High net worth and other investors are increasingly interested in the market for traded life policies, a relatively young market in the UK but already a big field in the US, a firm specialising in the sector says.

High net worth investors are increasingly interested in the market for traded life policies, a relatively young market in the UK but already a big field in the US, a firm specialising in the sector says.

Traded life policies, which are also known as life settlements, are US-issued whole of life assurance policies where the owner has sold the future policies at a discount from a fixed maturity, usually to unlock money early. The discounted policies are bought by funds, seeking to profit on the final value at maturity. The market originated in the 1980s when HIV patients and other people with potentially terminal illnesses sold policies early to acquire their value. In total there are about $23 trillion of life cover policies outstanding and each year, $1.4 trillion of these policies lapse without value - the policy owner stopped paying the premiums before the life or lives assured died so no value was unlocked.

TLPs have been promoted on the basis that their performance characteristics – relatively modest but steady returns – are lowly or even negatively correlated with markets such as equities, which is a highly attractive proposition since the financial panic of 2008.

Investors in regions such as Asia are showing greater interest in this sector, Jeremy Leach, managing director at Managing Partners Limited, told WealthBriefing recently. His firm operates a Caymans-registered fund holding such policies that is open to retail and institutional investors.

“Our core [for clients] is institutional investors, principally investment banks, discretionary managers, pension funds and private family offices” he said. “More recently we launched a range of share classes that high net worth individuals are eligible to subscribe to as well as smaller subscriptions from sophisticated investors.”

There is considerable upside potential in the market, he says; there were around $31 billion of life settlements in force at the end of 2008, according to a report in August 2010 by Professor Merlin Stone of Oxford Brookes University Business School. That report cited findings from Conning Research & Consulting, estimating that between 2007 and 2016, the average size of the US life settlement market could be between $90 billion and $140 billion per year. The growth potential is vast. Another survey, also cited by Prof Stone, suggests the market could be as large as $161 billion by 2030.

But as the report said, some advisors and investors are ignorant about the sector. To quote Prof Stone: “The problem for TLPs is that they are not well known, they are not generally accepted, either officially or unofficially as a separate asset class and their performance track record has yet to be fully established, although some funds have existed for five years or more, with very positive results.”

As Leach told WealthBriefing: “Many people in America still do not know that they have the right to sell their policies to a third party for a cash sum and in the vast majority of cases they would get considerably more money than if lapsed or cashed in. In April last year the Washington state regulator was the first regulator to force Washington based insurance companies to inform policy owners that they have the right to sell their policies.”

The hard numbers

The Cayman-domiciled Traded Policies Fund, run by Managing Partners Limited, was first launched in a dollar, institutional share class form in June, 2004 and is now available in euros, sterling and yen. Leach said MPL only accepts subscriptions from retail investors where they confirm that they have consulted with a professional advisor before entering the fund.

And the figures are pretty reassuring: the oldest, dollar share class of the fund has clocked up gains over the 12 months to 1 January 2011 of 9.59 per cent; since launch, it delivered returns of 74.25 per cent. The euro institutional share class made returns of 53.36 per cent since launch in 31 July 2005; the sterling institutional share class made returns of 59.5 per cent since its launch on the same date. The yen institutional share class made total returns, since launch in September, 2009, of 11.98 per cent. Not one of the share classes of the fund made a loss during its lifetime. These figures look attractive when considering the 40 per cent fall in the MSCI World Index of developed countries’ equities in 2008.

Leach said MPL only accepts subscriptions from retail investors where they confirm that they have consulted with a professional advisor first. The average age of a person at the time their policy is sold is 80 years, an age that cuts longevity risk issues significantly in relation to much younger lives because the key focus on an octogenarian is age-related mortality, whereas with younger lives the focus is disease related mortality which is much harder to predict within a sample of lives.

The fund holds TLPs from a variety of different insurance companies (68 in total) to protect against problems in any one firm from a credit risk perspective. Some 95 per cent of the portfolio holds policies issued by insurers that are A-rated or higher. The fund has its own AA rating issued by Telos, the German rating agency.

The market, however, has had its hiccups. In 2008, the market’s growth temporarily stalled. As the Merlin Stone report said, this seems odd at first glance, since cash-strapped individuals worried about the financial turmoil might have tried to unlock their life policies for cash, driving supply in the industry. But this did not happen.

Prof Stone’s report said that 60 per cent of brokers in the US industry who were surveyed saw fewer policies coming through their books. The largest reason for selling policies early was inability to pay premiums, followed by need for cash.

The market has so far come through recession and market turmoil in decent shape, but what would happen if interest rates rise from their current low levels?   

“If they rise in America, the purchase price [of the policies] is likely to be forced down to create deeper discounts to sustain longer terms yields that remain attractive against prevailing interest rates,” said Leach.

There will be some short term impact on the market, but it should not last beyond a certain period, he said.