opportunity. They are a true alternative with low correlation to investment markets, and when managed properly they provide stable and predictable returns. But you need to choose who you entrust your money with.
So, here are a few truths:
Life settlements are not immoral – They utilise exactly the same principles as an annuity, which is estimating the life expectancy of the policyholder. They enable the policyholder who no longer wants their policy to get substantially more for it than cashing it in or surrendering it and they enable them to enjoy the proceeds.
Valuation – There is no Industry standard, meaning all managers utilise their own particular rules. Some even charge performance fees on this basis which is hard to understand. Valuation methods should use proper actuarially-based standards and be transparent, such that they enable investors to enter and exit the fund at fair value, and the fees charged (based on the valuation) are fair and transparent.
Most debate about life settlements has focussed on longevity risk, whereas liquidity risk is in reality the bigger issue.
Life settlement portfolios require liquidity to meet premiums and expenses. Liquidity is obtained from the cash reserves the fund maintains, borrowings, new investors, or from early policy maturities. Failure to maintain sufficient reserves to pay on-going policy premiums will result in a loss of value because policies will lapse, jeopardising the long term health and viability of the fund.
That is why liquidity is more important than longevity. Assuming the fund uses a properly weighted actuarially derived maturity curve, which is a probability curve that simulates the best actuarial estimates of life expectancy, the fund is able to withstand those instances where people live longer than expected, without any material impact to investors’ returns.
This is why people should avoid unrealistic ’straight line’ estimates of policy maturities which assume nearly all deaths occur prior to the estimated life expectancy, or an artificial ’life expectancy plus one year’ magic formula. They over-estimate the level of early policy maturities, resulting in a lack of maturity proceeds coming into the fund, creating a liquidity problem.
Liquidity is king – manage the liquidity and the policies will stay in force until they mature. If proper actuarial assessments have been carried out when policies were purchased, managers can predict with a very high level of probability the shape of maturities and the resulting investor returns.
Jeremy Brettell is chief executive of SL Investment Management