The Financial Services Authority (FSA) is to restrict the marketing of unregulated collective investment schemes (Ucis) to private investors, making it harder for financial advisers to promote investments such as traded life policy settlements, overseas property, fine wine, timber and some Enterprise Investment Schemes (EISs).
The regulator has already issued guidance against marketing traded life settlements and is now consulting on restricting marketing of a wider range of Ucis. These are already restricted in that you have to self-certify yourself as a high-net-worth or sophisticated investor to buy them.
The FSA is particularly concerned about traded life policy settlements, which invest in life insurance policies, usually of US citizens. Investors buy the right to the insurance payouts upon the death of the original policyholder, so are betting on when a particular set of US citizens will die. If these people live longer than anticipated the investment's returns may be negatively affected.
The underlying investments are also hard to buy and sell due to their specialised nature and there is only a limited secondary market for them. This means they could be sold at a significantly reduced value if a fund that holds them needs to raise money at short notice, reducing the value of the portfolio.
If any of the parties involved in the traded life settlements become insolvent and are unable to meet claims upon the deaths of the original policyholders, the traded life policy investment could find itself in difficulties.
Many traded life settlement funds sold in the UK are operated by offshore companies so investors have limited or no recourse to the Financial Services Compensation Scheme (FSCS) if things go wrong and the product fails.
In some funds, yields are promised to previous investors, which can only be sustained by using new investors' money, so the model in effect borrows from itself.
The FSA says there have been numerous cases of advisers recommending traded life settlement investments without properly understanding how these work and what risks are involved. "The TLPI retail market is worth £1bn in the UK and we were very concerned that it was likely to grow even more,” said Peter Smith, head of investment policy at the FSA. "At the time that we published our guidance, more than half of existing retail investments were in financial difficulty – even so, we were hearing about the development of new products intended to be sold to UK retail customers."
The FSA had initially published guidance for consultation in November 2011 strongly recommending that traded life settlement products should not reach the vast majority of retail clients in the UK.
"It is worrying to see that the traded life policy investment market in the UK has already reached £1bn, as we can only think of very limited circumstances where one of these might be suitable for our clients," comments Martin Bamford, managing director of independent financial adviser Informed Choice. "Hopefully the new rules from the FSA will clarify which investment types are suited to retail investors and which should be generally excluded from advice."
However the regulator admits that: "There may be some retail (private) investors willing and able to take the risk of significant capital losses, perhaps with a small proportion of their capital and after having undertaken sufficient due diligence to understand the various and complex risks involved with traded life settlements. However, these are unlikely to be investors of ordinary means and experience."
EEA Fund Management, which had run a traded life settlements fund without problems until the FSA's November warning, argues that life policies are a valid and appropriate asset class for investment providing they involve fixed and known payouts from reputable, creditworthy life insurance companies established in a mature, regulated market where the rule of law is upheld.
"It is possible to design a traded life settlement product that mitigates risks, for example by spreading risk across a large number of policies where the underlying insureds have short, medically impaired life expectancies across a diverse range of illnesses to reduce longevity risk, and only buying policies issued by reputable, creditworthy life insurance companies to reduce counterparty risk," says EEA. "Traded life settlements can offer sophisticated investors the means to diversify risk within their portfolio. Investors in our fund have benefited from positive performance at a time when they could have suffered losses in many other asset classes, including UK equity funds and property funds."
EEA was forced to suspend investors taking their money out of their fund or putting new money in after the FSA issued its warning in November following a higher level of cancelled subscriptions and redemption requests than normal.
However, EEA now says: "The FSA's finalised guidance is helpful and clarifies a number of points that were not wholly clear in the original consultation guidance. We now expect our fund to be able to finalise its plans for a possible restructuring."
• Holding existing shares in the fund with some additional dealing restrictions;
• Exchanging shares in the fund for shares in a run-off vehicle where distributions are made as policies mature; or
• Selling shares to institutional investors.
EEA says that, despite the suspension, the fund has continued to perform normally, generating $62m from 36 policy maturities over the three months to 1 February. "These figures show the fund is experiencing maturities in excess of premium payments and so generating cash at the fund level," says Peter Winders, marketing director of EEA Fund Management.
Even if private investors are not certified as high-net-worth or sophisticated investors they may be able to access traded life settlements via the US Traded Life Interests investment trust. However there is not much secondary trading of the trust's shares, which only has a market cap of around £15m.
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