The UK’s financial regulator yesterday moved against the retail market in traded life policy investments or “death bonds” in which investors try to profit by betting on when people die, claiming this is a risky market unsuited to ordinary members of the public.

In what was an unusually blunt statement, the Financial Services Authority said that traded life policies, which invest in US life insurance policies, are “toxic” and “completely unsuitable for most UK retail investors”. The FSA's comments do not, however, necessarily apply to wealthy and professional investors, this publication understands.

The watchdog said it intends to ban firms from marketing TLPs to UK retail investors and will consult the industry next year to erase the risks that the FSA says they pose.

One of the firms operating in this space, Managing Partners, said it has consistently maintained that this is a market for sophisticated investors who understand the risks.

With TLPs, an investor bets on when a particular set of US citizens will die; if these people live longer than actuaries expected, the investment may not function as expected. The market for such policies forms part of how investors are trying to profit from longevity risk, a subject that has been thrown into sharp relief by the strains imposed on pension schemes as people live longer than actuaries expect. (To view a recent article on the issue, click here).

The FSA’s statement comes at a time when the watchdog has punished – sometimes with large fines – financial firms for selling products that the FSA considers to be unsuitable for certain types of client. (To view a recent roundup of FSA actions against wealth managers, click here).

Over a year ago, a UK academic, Professor Merlin Stone, warned about the risks involved in some – but not all – of this market. (See here).

The FSA’s warning, however, was emphatic that the market is unsafe for retail investors.

“Evidence from the FSA’s work to date has found significant problems with the way in which TLPIs are designed, marketed and sold to UK retail investors.  Many of these products have failed, causing loss for UK retail investors,” it said.

“TLPIs are toxic products which pose significant risks for retail investors,” Margaret Cole, FSA managing director, said in a statement.

“The failure of these products in the past has led to significant consumer detriment and we fear new investors will suffer unless we take the necessary steps now to prevent their sale and distribution. We are issuing a strong warning to the industry not to market these products to UK retail investors. Ultimately, we aim to ban TLPIs from being marketed to UK retail investors, and we intend to consult on this next year to help erase the risks they pose,” Cole said.

The FSA said the main risks of TLP investments were that: product structures were opaque and complex, involving several firms working in different jurisdictions;  the underlying assets are risky, because investments could be hit if actuarial guesses about lifespans prove to be wrong; some TLPs lack liquidity to meet ongoing costs; and TLP providers may struggle to sell assets if they need to pay people whose life policies they have bought live longer than expected.

The FSA also warns that if the underlying assets of the TLP are based offshore there is also an exchange rate risk, both in terms of the costs of meeting ongoing premiums and the final payout for the underlying insurance contracts.

Jeremy Leach, Managing Director of Managing Partners Limited, a firm investing in this area, said it appreciated the FSA's concerns.

“We fully understand why the FSA has concerns about TLPs as indeed they have with many UCIS investment products. Their challenge is to ensure that all IFAs are fully equipped to assess the risk and suitability of complex financial products for their clients and whilst many financial planners are extremely adept at doing so there is no doubt that there are many who do not," Leach said.

“We have continued to maintain that TLP funds are complex investment vehicles and are therefore only suitable for those investors that are sophisticated enough to understand all the risk implications and fully support the FSA’s intention to prohibit IFAs from recommending such investments to ‘retail’ clients [as opposed to sophisticated investors] as this action will assist providers of highly complex financial products to focus on their target market, which is certainly not the retail sector," he continued.

“The performance of the Trade Policies Fund [of Managing Partners] is testament to the fact that when managed in a prudent manner, life settlements can deliver steady incremental returns. The longest running share class in the Fund, the US dollar Institutional, has delivered an annualised return of around 9 per cent net of all charges since its launch on 1 July 2004," he added.

Another practitioner in the field, Centurion Fund Managers, said it agreed that TLPs should be sold to retail investors but disagreed with the FSA that these products were "toxic".

“We agree with the FSA that longevity investments should not be marketed to retail investors," said David Rawson-Mackenzie, managing director at the firm.

"As the name suggests, longevity is a long term investment suitable for investors who understand the risks of this asset class and how they can be mitigated, as they would for any other alternative asset class.

“However, we do not share the FSA’s view that all traded life policy investments are ‘toxic’. Longevity investments do have low correlation to financial markets, they do enable investment managers to diversify portfolios and it has been proven that they can make a positive contribution to asset allocation models," he said.