“Uncorrelated alternative investment with low volatility and predictable returns.”
For investors seeking an uncorrelated alternative investment with low volatility and predictable returns, we believe there are few investments that deliver on this profile as well as life settlements.
Life settlements are investment vehicles where investors purchase life insurance policies on seniors with a life expectancy of 3 to 15 years for an amount higher than cash surrender value and less than the policy face amount. Investors receive a return based upon the price paid for the policy (inclusive of premiums) and the death benefit received.
History
1980s AIDS crisis: The life settlement industry was born in the 1980s AIDS crisis, as afflicted individuals sold their life insurance policies for cash to pay for medical bills and enhance their final days. When the cure was discovered, the industry then focused on old-age mortality.
1990s–2000s: Major Wall Street firms such as Goldman Sachs, Credit Suisse, Deutsche Bank, Berkshire Hathaway, and AIG discovered the non-correlated nature of life settlements, along with healthy gross returns in the 12% - 14% range.
2010+: Increasing regulations in licensing, with life settlements transactions becoming regulated in most states. Licensing of life settlement brokers and providers became mandatory, along with the transparency of the entire process and fee structure.
Why Should an Investor Invest in Life Settlements?
Pros:
Uncorrelated Returns: Life Settlements provide a return and potential cash flow in an alternative asset class that is not correlated to stocks, bonds, currencies, interest rates, etc. - a risk that is not correlated with other markets because the value of an investment in life settlements depends on life expectancies of the policyholders. When insureds pass before the underwritten life expectancy, investors make a greater-than-expected return; if insureds outlive life expectancy, investors make less than expected.
Low Volatility: Volatility in life settlements is impacted by the size of the policy, pricing, life expectancy, premium schedule, and specific policy features – not traditional macroeconomic factors. The most significant factors are the size of the policy and the accuracy of life expectancy estimates. Therefore, because the underlying assets of a life settlement investment fund are life insurance contracts and life expectancy is generally a more stable rate than others, the fund has lower volatility compared to other financial markets.
Diversification: Due to the uncorrelated returns as an alternative asset class, life settlements diversify investors’ portfolios, therefore reducing beta.
Cons:
Long Holding Period: Since life settlements have a typical holding period of 5-7 years, investments in life settlements have a higher-than-average lock-up period relative to more traditional asset classes. Investors need to consider a long-term plan when making such investments.
Bias of Life Expectancy Estimates: Historically, life expectancy estimates have generally been too short, reducing expected returns on an absolute and relative basis. Improvements in market and investor-specific practices have generally improved the accuracy of life expectancy estimates over the last few years.
Market Size: “The Market is Large”
“Based on a $100,000 minimum face value, Conning estimates … where the insured has one serious medical condition, then the forecast U.S. gross market potential would range between $229 billion and $267 billion in face value for 2021 through 2030, with an average face value of $250 billion.”
Prepared by Conning, Inc.
Life Settlements Funds
Most of these funds are large and are forced, by their size, to deploy capital principally in the tertiary market (investor to investor) because the secondary market (policyholder to investor) is too small. Larger funds aim for returns based on the mortality curve and seek to reduce exposure to any single policy by holding a large group of policies. Instead of carrying risk to any particular policy, they have the risk that changes to the mortality tables adjust the mortality curve the wrong way, in which case the prices of all their policies are affected. Historically, changes to the mortality tables have extended life expectancies rather than shortened them (thereby reducing prices) and most big funds rely primarily upon the same mortality tables to price their assets.
We believe that the best-positioned funds diversify risk by:
holding a relatively large number of policies,
diversify portfolios across both specific health impairments (to limit the risk of material improvements in the treatment of specific health conditions) and geographies (to limit the regulatory risk within specific markets), and
having adequate internal resources to develop proprietary views on life expectancy (hence being less subject to external / third-party life expectancy underwriters).
Returns of Investments
The typical life settlement may afford the buyer a 10% - 14% gross IRR (net returns of 10% are realistic). Importantly, the rate of return is contingent on the accuracy of life expectancies at the time of policy purchase and the manager’s ability to finance and control fund expenses efficiently. Best practices require a life settlement “pool” of at least 400 policies so that the actual results track the expected mortality curve and reduce volatility.
The typical lock-up period of 7 – 10 years.
Most life settlements are backed by the benefit value of the life insurance policies, which are underwritten by the credit ratings of the writing life insurance companies.
Source: University of Connecticut
Types of Life Settlements
Types of Life Settlements:
Viatical Settlements: a situation where the insured has a life expectancy of <2 years.
Life Settlements: a situation where the insured has a life expectancy of <20 years.
Transactions of Life Settlements:
Direct Purchases: require a large outlay of cash with expertise to buy the right policies.
Direct Fractional: larger policies are divided into smaller portions and sold individually to investors.
Life Settlements PE Fund: involves purchases of portions of a fund comprised of hundreds of policies.
Fund Structures
Hedge Fund (open-end).
Private Equity Fund (closed-end).
Hybrid Structure: mix of Hedge Fund and Private Equity Structure.
Debt Structure:
Pay out a variable coupon based on returns.
Pay out a yearly/quarterly fixed coupon after some time.
Pay out a yearly/quarterly coupon at the end.
Types of Players
Sell Side:
Policyholder: The life insurance policyholder would like to sell the policy as a life settlement and obtain the highest bid possible in the market.
Life Settlement Broker: Life Settlement Brokers are licensed and regulated by the states. (1) The brokers represent the policyholders and hold auctions with institutional buyers to obtain the highest bids for their clients. (2) Life Settlement brokers collect medical records, prescription drug history, life expectancy reports, copies of the life insurance policy, and perform dozens of process-driven tasks to compile a complete life settlement package that is ready for auction. There are approximately 20-30 life settlement brokers nationwide representing most policyholders who are seeking life settlements.
Buy-Side:
Life Settlement Provider: Life Settlement Providers represent the institutional funds and large private investors seeking to purchase life settlements from policyholders. Providers, like their broker counterparts, are state-licensed and regulated entities. Providers bid competitively to win their bids on behalf of the funds they represent and subsequently help the funds complete the transaction by transferring ownership from seller to buyer.
Institutional Funds: There are many institutional buyers of life insurance policies in the secondary and tertiary markets for their portfolios, including banks, hedge funds, private equity funds, pensions, foundations, endowments, and single/multi-family offices.
Example
A male aged 77, with a life expectancy of 8 years based on his current and historical medical conditions, owns a Universal Life insurance policy with a $1 million death benefit. Since he no longer needs, wants, or can afford the policy, he understands that he can sell the policy in the secondary market instead of lapsing or surrendering the policy back to the insurance carrier for little or no cash. Therefore, he contacts a licensed life settlement broker, who holds an auction on behalf of the insured with a life settlement Provider, also a licensed entity that represents institutional investment funds that purchase life settlements for their investment vehicles.
The Broker and Provider agree on a price, and the insured receives a lump-sum cash payment of $225,000. The fund that purchased the policy becomes the owner and beneficiary of the policy. The fund then pays the policy premium until the death of the insured, when the fund receives the $1 million death benefit.
Institutional buyers pool hundreds of these policies with the goal of having the actual mortality results track the expected mortality curve. Life Settlement pools are non-correlated to the general markets, provide low-volatility, predictable returns, and are most typically held in a passive “buy-and-hold” strategy. The fund purchases pools of these policies at an average projected gross internal rate of return (IRR) of 12 - 14%. Net returns are ultimately based upon the accuracy of life expectancies and the manager’s ability.
Special Thanks to our Contributor
RiverRock is a dedicated life settlements investment manager with over ten years of experience managing pooled investment funds investing in the secondary and tertiary markets for life insurance policies.
Hugh P. Tawney Director of Sales Office: +1 713.375.1307 Mobile: +1 410.952.2374 htawney@riverrockfunds.com
RiverRock is not affiliated with and does not endorse PrimeAlpha Insights.
Table of Contents
Introduction
History
Why Should an Investor Invest in Life Settlements?
Pros
Cons
Market Size: “The Market is Large”
Life Settlements Funds
Returns of Investments
Types of Life Settlements
Viatical Settlements
Life Settlements
Transactions of Life Settlements
Direct Purchases
Direct Fractional
Life Settlements PE Fund
Fund Structures
Types of Players
Sell Side
Buy-Side
Example