It seems that fake news has been a hot topic lately. Even the life settlements market isn’t immune. We sometimes see published returns that seem too good to be true. We fear that some of these rely on valuation assumptions rather than actual realised returns.
Headlines that report solely positive or smooth regular returns are prevalent. We understand the nature of the asset may sometimes be a difficult sell. But we believe the asset is worthy enough not to be faked.
When the fundamental return of a life settlements policy is the maturity/death benefit, it may appear that some managers are still promoting their portfolios through rose coloured glasses.
Certainly, it’s common to see published returns with consistent monthly increases. Sometimes every month from day one. In an asset where returns are randomly generated by maturities, it’s inconceivable that funds would be getting regular returns. ‘Fake returns’ should no longer be a tactic used to sell a life settlements fund.
It is normal to have negative returns as part of the establishment cost of a fund. The certainty for many newly established portfolios is an initial long period of small negative return, as a result of continued premium payments and initial purchase of policies. We have looked in the past about the nature of returns in the asset class and its initial poor performance.
How does an investor get past all the smoke and mirrors and find the real returns? To answer that let’s briefly examine the components of performance for a secondary life insurance portfolio.
Performance Components for a Secondary Life Insurance Portfolio
The returns from a portfolio of Secondary Life insurance policies are relatively simple to compute but many remain a mystery to investors. Therefore, the industry has been bedevilled over the years by more than one questionable practice in valuation as well as the representation of published “Performance”.
Essentially there is a binary outcome with this type of asset. You buy an unwanted life policy in the secondary or tertiary market, pay the premiums for some time, and then you either get paid (hopefully at a profit) when the policy matures or you do not get paid. This, of course, assumes that the portfolio manager resolutely maintains a “buy and hold to maturity” strategy.
We could spend a great deal of time discussing the dilemma in valuation methodologies and practices. However, will assume the reader accepts the view that a probabilistic valuation methodology is the most appropriate in mortality based instruments like life policies. This method is the benchmark in the industry.
Performance and Valuation Assumptions
Probability works best when the number of data points is large. Insurance tables are calculated on hundreds of thousands of data points if not millions. Therefore, it is self-evident that returns from portfolios of a few hundred or even a few thousand policies will be “lumpy” because the law of large numbers is not present.
Modelling using tools such as Monti Carlo simulations will give you the mathematically most likely outcomes. But, may also assume several factors, including uniform policy size, uniform health impairment characteristics to name a few. Typically, the most likely returns would be more heavily grouped around the second and third quartiles of the average mortality curve of the portfolio. Periodic re-underwriting of the underlying cases (if adopted) potentially adds another variable into the equation. Actual individual case characteristics will normally be expected to each be idiosyncratic. This is the fundamental non-correlation basis of the asset class.
Hence, it logically follows that it is almost impossible for the asset to exhibit smooth monthly performance. Portfolios that appear to show uniform monthly performance with uninterrupted growth from day one would appear therefore to be at odds with the underlying intrinsic characteristics described above. Therefore, the only way to “smooth” performance is to introduce some valuation “assumptions”.
How can I tell if valuation assumptions are affecting the published returns of a fund?
The only way to be certain of this is if your asset manager is willing to be completely transparent with you the (potential) client.
Unwillingness to be transparent with key issues such as performance calculation and fees (that may be tied to performance) is a “Red Flag” in any asset class and it is no different in the secondary insurance market.
Simple due diligence around an “Attribution Analysis” of quoted performance will quickly reveal where the return is coming from. This can be checked against actual published financial statements.
If the fund is valued say monthly, the components of that analysis should look like this.
Unrealised Change in Valuation
*Unrealised Change in Valuation is formed by the valuation process. This may be volatile in any single month for several reasons. Intuitively, when added up, say over a full year, should not be the sole or majority contributor to the fund performance. If investors understand how these valuation assumptions affect the performance they can make informed decisions.
In fact, in a month where there is no contribution from Net Maturities and or Asset Sales, it is common for the result to be a small negative. Simply, the effect of cash outflows for premiums is not fully offset by a conservative probabilistic valuation uplift. Commonly because not all policies pay premiums monthly.
We urge all investors to actively engage with their asset managers (or potential asset managers) in an open discussion of these processes and their expectations.
Miss-alignment of investor expectations is a key factor in lack of client satisfaction and potential future litigation or complaints to regulators.
An unhealthy over-reliance on smooth returns is a recipe for investor heartache with this asset.
As always we wish you well in the pursuit of your investment strategy. If you want to learn more about investing and valuation assumptions in this asset class, please contact us.
About Global Insurance Settlements Funds PLC (GISF)
Global Insurance Settlements Funds PLC (GISF) is an umbrella type investment company with segregated liability between sub-funds. The fund is incorporated in Ireland. The first sub-fund launched, GIS General Fund (the Fund), is listed on the Irish Stock Exchange.
This structure is aimed at Sophisticated / Institutional investors. Additionally, it provides tax clarity by ensuring there is no tax leakage. It enables several different investment options to suit the specific needs of our investors.
The Fund’s core activity is to actively manage a large and diverse portfolio of life insurance policies (life settlements). Policies are sourced by licensed U.S. Provider companies. The Board of GISF selects those that best meet the Fund’s policy purchase criteria.
Disclaimer: This information is intended for qualifying investors only. It was correct at the time of preparation. It has been prepared to provide general information only and should not be considered as a “securities recommendation” or an “invitation to invest” in any jurisdiction. Potential investors should consider the relevance of this information to their particular circumstances. Before proceeding, investors must obtain the prospectus and take their own legal and taxation advice. If you acquire or hold one of our products we will receive fees and other benefits as disclosed in the prospectus and relevant offering documents.
