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rmbbrave
15-08-2007, 12:49 PM
Investing in a dead certainty
A fund through which you can buy up the life insurance policies of rich Americans. Whatever will the financial world dream up next? John McCrone reports.

Here is a rock-solid investment you have probably never considered. What about buying up the life insurance policies of rich, elderly and soon-to-die Americans? Welcome to life settlements funds, the newest and perhaps most unsettling asset class to hit the investment world.

The proposition is a little ghoulish.

Find someone who wants to cash in a life policy worth a million bucks or more. Get a couple of doctors to certify the person really does have some life-threatening condition that will cause him to pop his clogs within a reasonable time frame. Pay the person about a third of the face value of the policy to take it over. Then just keep the premiums up to date and collect on his death.

Package together enough such deals and you have a unit trust fund. You can sell shares to eager investors. And unlike some other investments, such as stocks or commodities, you know there is a sure payout. No one has yet been known to escape the Grim Reaper.

So sit back and enjoy the promise of an annual return of 10 per cent-plus, with AA bond-like security. How can anyone beat that?

The first to hit our shores with such a product is Life Settlements Funds (LSF) of Queensland.

LSF director Stephen Knott says the fund has been going three years, but he admits it got off to a quiet start.

"It's the old thing. Something new takes a little while to get recognised," Mr Knott says.

Interest has since exploded. A year ago, LSF had attracted only about A$10 million of investor cash. Today it is up to A$500 million.

Five big institutional investors in Australia have signed up in the past few months.

LSF has not yet won over pension funds and other such institutions in New Zealand. But Mr Knott says the fund is selling like hotcakes to ordinary investors through financial planning chains such as Equity Investment Advisers and BNZ's private bank services.

Equity general manager John Commins says the claimed risk-to-reward ratio of life settlements is indeed impressive, if not extraordinary. So he would expect it to fall back in time.

"If it is the case, then the investments must be mispriced. There is probably now an opportunity to invest which in due course may well disappear," Mr Commins warns.

Either competition for the policies will bid their prices up, eroding profits, or else risks will emerge that show these deals are not quite so bullet-proof.

Whatever the story, life settlement funds are another remarkable example of the never-ending ingenuity of the investment world.

The idea itself goes back to business that sprang up in the 1980s with the Aids crisis. Aids hit mainly the young, who, believing they had less than a year to live, were happy to cash in any life policies they could.

Insurance companies pay out only a fraction on surrendered policies. Brokers would pay a higher market price for what Aids made seem a sure bet.

Eventually these deals expanded to cover other terminal illnesses, such as cancer. Helped along by United States laws that protected the right of individuals to sell their policies in this way, so- called viaticals grew to be a multibillion-dollar industry.

It had its problems, however. For one thing, medical science caught up on Aids and other severe illnesses. Patients would trade in policies to pay for treatment that prolonged their life – sensible for them, if inconvenient for the investor.

It was also an industry ripe for fraud. Policy- holders might feign illness to sell a policy. Bogus investment funds were set up, taking money from investors for deals that never materialised.

Viaticals were a collapsing business in the late 1990s when some bright sparks took the same principles and applied them to an older, richer, age group to create life settlements.

US retirees tend to be highly insured. Mr Knott says many high earners want good cover during their working lives to provide for their families in case anything should happen to them. But they come to retirement and the situation can be quite different. The kids have been through college. The partner may be divorced. They are so wealthy with other assets that it no longer makes any sense paying a fat insurance premium every month.

Research by US actuarial consultant Milliman shows an astonishing 90 per cent of policy-holders abandon them before death. And with the insurance companies often paying much less than 10 per cent of the sum insured on surrender, selling to a third party is a better bargain.

To make the deals pay there has to be reasonable expectation of death. There normally has to be some medical problem that gives the person less than 10 years to live. So though life settlements can be considered from the age of 65, in practice the majority of policies are sold nearer 80.

Another key is that US law imposes a non- contestability clause on insurance companies in most states. Once a person has held a policy for two or three years, companies can no longer refuse payouts because of undisclosed medical conditions or other reasons that might suggest a policy was taken out in bad faith. This makes it safe for a third party to take on a policy. Without the clause, the business could not exist.

Mr Knott accepts that life settlements may strike people as creepy. He says, however, that insurance policies are just another asset that people should be free to sell. After all, why should insurance companies enjoy a monopolistic right to buy back policies at prices they can dictate? An efficient secondary market would create fair value.

Analysts have certainly been talking up the potential. A report by US researcher Conning says that with the retiring baby boom generation, there could be a US$100 billion trade in policies.

But like viaticals, it is also a market with scope for scams and abuses. An unsavoury aspect is the emergence of SOLIs, or stranger-originated life insurance deals, whereby agents persuade people to take out policies just for sale. "They find some poor person with a health condition and say, 'We will buy you a policy. We'll pay all the premiums, then we'll sell it again in two years' time and give you $10,000 for your pleasure'."

The agents cover their cost from the commissions they earn. The really unscrupulous can take out multiple policies in the same person's name, or lie about their insurable wealth.

There is the fear that such abuses may lead to a crackdown on life settlements as a whole. The need to regularise the secondary market in life policies is one of the reasons US authorities welcome the arrival of institutional investors.

To date, LSF has bought 200 policies with an average insured value of A$2 million. The typical age of policy-holders is 82; their life expectancy around three years. Each deal is carefully checked out to guard against fraud and ensure the numbers stack up. "On a monthly basis, we might look at 100 cases and we might buy 10."

So what are the essential characteristics of the fund for the ordinary investor?

LSF has been set up as an unlisted unit trust. The minimum stake to get in at wholesale rates is A$30,000. But the fund is carried by most wrap platforms, so can be bought in blocks of A$1000 through a financial planner.

Fund fees are around 3 per cent, plus 20 per cent on any earnings over 10 per cent. Financial planners are likely to charge their own fees and trail charges on top of that.

The returns are not hedged. For Kiwi investors, exchange rate fluctuations could make for a very bumpy ride. But that is a familiar story.

Australian ratings agency PIR has given the fund a solid AA risk rating and says over the long term it should earn 10 per cent or better.

Mr Commins of Equity Investment Advisers repeats that this exceptional risk/reward combination might be hard to maintain. A lot will depend on whether LSF can maintain the quality of its deals as it continues to expand rapidly. And how much competition squeezes the margins.

But he says the true value of the fund for portfolio investors is that life settlements look to be an uncorrelated asset class. In layman's terms, they are not tied to the fate of other investments such as properties, stocks and bonds. People are unlikely to die faster or slower as a result of what is going on elsewhere in the markets. So even if life settlements slip back to a more conventional rate of return, they may become a standard part of a balanced portfolio, helping to smooth out the ups and downs of financial cycles.

rmbbrave
15-08-2007, 12:52 PM
A life settlement is a financial transaction in which a policyowner possessing an unneeded or unwanted life insurance policy sells the policy to a third party for more than the cash value offered by the life insurance company. The purchaser becomes the new beneficiary of the policy at maturation and is responsible for all subsequent premium payments.

Life settlements are an important development in that they have opened a secondary market for life insurance in which policyowners can access fair market value for their policies, rather than accepting the lower cash surrender value from the issuing life insurance company.

Generally speaking, life settlements are an option for high-net-worth policyowners age 65 or older. Independent estimates report that among this group, 20% of policies have a market value that exceeds the cash value offered by the carrier. And while many policyowners are unfamiliar with life settlements until a financial professional mentions the option to them, the concept has gained attention from high-profile proponents such as Warren Buffett, former U.S. Representative Bill Gradison, and numerous media sources including The Wall Street Journal, Time Magazine, Business Week and The Economist. A growing number of experts now believe that informing clients about offering life settlements should fall under the fiduciary duty of a financial advisor.

http://en.wikipedia.org/wiki/Viaticals

rmbbrave
15-08-2007, 12:54 PM
http://www.lifesettlementsfund.com/