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What next after life settlements? – the dangers of blanket bans

There has been much talk about US life settlement investments over the last few years particularly in the wake of the Keydata Lifemark and SLS debacle, which continues to cause considerable pain to investors, the FSA and IFAs.

However, the FSA’s announcement that all such investments are toxic and that it intends to ban them for retail investors has quite rightly caused something of a stir in financial services circles and as a precedent threatens far reaching implications.

When Lowes was first approached by Keydata in respect of the company’s life settlement based Secure Income Bonds, it looked a panacea investment – no stock market risk, assets uncorrelated to other pooled investments, ‘guaranteed’ income, and a return of capital at the end of five or seven years.  However, we felt there was insufficient information based on the available literature and so we reserved judgment in anticipation of a more detailed explanation. 

The second issue had a lot of excitement around it from Keydata as the first issue had apparently done well for them, but again, as no one could properly explain the contract model to us, in particular the basis upon which the returns were achieved or losses could arise, we again declined to use the product.

Then, shortly before the third issue came out, at a function in London I was introduced by Keydata to the representative of SLS the Luxembourg-based provider behind the Secure Income Bonds.  The conversation, which underlined our concerns, went something like this:

Keydata: “This is Ian Lowes, he’s a big supporter in terms of our structured products but he needs some convincing on the Secure Income Bond.”

SLS Rep: “Is 3 per cent initial plus 0.5% trail not convincing enough?”

Lowes: “Apparently not.”

SLS Rep: “So what’s your problem then?”

Lowes: “I understand the basis of the US Life settlement market and that there is an opportunity there, but what I need to know is how you structure an investment that takes capital to purchase policies, then needs capital to pay premiums on those policies, the policies mature at some unknown point in the future and yet the investment pays out income from day one?”

SLS Rep: “So you’re a bit of a smart-arse then?”

Lowes: “Apparently.”

Conversation ended!

A week or so later the third issue was launched and whilst it wasn’t a structured product we felt there were far too many unanswered questions and so published our concerns about the Secure Income Bonds and, subsequently, the Lifemark plan as part of the product reviews on our website.

Whilst US life settlements is an investment area we at Lowes have not recommended to clients, we are concerned by the statement from Margaret Cole, the Managing Director of the FSA, that all such investments are “completely unsuitable for most UK retail investors”.

The FSA may be right to be wary of products where the manufacturers are largely based outside of the UK, and so outside the FSA’s authority, but for the regulator to tackle the area by way of a blanket ban on sale to UK retail investors would appear extreme in the least. I would also suggest that it is contrary to one of the principle objectives of the retail distribution review which requires all “independent” advisors to research all retail investment products in order to determine their suitability for any particular client’s needs. It is not inconceivable that there are some clients for whom investments based on life settlement plans would be an appropriate and suitable addition to their portfolio.

These investments are typically based on whole of life insurance policies that have a known ‘maturity’ value – i.e. payment on death of the policyholder – the sum assured.  Unlike the UK market, most have a surrender value stated in the policy document at outset for every year of the policyholder’s life.  As I am sure you will appreciate, as these surrender values have to be stated at outset they are rarely very generous and can’t be changed to take account of the health of the policyholder.  Purchasers of  ‘second hand’ policies know what the final payment will be, they know what premiums have to be paid during the remainder of the ‘term’ and all they have to do is calculate the possible range of returns based on the expected longevity of the life assured.   They will then decide whether the policy is worth more than the surrender value.  In this respect it is not dissimilar to the UK traded endowment market except that you know the exact sum that will be paid at maturity rather than the finger-in-the-air guess of a with-profits investment, but you don’t know exactly when it will be paid. 

There are several companies that take advantage of this market with a view to bringing capital together to buy policies, pay premiums and ultimately reap the benefits when the underlying policies ‘mature’.  Where there is a genuinely pooled resource and the process is managed properly, I see no reason why this entire investment proposition should be singled out as ‘toxic’.

There are of course moral issues in that the gains are achieved as a result of lives assured dying but don’t forget that this happens in the annuity market all the time.  Also appreciate that the original policyholder benefited by achieving more than the surrender value on a policy for which they perhaps could no longer afford the premiums or had no further need for the policy. 

One significant issue that these investments do have is that because the market has not evolved, they are fairly illiquid.  If an investor wants to take their money out of a portfolio then the manager either has to find someone to buy their share, or enough policies have to be sold to realise the cash required.  Likewise, there always has to be enough cash in the portfolio to pay the premiums on the policies.

Ultimately, investors are waiting for the policies to ‘mature’ and by constructing a portfolio with a range of elderly lives assured in different states of health, then a properly managed investment portfolio could provide reasonable returns.

While I am not au fait with the full reasoning behind the FSA’s announcement I am sure the nightmare of the Keydata Secure Income Bonds & Plans has played a significant role.  However, I hope the FSA’s proposal is not simply a reaction to this as this was not particularly a failing of US life settlements as an investment class but rather issues of completely inappropriate structures and also fraud in the case of the former.  

The FSA says its concerns are that US Life Settlement products will fail and investors will lose money. Yet by tarring all these investments with the same brush, in a market with limited liquidity, the FSA is creating a self-fulfilling prophecy. Consumers are already reacting and to date there has been a run on one fund (the EEA life settlements fund) so significant that it has had to be suspended.  It should also be noted that just a few short months ago, March 2011, the FSA authorised a new Life Settlement fund (the Huet Capital Life Settlement fund), albeit as a QIS which does not allow it to be marketed to retail clients.

Aside from that, my main concern is that if the regulator starts imposing blanket bans on whole investment areas that have genuine potential to evolve in a properly regulated manner it not only stifles innovation – and limits consumer choice – but it also begs the question: What next?

Ian Lowes is managing director of Lowes Financial Management

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Comments

There are 15 comments at the moment, we would love to hear your opinion too.

  1. Ian, who was the sls rep who you were introduced to? And also, who was the keydata individual who introduced you to them? Because your version of events sounds very far fetched, please remove all doubt and let us know..

  2. Have they banned blankets now?

    What will the homeless IFAs use to keep warm?

    But seriously, the conversation sounds more credible than any lame defence of Keydata.

    BTW how did a supplier of a CD Rom containing funds data become a manufacturer of dodgy products?

  3. IFAs were not at fault for the issues at Keydata, in fact I believe they are being used as scapegoats by the FSA for the issues and the FSAs incompetence. The issue was a fraud committed by David Elias, and then a self fulfilling prophecy regarding lifemark, the like of which you are seeing again with EEA. There were no dodgy products sold at Keydata, only an incompetent regulator and a dodgy businessman who Keydata performed a 3rd party distribution for. But if you want to keep believing the , then OK. But there are none so blind as those who cannot see. What do you need to be banned next , gilts? When are you going to see the real issue here?

  4. I think you will find that there are none so blind as those who will not see, rather than those that cannot see – although I accept that logically they would be as blind as each other.

  5. I find this article to be a good balanced piece or reporting. Thank you.

    Increasingly the FSA appear to be constricting how IFA’s invest their clients money. The FSA paper about investment risk has driven most advisers into risk rated fund of funds and now no life settlements.

    All this adds up to less diversification for clients which is the complete opposite of the FSA’s paper on IFA’s needing to prove that they have considered all investments for their clients.

    What is to say that a properly structured life settlement investment will produce less than a REIT or equities or Gilts?

    This does seem to be a case of regulation by the lowest common denominator which is lazy to say the least. I am sure with effective active regulation we could allow the good advisers and product providers some slack if not I fear the result will a lack of innovation which is surely a dangerous proposition?

  6. A very good and balanced article from Ian. I do not doubt the veracity of what he heard in the meeting as it is similar to what many salespeople will say yo a broker thinking commission influences their decision. That is NOT to say that it implies any fault on the part of Keydata.
    I am still inclined to believe what Ex keydata | 5 Dec 2011 11:49 am has posted over the statements of the FSA, PWC, KPMG, Deloittes and so on as I read about a non life settlement case where yet again anotehr big name auditor has failed to pick up a fraud, when they or the FSA (or in this case the SEC) have failed to notice an error or trend which had an IFA had access to teh same data would have started alarm bells ringing.
    Where is the SMOKING GUN. It’s a bit like where’s the WMD isn’t it.

  7. Whilst the FSA keeping laying everything at the IFA,s door that goes wrong, do they not realise that they or their new named organsations days are numbered, because there will be no IFA,s left to pay their fees

  8. Life Settlements as an asset class are a constant return producer with a very low standard deviation. It is not the asset class that is that problem, but the structure it is managed through. It is nigh on impossible to have a closed end or income producing Fund because of the sheer nature of the asset class, however an open ended accumulating Fund should work fine with the correct liquidity policies and governance in place. Who wouldn’t want an asset class as part of their portfolio which has shown to produce 8%+ year on year, with SD of around 5%?

  9. “just a few short months ago, March 2011, the FSA authorised a new Life Settlement fund (the Huet Capital Life Settlement fund)”

    Obviously the FSA don’t think all Life Settlement offerings are Toxic, otherwise they wouldn’t have authorised the Huet Capital Fund.
    They should therefore retract statements made about the asset class and focus instead on the structures they believe to be toxic.

  10. FSA Authorised?? 5th December 2011 at 1:30 pm

    lol !!, a fund thats fsa authorised doesnt mean a thing. They authorise it, then slam the asset class. You couldnt make it up. Authorisation by this bunch of incompetents gives me no assurance. Theyve made their stance clear on Life settlements, good luck to any adviser that recommends them now. You will face the wrath of the regulator no doubt about it.

  11. It’s my lunch hour so I can allow myself 10 minutes on a subject that has exercised me since the first Keydata life settlement launch (about which I raised my concerns with the FSA and Keydata at the time).
    Life settlement policies are potentially a great investment if you’re prepared to bear the mortality and currency risk, can hold them to maturity and can trust the various parties involved in the transactions. I’m sure in the case of EEA there won’t turn out to be any issues with the other parties (as there was with Shepherds and Keydata and possibly more). Like any illiquid asset, Life Settlements aren’t well suited to open-ended investments for older investors seeking a regular income and some liquidity for their investment (it’s not just the lives assured that die in this equation). The FSA has been highlighting their concerns over this problem for almost 2 years, so no IFAs should have been surprised by their recent statement that has precipitated the suspension of withdrawals from the EEA fund.
    The returns of c9%p.a. on the EEA fund, plus 4.5% p.a. in fees (on top of initial charges) are surprising for two reasons. Firstly, how has an asset that delivers such great returns with so little volatility escaped the attentions of professional investors and ended up being offered to retail investors? Secondly, why has a 20-25% drop in the value of the pound against the US Dollar not affected the performance of the investments at all – I would have thought there would have been some effect shown by increased hedging costs if nothing else?
    I’m sure product providers offering Life Settlement funds have the investor’s best intentions at heart, but in EEA’s case, the very high fees earned and the fact that the Investment Adviser (who benefits from the performance fee) also provides valuations on the policies that make up the fund should have encouraged some scepticism about the remarkably steady performance. Ultimately though, if the assets of the fund are really worth what the valuations have suggested, there should be nothing for anyone to worry about. If, however, the valuations turn out to have been overly ambitious, then current investors will suffer at the expense of investors who have already taken their money out.
    All IFAs should always be sceptical of every investment proposition placed before them – the better it looks the more sceptical they should be. Liquidity is critical, ultimately any investment is only worth what someone else will pay for it, however much a valuation model suggests it should be worth.

  12. Toxicity, exacerbated by publicity,
    All is lost as far as I can see,
    Courtesy, the FSA.

    Assurance plan, there’s no better investment known to Man,
    It works so good – there must be a ban!
    If it don’t fit their master plan.

    Why did they wait so long? — it isn’t clear,
    But, what they did was for themselves,
    And not for you My Dear…..

    Other lyricists are available, thankfully!

  13. I think your article was fair and balanced and “spot on” that there is really nothing wrong with the US Life Insurance Contract in the SLS market but rather structure, fraud or the sponsor, which can happen with ny asset class and that’s what the FSA should be focusing their attention on. This is a great asset class, it just needs to be properly structured.

  14. Good article, Lowes do carry out significant due diligence.

    Not all such funds can be Toxic yet some people who have been involved or are attempting to be from personal experience are.

    My own concerns that I would raise on the exit from these funds on the FSA declaration would be that anyone would know this will cause a run on the fund and suspension.

    I wonder how many truly sophisticated investors are in this, my hope is 100% but it may not be the case.

    The FSA’s 2 favourite words ‘in hindsight’ indicate that this area shall form a thematic review with redress payments to follow.

    oddly enough I think that the Regulator is right to raise concerns over liquidity, protection and pricing models of these or any similar investments.

  15. Structured settlement questions 23rd December 2011 at 9:54 am

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