As an asset class, life settlements have not had an easy introduction to the UK marketplace and highprofile mistakes have been made with how they have been communicated and sold.
However, these issues have not been down to the product. The asset class itself remains a good one, offering unique benefits to investors.
Life settlements offer investors a way of generating potentially good returns without the need to access traditional markets so they could be a suitable uncorrelated asset to hold in a well diversified portfolio. After all, who would doubt one of the biggest purchasers of life settlements – Warren Buffett?
Life settlements are worth getting to know a bit better.
As life settlements have grown in popularity, the FSA has run its rule over them to identify potential risks to investors.
Like all asset classes, they have certain risks but the market for life settlements is maturing and new players are coming in to the market and are addressing these risks through product innovation.
One of the issues levelled at life settlements is that the products profit from someone’s death. This not only ignores the fact that the management of longevity risk is a fundamental aspect of financial planning but it also ignores the fact that the original policyholder has benefited from the sale of their policy they no longer want.
In the US, $1.4trn in life insurance policies lapsed last year because policyholders either no longer wanted them, could no longer afford them or felt their policy was no longer suitable for their needs.
By providing a secondary market, these policyholders can derive significant value instead of ending up with nothing despite years of premium payments.
Another challenge thrown at life settlements is that of longevity risk.
Here again, providers are developing and structuring products which can reduce or mitigate this risk. In addition to better life expectancy estimations, some life settlement providers are looking to build in additional premium payment cushions into their policy payment plans. Others escrow away a contingency fund which can be used to pay additional premiums. This kind of product innovation, which is a progression from the more traditional life settlement fund, is symptomatic of a maturing market.
The relative illiquid nature of the asset class has also been remarked upon.
Typically, we would suggest that investors hold no more than 10-15 per cent of their portfolio in life settlements. Therefore investors’ liquidity would come from other more liquid assets.
However, the longer term aspect of life settlements – which is no bad thing – can make them suitable for retirement planning, which is a longer-term investment strategy.
A maturing market
In addition to product providers raising their game, the life settlement sector in the UK is taking a more mature and sophisticated approach.
Advisers can take heart from the fact that the European Life Settlement Association has recently published its code of conduct, which aims to provide industry standards for its members to help give additional comfort to investors in this market.
As a result, we believe that future products will be more transparent and easier to understand.
The uncorrelated nature of life settlements makes the asset class ideal for investors to diversify into.
Diversification is one of the pillars of financial planning but this is little help when assets all seem to be moving in a downward direction at the same time as in autumn 2008 when stockmarkets halved in value at the same time as returns on property, cash and corporate bonds also crashed.
Life settlements, on the other hand, offer some significant advantages to investors who want to diversify a portion of their portfolio.
These include: returns uncorrelated to financial markets, a known maturity value, low volatility and potentially strong returns. In a nutshell, they can offer investors a degree of certainty in an uncertain world.
Take a closer look
We recognise that life settlements have been a soft target for some commentators but the asset class is coming of age.
Providers are developing new products that mitigate the traditionally associated risks and making them more accessible and appropriate for retail investors.
For those who recognise the positives and are prepared to take a closer rational look, they will see the benefits of presenting an investment strategy that learns from the mistakes of the past and invests clients in an uncorrelated and more certain asset class.
HOW LIFE SETTLEMENTS WORK
Life settlements are a secondary market for US life insurance policies.
In a life settlement investment fund, the original owner of a life insurance policy sells the policy on to a third party (in this case the investment company) for a price usually higher than the surrender value of the policy but lower than the sum assured.
Typically, transactions involve policyholders of 65 or older.
Following the sale, the new owner of the policy has to maintain the premiums on the policy and when the insured dies, the new beneficiary gets the death benefits.
CRITICISMS OF LIFE SETTLEMENTS
The life settlement industry has in the past been questioned over the ethics of benefiting from the death of the underlying policyholders.
In February this year, the FSA raised concerns about the marketing of life settlement investments with head of investment policy Peter Smith saying: ’If it is such a good product, why do you have to pay people so much to sell it?’
The FSA said it also had concerns about the ’real and significant’ risks caused by a lack of diversification in some funds, and by illiquidity and counterparty risk.
In July, the US Senate raised concerns about the valuations being placed on life settlements as well as the high levels of fees that sellers of life insurance policies are being asked to pay.How life settlements workcriticisms of life settlements