IA: Are life settlements too risky to handle?
MA: All investments carry risk. It’s just important to understand where risk lies. In life settlements one of the main risks is that the fund manager underestimates life expectancy and so has to wait longer to receive the sum assured and pay more premiums in the interim. You need to understand how the provider meets that challenge. Some companies focus on shorter life expectancy and medically re-underwrites policies. Other funds rely on sophisticated actuarial models. If you can be sure the manager is pricing policies accurately then you will surely struggle to find an investment that can deliver uncorrelated absolute-like returns of 8-10% pa for less risk.
IA: What about fraud or mismanagement?
MA: Risk is prevalent in all funds, not just life settlements. Look for a fund in a reputable jurisdiction. Look for respectable fund counter-parties – the auditors, custodians, administrators, managers and what checks and balances are in place. Check out the people behind the fund and their history. Transparency is important. If the manager won’t disclose details of underlying charges –¬ like commissions taken on policies purchased – be wary. How many policies are held? How many policies have matured in the lifetime of the fund? How many have gone beyond life expectancy? How is the fund valued – conservatively? The manager’s response to probing questions like this should help.
IA: Does it matter where funds are domiciled?
MA: I think most international advisers know which areas are strong. Guernsey, Jersey and Luxembourg are more accessible and have rigorous regulatory controls.
IA: Some people worry about liquidity – how serious is this threat?
MA: Liquidity is a concern with many asset classes. Life settlements funds that focus on shorter life expectancies offer considerable comfort on the liquidity issue. The average age of policyholders within the EEA fund, for instance, is 83 and the average current life expectancy is 26 months. Many would argue that, as a result, the fund is self-liquidating. This is an unusual feature of the asset class. Maturing policies generate money into the fund all the time. Importantly, the inflow is unaffected by market sentiment – the sum assured on maturity doesn’t fluctuate. It is “assured”. That’s a tremendous strength.
IA: Does the ethical dimension restrict the international market?
MA: There is nothing ethically challenging about life settlements funds. Some people think them a bit macabre at first, but when they understand the way they work they usually see them as a very ethical investment. The people selling their policies – who could be terminally ill, in need of cash for medical treatment or to pay for quality time with family, and struggling to meet the premiums – do so into a competitive open market. They receive far more from life settlements investors than they would if they cashed them in with the insurer. Life settlements are no less ethical than annuities.
IA: Can this market ever spread beyond the US?
MA: I doubt it. The reason that it is a US-based industry is because US legislation means insurance companies are unable to contest policies on the grounds of medical non-disclosure after they have been held for two years. This means investors can buy policies knowing that they will be honoured. There is also a State Guarantee Scheme if insurers themselves get into difficulty, which is another distinctive feature of the US market.
IA: Can you see any risk of regulatory change that might kill the market?
MA: I see nothing on the horizon. Two years ago Obama confirmed a 30% withholding tax that affected many life settlements funds. Most restructured or found ways to offset some of that, and it had a small impact on returns, but some might argue that the tax revenue the industry now generates helps safeguard it against further threats.
IA: Is there any risk that demand for policies will exceed supply, driving up prices paid and reducing returns?
MA: The Conning Report into life settlements estimates that the US life insurance market has total insurance coverage of around $21trn. It estimates the value of policies purchased by the life settlements industry is around $12bn annually, We’re not scratching the surface yet. I think we’ll see good funds continue to deliver near double-digit returns for some time.
