Published: August 6 2010 18:56
By Matthew Vincent, Financial Times
Trading in second-hand life insurance policies is expanding rapidly due to increased interest from banks and institutional investors, according to specialist brokers and fund managers. But independent financial advisers warn that this is still too risky an asset class for private investors to buy into.
Earlier this week, research commissioned by fund manager Managing Partners revealed that banks including HSBC, Credit Suisse, Citibank, and Allied Irish were now investing in traded life policy funds, or “life settlements“. These funds aim to generate returns by buying life insurance policies from older US citizens, maintaining the premiums on them, and receiving the proceeds when the policyholders die.
Seven out of 10 life settlement brokers in the US expect to see more policies being traded over the next five years, the research found – suggesting further growth in funds. Managing Partners said that five of the world’s top 20 banks were now investors in its own fund, which has seen assets under management rise from $176m in June 2009 to $190m in June 2010.
Later in the week, SL Investment Management, one of the biggest life settlement providers outside the US, announced it was acquiring two other firms to create a traded life policy “super-power”. Patrick McAdams, investment director at SL Investment Management and chairman of the European Life Settlement Association forecast further growth in trading. “It is a growing market – demographics will support the supply of policies.”
However, the author of the research, professor Merlin Stone, also warned that “this relatively new asset class is creating several dangers for unwitting investors”. Similarly, four of largest independent financial adviser (IFA) groups in the UK cite risk factors as the reason they still refuse to recommend traded life policy funds.
Longevity risk – miscalculating when a traded life policy pays out – can dramatically affect a fund’s performance. “For this type of investment to work, they must be valued accurately, and this entails the difficult job of getting mortality assumptions correct,” says Darius McDermott of Chelsea Financial Services. “Should subjects live longer, it will reduce the return on the investment.” Adrian Lowcock of Bestinvest says: “With valuations based on actuarial calculations on life expectancy, if these are wrong then they could be revalued very quickly.”
Liquidity risk – not being able to sell fund holdings to return cash to investors – can also mean that investors lose money. “If there were a run on these types of fund, assets cannot be sold to meet redemptions,” says Danny Cox of Hargreaves Lansdown. “While the fund has positive cash flows everything in the garden is rosy; however if this were to reverse, there is the potential for values to collapse.”
Charges levied on traded life policy funds have been called into question, too. “The FSA has raised concerns that the commission is too high . . . if the products are as good as the sales literature, suggests then the commissions being paid wouldn’t need to be so high to incentivise people to sell,” argues Lowcock.
Managing Partners has proposed a six-point check list – covering risk, charges, fees and regulation – to help private investors avoid unsuitable products. But Hargreaves Lansdown, Bestinvest, Chelsea Financial Services and Towry say they will not recommend funds to clients. “We are extremely uncomfortable with these investments, and would not wish to be involved,” says Andrew Wilson of Towry.
Life Policy Group comments: some interesting comments in this article not least those of Adrian Lowcock´s – ‘if the products are as good as the sales literature, suggests then the commissions being paid wouldn’t need to be so high to incentivise people to sell,” argues Lowcock. He is surely well aware that the smaller funds have always needed to deliver better value than their established larger cousins but are unable to do so until they have a track record, and they can´t get this until someone sells the product. The large fund creates impetus by massive marketing spend, these costs all come from the fund. The smaller fund pays that same marketing money directly to the broker and allows that broker to determine whether he keeps it or credits it to the investor – some do, some don´t