When it comes to the preservation of wealth for family offices, an alternative investment such as investing in life insurance policies should be considered in asset management strategies.
With the worldwide increase in private wealth, Forbes has reported a boom in the single family office structures. While these ultra-wealthy are motivated towards upgrading their level of investment competency they are faced with a unique set of challenges with their wealth creation tactics.
Let’s face the music and declare that investing in life insurance assets is no longer a new idea. Life settlements did not arise from a radical new concept but was formed out of necessity.It is grounded in the same financial modelling as life insurance. A secondary market has bloomed for life insurance policies holders where there was previously none.
When planning for strategic asset allocation, this evolving asset class may be worth considering by family offices. It is a powerful tool for the preservation of wealth during periods of severe and prolonged market volatility.
As family offices take charge of their investments they should simply take into consideration the following question. How can investing in life settlements assist in the growth and preservation of wealth?
An Asset Class With Real Diversification
Returns from life settlements have little or no correlation to traditional asset classes. Studies have been unable to detect any correlation between human longevity and the cycles of financial markets.
There is a historical volatility of the equity and real estate markets in particular, but also the well-publicised failures in both fixed interest and derivative based hedge funds. Coupled with this is historically low interest rates. This suggests that investors more than ever need to consider diversification into non-traditional asset classes.
An Attractive Return Portfolio
Interest has returned to the industry as institutions look to reduce the level of risk and correlation they hold by further diversifying into the life settlements asset class. Currently, life settlement policies can be obtained at very attractive rates of return (IRR’s), because supply outweighs demand.
Today, multi-national banks, international corporate conglomerates, global insurance companies, pension funds, and other major financial institutions are purchasing life insurance policies through life settlements. The same institutions that invest in life insurance companies. One of the largest insurance holding companies in the United States, Berkshire Hathaway, have been among one of the significant purchasers of life insurance policies adding to their life settlements portfolio as recently as July 2013 confirming it purchased a $300M Portfolio. If you are investing in a major corporate conglomerate there is a likely chance that they are investing in life settlements too.
The methodology of calculating gross market return continues to evolve along with the science of medical underwriting. The presence of large institutional investors in the life insurance assets market has increased and promises to continue to increase the liquidity of the market and the market’s stability.
Quality of the underlying Asset
Like any investment, you want to be sure you get paid in due course. In this case the counter party is a USA insurance company, or in the case of the Global Insurance Settlements Fund PLC, a diversified pool of highly rated US life insurance companies that have issued the policies held by the investor.
So how safe is a policy issued by them? Let’s look at it in simple investment terms –you could have shares in that insurance company, you could have a bond issued by them or you could own a policy they’ve issued.
Which is safer? Well certainly bond holders get paid before any distributions are made to shareholders. But above that the policy claim is made against the legally distinct policy reserves held by the company, that are regularly audited by the insurance regulator. Hence, they are the highest priority and free of any creditor claims against the company itself. That’s a very good position to be in.
Hence the credit risk of a life policy is theoretically much less than say a corporate bond issued by the same insurance company itself. The health of these reserve funds is also subject to external assessment by rating agencies in the USA such as AM Best.
Each USA state government insurance regulator maintains fidelity reserves (subject to certain limits) to assist payment of policy benefits in the unlikely event that an insurance company reserve failed. This is important to remember for family offices looking for assurance of the asset quality.
Known Future Value
Life settlements offer a known future cash flow. US Life policies typically offered as life settlements generally fall into the category of “Universal Life” products. These are defined technically as a “Non-participating permanent life insurance contracts”. This means the contract itself is not subject to regular renewal and the benefit amount is set out in the contract and because it is “non-participating”. No part of the benefit is at the risk of the company’s investment performance or profitability.
This is further enhanced by the unique feature of US life policies being “Non-contestability clauses”. Under these clauses, (which have been tested in the US Supreme Court), US life companies as a consumer protection mechanism contractually waive their ability to contest future claims after a certain minimum period, (usually two years) of the policy being in force.
As a result the beneficiary of a US life policy has a very high level of assurance of being paid the benefit in due course.
In the United States, insurance is regulated at State level, although State regulators have a national body known as the National Association of Insurance Commissioners (NAIC).
The regulatory framework, which protects both the policy holder and the investor, is robust. Not only does this provide protection but it also enhances market transparency and reputation. The regulation of the life insurance secondary market now exists in forty-five of the fifty states.
Also a growing number of American states include Life Settlements under their definition of securities, while many states have adopted the consumer protection approach, or both. Some states have used existing insurance regulations to control potential fraud.
Well-publicized abuses within the industry have led to action by the federal government and state agencies. Laws regulating licensing of the older viatical and newer Life Settlement companies vary from state to state. Efforts to establish uniform guidelines have been moderately successful. A small number of states still have no licensing requirements while some states such as Florida, Ohio, and Texas, have more stringent licensing requirements.
The regulatory changes over the last few years are encouraging and continue to grow. It attracts reputable players to the industry giving investor’s greater confidence.
Financial assistance provided to the insured
What about the ethical considerations? There is a compelling realisation of the true assistance provided to the insured selling their life policy.
Recent studies and events show the industry’s has growing reputation a responsible and financially-compelling alternative to traditional asset classes. As a collateral benefit it has injected several billion dollars into the savings of US retirees and or their family structures.
In his detailed study Narayan Naik, Professor of Finance, London Business School, shows that secondary life insurance market benefits both the investor and the insured selling their unwanted life policy.
Professor Naik, says: “The evidence suggests that the life settlement market has helped significantly in enhancing the welfare of policy-owners who, instead of surrendering, sold their life insurance policies in the secondary market”.1 We have performed a brief review of his research paper, Empirical Investigation of Life Settlements Secondary Market for Life Insurance Policies.
Further support of the Life Settlements industry was shown on June 14, 2013 when signed into law a bill that lets Texas state Medicaid officials tell policyholders applying for Medicaid assistance that they can sell their contracts to a life settlement company to cover custodial healthcare expenses.
With similar bills pending for other states, time will tell what effect this will have on the profits of major life insurance companies. However, it brings a new mark of legitimacy to life settlements while helping those most in need pay for medical care.
These insurance linked assets mitigate short-term volatility and pursue long-term growth from an asset class with a truly different return profile. Therefore, to meet wealth creation objectives, family offices should use a broad range of asset classes, including we believe, incorporating Life Settlements as part of an alternative investment allocation.
As always we wish you well in your endeavours in this interesting and valuable asset.
Please feel free to contact us if you have further questions.
 N.Y.Naik and A.V.Juanário, 2013,Empirical Investigation of Life Settlements: The Secondary Market for Life Insurance Policies, pp1
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