Certainty In Uncertain Times: Investing in Life Settlements

Jan 5 2011 | 12:41pm ET

By Mark Goode, The Peninsula Group -- In spite of today’s market conditions, a high-yield investment opportunity exists within a non-correlated asset class—life settlements.  The life settlement market is experiencing an abundance of suitable investment grade policies being offered for settlement as limited capital is flow available for purchase.  This is creating an atmosphere that is producing additional value and exceptional returns for investors.

The Risk-Return Ratio

The strength of a life settlement asset within any portfolio comes from its risk-return ratio.  Unlike other assets that are dependent upon market fluctuations to produce returns, life settlement products provide consistent and stable returns.  The decreased volatility within a fund of life settlements can help to yield a more averaged rate of return for an investment.  The diversification of a portfolio of life settlement assets further decreases risk.  A life settlement fund has little market correlated risk and is able to provide a steady return at a rate higher than corporate bonds.

Arguably the most important metric from an investment standpoint is the rate of return offered by a fund of  life settlements.  The 2009 Life Policy Dynamics Market Analysis, an annual report completed by Life Policy Dynamics, LLC, provides detailed analyses of the life settlement industry.  The 2009 report collected IRR values for policies that closed during that calendar year. It must be noted that any analysis of market IRRs is complex, since the data is coming from a multitude of sources, each with different calculation methods.  Variation may be a result of factors such as different approaches to cost of insurance projections, intended future premium payments or, perhaps most significantly, the use of different life expectancy providers. Further, the use of proprietary valuation models can change IRR calculation methods. Despite these factors, the numbers for 2009 were in line with the word‐of‐mouth understanding of the market–an average IRR of 14.38% and a median of 13.93%. Three quarters of all settlements were calculated with a purchasing IRR of between 12‐16%.

Maturing Asset Class

The asset class, as it passes its 10th anniversary, is becoming more mature. Oversight and a lack of regulation have long been the source of scrutiny in the industry.  More and more states are now regulating providers.  Within the industry, best practices focused on greater due diligence and disclosure are continually improving the quality of companies in the industry.  Companies that have been unable to adhere to the new standards have been forced out as the Life Insurance Settlement Association and the Institutional Life Markets Association improve industry standards.

The industry now has a better understanding of mortality risk which affects the timing of returns on investment. On a combined basis the largest and most respected life expectancy providers have completed nearly 1 million individual life expectancy projections during the last decade.  Based upon their considerable data and experience, mortality tables have been updated, processes have been improved and methodologies have been enhanced.  Today’s life expectancies benefit investors with what we believe to be more reliable mortality predictions.

Other changes favorable to those investing today have taken place.  In late 2007, the amount of capital available for the purchase of policies exceeded the number of quality policies available for settlement.  There was significant competition driving up the purchase price on life settlements, thus lowering the yield.  On average investors were paying 25% more for life settlements and ingoing return projections were in the low teens on a probabilistic buy and hold basis.  Remarkably, considering the favorable reduction in mortality risk due to increasing life expectancies, Peninsula has been able to acquire high quality life settlements during 2010 with an average ingoing IRR projected in the high teens.  During the global recession and liquidity crisis, life settlement investments have becomes a buyers’ market.  A reduction in capital and limited credit availability has reduced demand for life settlements.  Acquisition costs for policies have decreased allowing for selective acquisitions focused on policies with higher quality and better value.

Demographic Shift Gives Life Settlements A Boost

The abundance of life settlement options is driven by the demographic shift in the US with a rapidly growing affluent senior population.  An expanding supply of life settlement opportunities is also a result of the growth in the awareness of consumers, their life agents and financial advisors regarding the benefits of the life settlement option.  These combined and complimentary forces have resulted in an increased supply of policies available for settlement within the market place.

Industry sources estimate that the life settlement market has grown from a de minimis amount in 1999 to a forecasted annual market of US$9 billion for 2010.  Specifically, a Conning & Co. report published in 2009 estimated that approximately US$12 billion worth of life insurance policies (based on face value) were settled in 2008 with a total of approximately US$31 billion life settlements transacted  historically.  More recent figures from both Conning and Cantor Fitzgerald suggest that $60 billion of Life Settlements have been transacted in the past decade.  Based upon assumptions from the Life Policy Dynamics Settlement Market Analysis, we believe that nearly 24,000 individual senior insurance consumers were served by the life settlement market in the past 10 years.

Mark Goode is CEO of The Peninsula Group, a Washington, DC-based holding company serving both the emerging senior life insurance settlement and the life premium finance markets. The Peninsula Group managers are experts in longevity investing.  Peninsula’s integrated capabilities and dynamic management group enable the enterprise to innovate and develop new investment strategies and products within the senior life insurance marketplace.  Since 2003, Peninsula continues to offer unique and transparent investment products, that can meet short or long-term investment goals with performance that is unaffected by current market volatility.

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