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Comment: A safe haven for choppy markets

Created:

30 January 2008

Written by:

Peter Winders

The recent equity market falls, and the prospect of further volatility to come, doesn’t bode well for the millions of investors in with-profits funds. Norwich Union and Friends Provident are the first in a predicted line of providers to announce disappointing returns on their with-profits funds for 2007. The Norwich Union CGNU and CULAC with-profits funds returned just 5.4 per cent last year compared with 11.9 per cent in 2006, whereas Friends Provident's fund returned 5 per cent in 2007 against 8.1 per cent in 2006.

While both life offices have increased final bonuses this year, this will come as little solace to investors. In their defence they say that their with-profits funds have been hit by the sub-prime crisis and volatility in the stock market.

So, with continued uncertainty surrounding equity markets, investors have been looking to uncorrelated asset classes to provide portfolios with much needed stability. Until now, property and gold have been popular safe havens, but the high prices in these sectors have left investors fearful of a downturn here also.

One possible alternative is life settlements. Previously little known, demand for this asset class, from multi-managers and pension funds in particular, has grown considerably in recent months as the desire to diversify away from equities grows.

Life settlements offer low volatility and have been proven to rise steadily even during bear markets, plus they have no correlation to other asset classes. A life settlement is the sale of a US life insurance policy to a third party, where the insured has an impaired life expectancy. In exchange for a payment in excess of the policy’s cash surrender value the purchaser becomes the new owner of the policy. The new policy owner pays all future premiums during the remaining life of the insured and ultimately collects the full ‘face value’ of the policy on maturity.

Over the years, questions have been raised over the capacity of the life settlements market but research estimates that approximately $1 trillion worth of policies are surrendered or lapse each year in the US and, of this amount, it is estimated that more than $230bn would theoretically be eligible for purchase. Only between $7bn and $20bn of policies were actually traded last year.

The number of policies coming to the market has been growing in recent years due to two main factors: growing awareness of the secondary market and a period of history when baby-boomers are hitting retirement age. This generation has outlived the need for insurance and is increasingly looking to boost retirement savings. Like the UK, the US has seen a significant shift from defined-benefit to defined-contribution pension schemes, putting pressure on many people’s retirement plans. Over the next five years, we could see another $100bn of policies of tradeable quality coming onto the market, earmarking this as a significant growth market.

Peter Winders is marketing director of EEA Fund Management