Sunday, 21 September 2014
Last updated 1 day ago
Aug 5 2010 | 9:32am ET
By Wm. Scott Page, The Lifeline Program -- In an era of dwindling and unpredictable returns in other asset classes, a comprehensively underwritten and properly structured life settlement portfolio holds out the promise of a safe haven asset that generates solid, predictable returns with acceptable risk to return and almost no risk to invested capital.
Although the difficulties of the life settlement industry over the last few years are well publicized, and, in many cases, self inflicted, the industry is poised for meaningful growth into a mainstream asset class that delivers healthy returns for investors and provides a valuable service to consumers. As the founder and CEO of The Lifeline Program, which has underwritten and funded more than $1.5 billion in life settlements since our founding in 1989, including $750 million during the market heights of 2007 and 2008, I am pleased to offer some practical tips to hedge fund managers who wish to invest in life settlements. Moreover, as one who did not participate in, but rather decried some of the industry’s worst excesses before it became popular to do so, I can provide honest guidance to avoiding the traps and potholes created by some of the less scrupulous life settlement providers.
Understand the risks - then mitigate
While asset managers don't invest in life settlements to achieve outsized returns, but rather, for steady and predictable returns, the likelihood of unlevered 15% IRRs is very realistic in a properly constructed portfolio. In such a portfolio, the individual policies—which are discrete assets—are properly underwritten to minimize all collection risks and the portfolio is aggregated (structured) in such a way as to fully account for life expectancy (LE) variability across the portfolio.
Any risk to the beneficial rights holder’s ability to collect the death benefits upon the demise of the insured is called collection risk. This risk can take on a number of forms with each requiring specific expertise to mitigate. The most obvious collection risk is that the carrier might not honor the claim upon the demise of the insured. A wave of StOLI (Stranger Originated Life Insurance) policies, where one party initiates a policy on the life of another person and pays the premiums, pollute many of today’s portfolios. Due to the questions surrounding the insurable interest of those policies at the time of issuance, beneficial rights holders may not receive the full death benefits or, at minimum, will bear substantial legal costs to fight the carriers’ claims. While regulators have made it exceedingly difficult in most states for such a policy to be issued, there will still be a consequential burden on responsible underwriters to detect other potential barriers to timely collection of full death benefits upon the demise of the insured (e.g., convoluted Trust structure).
Extension risk, or the risk that the insured lives beyond the life expectancy on which the IRR is calculated, is the exogenous variable that is most difficult to mitigate. Thus, the responsibility of the underwriter must be to identify the source of the variability among multiple LE’s from independent LE providers and determine, in conjunction with other qualitative inputs, the likelihood of extenstion. It is also recommended that an independent analysis of the insured individual, such as a paramedic visit, be performed in order substantiate any health claims made at the time of submission of the settlement application.
Underwritten properly, the risk of a life settlement portfolio can be, for all intents and purposes, isolated to extension risk. Thoroughly understanding the underlying conditions of each of the insured individuals and then pricing the risk appropriately can serve to ensure that this risk has little impact on realized yield.
Actively manage the portfolio
An understandable tendency among investors in Life Settlements is to take a rather passive approach to managing the asset. At minimum, in order to determine the NAV each year, it is critical to have as complete of an understanding as possible of the evolving health status of each of the insured individuals in the portfolio. As tempting as it may be to simply age the portfolio, the asset manager will not have an accurate view of its true value. Moreover, it will render impossible any meaningful optimization strategy that involves trading in and out of any of the assets to maximize overall returns. To accurately value their portfolios, hedge fund managers should ensure proper tracking of the insured individuals’ health status and get updated LE’s and medical records. The cost of doing so is relatively minor (full medical records and LE calculations would likely cost less than $500 per incident), but the benefit to the manager is substantial.
If considering an existing portfolio, caveat emptor
Many of the portfolios that are on the market today suffer from three primary problems: Pricing, Risk, and a lack of understanding of the “real” NAV. So, I believe that anyone looking to purchase an existing portfolio should do so with great caution and only after coming to a full understanding of the implications of the risks.
Pricing: Most portfolios now on the market were constructed at the height of the market and purchased at IRRs far below what today’s market will bear. So, unless the seller is willing to take a loss on the portfolio, it is unlikely that it can be acquired with an IRR comparable to that which can be achieved with a “new” portfolio.
Risk: With few exceptions, portfolios created over the past four or five years have substantial StOLI exposure, the risk of which is exceedingly difficult to properly price.
NAV: Without a comprehensive update to the life expectancies and the medical records of each of the insured individuals remaining in the portfolio, and a premium optimization evaluation of each policy, it is very difficult to build a detailed understanding of the “real” NAV and capital requirements to keep policies in force.
Select the right partner – experience, expertise, and capital
Rubber, meet the road. Talk is easy, but executing and delivering are hard work and require experience and significant expertise. The Life Settlement industry has long been plagued with far too many marginal participants that have little financial sophistication, little understanding of the risks of the asset, and no capital. These firms act solely as middlemen and take far too large a percentage of the capital in the transaction. Many have no understanding or concern for the efforts that are required to minimize the risks so that everyone in the process – from the insured who sells his or her policy to the investor who puts their capital to work by purchasing policies – is properly compensated for their role. Consumers win by unlocking value in an asset they own. Investors win by receiving an exceptional risk-adjusted return on their capital. Moreover, experienced aggregators like The Lifeline Program win because the industry grows and our businesses grow.
So, select a partner 1) with a track record of experience and a demonstrated ability to properly source and underwrite policies for settlement, 2) that can speak comprehensively to the risks of the asset and understands how to isolate and mitigate those risks, 3) that can assist you in the management of the asset, and 4) that can, by deploying their own capital to purchase policies which they deliver to you, actually have meaningful skin in the game.
Wm. Scott Page, President and Chief Executive Officer of The Lifeline Program, is one of the true pioneers of the life settlement industry. In the late 1980s, his simple solution to a friend's problem launched The Lifeline Program and helped pave the way for thousands of individuals to discover the potential value of the sale of an existing life insurance policy. Since that time, under Page's guidance, The Lifeline Program has become one of the most dynamic and trusted providers of structured life settlements in the country. Today, Page is one of the most highly regarded individuals in the industry and he is regularly called upon to appear in the national media, testify before governmental agencies and contribute to the ongoing development of life settlement legislation and regulation. Within the company, Page's wealth of knowledge, vast experience and unmatched expertise enable him to truly provide leadership, counsel and solutions unavailable anywhere else.
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