The Grim Reaper is offering a helping hand to investors struggling to find places to make any money or safe-haven alternatives to cash. Stock markets may tumble and banks may go bust but people continue to die at the same rate.
Life settlement funds enable you to profit from this mortality: instead of betting on the stock markets, your fortunes rest on the life spans of US citizens.
You may not have heard of life settlements, but you are probably familiar with life assurance, on which they are based. Life settlements - their less appealing moniker is "death futures" - are life assurance policies issued by US life companies insuring mainly US lives, which are traded in the secondary market.
Investors buy the legal rights to the policy and pay premiums before making a return by collecting the entire death benefit of the policy upon the death of the life insured. It sounds morbid but proponents argue that the benefit to the original policyholder can be substantial. Life settlement funds can even be viewed as 'ethical investments', they say, because they enable terminally ill people to realise their dreams.
As a predictable, low market-correlated investment, life settlement funds, returning a consistent 8 per cent or 9 per cent a year, are proving to be particularly attractive given current market turbulence. Surrenda-link Investment Management, a traded life policy investment specialist, reports soaring levels of enquiries from institutional investors regarding US life settlement investments. The company attributes the accelerated growth in enquiry levels to the credit crunch and the ensuing 'flight to safety'. It forecasts a boom in life settlement investment for the rest of 2008 and throughout 2009.
Rob Pemberton, investment director at independent financial adviser HFM Columbus, is recommending life settlement funds to his clients. The major benefit of such funds is that they "produce a consistent, positive monthly return that is not linked to the fixed interest, equity or commodity markets".
Life settlements are not completely immune to the economic downturn, though. The issues that have shaken global equity markets have unsettled investors everywhere, and the life insurance sector is no exception, as Andrew Walters, finance director of the Assured Fund, explains: "In September, there were concerns about the implications of the AIG situation for the whole of the insurance sector," he says.
AIG was saved from bankruptcy in September by the US Federal Reserve, which loaned the troubled insurance giant $85bn, in return for an 80 per cent public stake in the firm.
"It is worth stressing that the fears over AIG evolved from its involvement in underwriting sub-prime securitisations and had nothing to do with the book of life insurance business - which was one of the soundest parts of their business," says Mr Walters.
"In a worst-case scenario for any life company, the liquidator would seek to sell on the book of the life business as a valuable asset for a competitor company to continue to administer."
What are life settlements?
Imagine that you have set up and paid premiums on a life policy that will pay out $500,000 on your death. You then develop cancer and decide that you no longer want to pay into this policy and would prefer to cash it in to travel the world and realise your dreams. Your family doesn't need the death benefit as your kids are grown up with stable jobs and your wife has independent means. They'd rather see you enjoy the money while you are alive.
Your insurance company offers you a measly cash surrender value of $55,000. A life settlement fund calculates that this sum is well below the true value of your policy, given your age and state of health. They offer you $150,000. They offer you more money because they think that you will die earlier than the actuarial calculations on which your policy is based suggest. You take the cash and assign to them the benefits and responsibility for paying the premiums. So, when you die the life settlement fund receives the $500,000 payout.
Mr Walters explains: "Americans have a different view of life insurance - it is an asset that can be bought and sold, for example if your circumstances change or if you think you can get better coverage elsewhere."
Importantly, the seller of a life policy gets more if they sell it on the second-hand market than they would by surrendering it back to the life office. "Typically, they'd get 4 per cent of face value surrendering it to a US life office. But they get 20 per cent on the secondary market," he says.
There are plenty of these policies around for investors to buy. According to Surrender-Link, the senior life settlement market is worth an estimated $15bn in 2008, but the market potential is thought to be $160bn "over the next several years".
The downside
Life settlements have a number of significant potential pitfalls, according to independent financial advisers at Bloomsbury Financial Planning, who have decided not to invest in them.
First, life settlements have been drawing the attention of regulators who allege backroom dealings and predatory sales tactics by brokers who source the policies for life settlement funds. Bloomsbury believes that future class actions against the life settlement industry could have repercussions for future returns and damage the reputation of the industry, as well as those of investors who have invested in them.
Bloomsbury also points out that as more profit-hungry competitors enter the marketplace, they risk bidding up the price they pay policyholders to buy the policy - good for the seller, but not so good for the investor, as returns are likely to fall.
Life settlement funds rely on medical diagnoses to assess the worth of the policy. That these diagnoses may not always be accurate is the main risk to the investor. Mr Pemberton says: "These policies will always pay out, the only question is when so the investment risk is in accurately predicting life expectancy."
Investors also need to be aware that advances in diagnostics and medical treatment could severely impact the secondary market. A major medical breakthrough, such as a cure for cancer, could have return repercussions, although a good fund will hold a diverse pool of policies, whose policyholders will have different impaired life circumstances.
Costs tend to be opaque in the life settlements industry. Medical analysis, both upfront and on an ongoing basis, along with broker commissions (which Bloomsbury says can be 6-20 per cent of the purchase price) make this an expensive process, taking up to 50 per cent of the total return.
The final downside is that you are benefiting from other people's misfortune, which might make some investors uncomfortable. Robert Crawshaw at Brewin Dolphin says: "At the end of the day the fund manager hopes that policies 'mature early', and while the original holders may have sold on their life policies at a higher value than they would have received had they redeemed directly from the life assurance companies, some investors may still be uncomfortable with being part of this process. This is clearly an emotive issue."
However, life settlements' proponents cite a report published by the Pensions Institute in July 2008, which concluded that, given full transparency and the safeguarding of the policyholder's privacy, there are no ethical issues to distinguish life settlements from other mortality-based products, such as life insurance, annuities and equity release.
Funds options
There are two main funds available to UK investors.
The Assured Fund launched in 2004 and launched a sterling share class at the start of 2008. It is managed by Policy Selection, a private firm, registered in The Cayman Islands. Finance director Andrew Walters says: "Crucial to our performance is the fact that we maintain a well-diversified portfolio of policies.
"We not only assess the mix according to the status of the insured, but also the issuing life offices, and we currently hold policies from 52 life offices, all rated A or above by Standard and Poor's."
"We try to protect investors' money all the time. For example, we get assignment of policy to our name before anyone is paid in the supply chain.
"The average age of the insured is 82 years. The average life expectancy is five years. Our model filters out people under the age of 65.
Its sterling B class for experienced investors has produced annualised growth since launch of 10.24 per cent. The Assured Fund is available for Sipp investment, but not Isas.
Mr Pemberton's preferred recommendation is the EEA Life Settlements Fund, which has produced consistent returns of around 9 per cent a year since launch nearly three years ago and is worth over $270m, holding 270 policies.
EEA Life Settlements Fund is a Guernsey-regulated and Channel Islands-listed open-ended investment company (Oeic), launched in November 2005. It employs ViaSource, an independent American-based adviser, to buy from a range of policy providers. The fund has provided 33 consecutive months of positive returns.
EEA focuses on buying policies at the shorter end of the life expectancy range and has a policy of re-underwriting every case before bidding for the policy. This involves getting a minimum of two reports from specialist independent medical experts on each policyholder looking to sell their policy.
The firm uses a "beneficiary transaction form" to ensure every one of a would-be seller's beneficiaries' consents before a policy is sold.
The fund's sterling C class share has distributor status, which means gains are treated as capital gains rather than income for UK investors. The fund charges a performance fee on returns above 8 per cent a year.
Mr Pemberton points out some structural risks to life settlement funds: "They are invariably unregulated collective schemes domiciled offshore, so investors will not have any recourse to a government-backed compensation scheme should anything go wrong.
"Minimum investments can be quite high, often in the order of £25,000 or more."
"The other key issue is that of 'operational risk' in that you need to make sure the chosen fund manager is reputable and uses large and equally reputable trustees, life settlement provider, medical examiners, auditors and escrow agents."
Robert Crawshaw, fund research manager at Brewin Dolphin, says: "While the principal risk lies with the fund manager's ability to identify life insurance policies that are incorrectly priced in accordance with their proprietary life expectancy estimates, concerns also reside over liquidity and the high performance fees that these funds employ."
