What if the fund had a poor performance to date, what then? To begin, let’s examine some insightful statistics for our open-ended Irish regulated investment structure. The fund holds a pool of “seasoned” policies. Below, we have included the most current age spread for the GIS General Fund with policies awaiting maturity. Notably, a significant portion of the policies, 69.4%, are expected to mature between 85-95 years of age. Most noteworthy, in our asset purchasing history the average age of maturity is 88 years of age. This is for our entire catalogue of purchased life insurance policies. By examining the GIS General Fund, it would appear that the best times are yet to come. Our conservative acquisition strategy has resulted in a modest return in initial years to ensure future stable return on investment in the future.
*Source GIG General Fund as at 31.12.2016
Evidently, past performance is frequently not the best indicator of future outcomes. Certainly, this may be true for any asset but particularly when it comes to life settlements. In fact, the best predictor of future performance is the quality of the investment process. This process enabled the investment manager to perform in the first place. We have provided some tips on how to review your life settlements asset manager.
The most important questions to ask are clear! “Do they efficiently collect every benefit that has become payable so far? Where are they along the expected outcome curve?” The best predictor of future performance is where the fund currently stands. Clearly, with this asset, it refers to its progression with the average maturity profile of the fund. If this process is robust and consistent, the manager is likely to continue to perform.
When is the best time to invest in life settlements?
Anyone familiar with the secondary life insurance market would be aware that it involves the purchase of the fixed benefit amount of an unwanted, permanent life insurance contract, at a discounted price. The physical return only actually occurs when the benefit pays out at the uncertain future date. Meanwhile, the new owner assumes the burden to continue to pay the premiums until such time as the benefit pays out.
We would normally say that life settlements should only be the domain of patient investors with a 5-10-year time frame. However, the astute will recognise opportunities presented by the nature of the asset. The key for investors is not to miss the peak of maturities. Once the pool reaches its peak, the frequency of maturity begins to decline.
So when will I see returns you ask? The short answer is that normally the bulk of returns would be expected in the second and third quartiles of the average mortality curve[1] of the pool of insured lives. However, a number of factors can skew this outcome. Particularly if there is a big variation in policy size within the portfolio or if the portfolio is small.
It is normally unusual to see significant maturities in the first few years of a newly originated portfolio.
One factor at play here is the phenomenon of “Anti-selection bias.”[2]
So why the initial poor performance?
The certainty for many newly established portfolios is an initial long period of small negative return. Certainly, a result of continued premium payments and initial purchase of policies. Investors in smaller portfolios, say less than 2000 lives, should also expect lumpy returns. Due to probability and chance in small samples. An initial negative return profile similarly observed in investments like infrastructure or a “Land Bank”.
In fact, it’s often a “Red Flag” when published returns indicate regular and invariable positive returns. Especially if the positive returns are from the very outset of a fund’s establishment. Any fund manager worth their reputations should be prepared to show prospective investors the Attribution Analysis. Above all, this will back up the published returns. Consequently, this will eliminate any attempt to artificially “smooth” returns by using valuation assumptions.
Taking a global view on the asset class, this investment is rewarding to those who show patience. Importantly, the openness to recognise asset managers who take a conservative approach to stable ongoing returns. Frankly, investors looking to invest in the asset class should commit to at least 8 to 10-year horizon in order to realise respectable gross risk-adjusted returns.
To appreciate the logic behind the unique performance characteristics of life settlements you must first understand the nature of the asset class.
The Underlying Asset- Life Insurance Policies
A life settlement is the sale of an existing life insurance policy for more than its cash surrender value, but less than its net death benefit to a third party. The focus is on policies insuring older individuals, typically 65 and over. Typically, they own a life insurance policy with a face amount in excess of $100,000.[3]
A life settlement can prove to benefit both the investors and insured. For the insured, it proves to be an alternative to lapsing or surrendering the life insurance policies. For the investor, the underlying assets are uncorrelated to events in the stock, bond or property markets. This helps reduce the volatility in your investment, whilst maintaining the potential for a strong return. Actuarial and hands-on insurance experience is useful in understanding the probabilities around the likely timing of benefit claims and duration of cash outflows for premium payments.
For many institutions, a life settlements investment through a fund is significantly more opportune than the direct purchase of the underlying life insurance policies. However, the relatively long investment horizon of minimum 5+ years and the apparent “poor early performance” of many funds can prove to be a deterrent for some.
Key Risk to Performance
One of the key obstacles to performance is longevity risk, which we have examined multiple times in our articles. Longevity risk is essentially the risk that the insured will live longer than anticipated, subsequently, the investor will realise a lower than expected return or potentially even a loss. The extent of which can be due to flawed underwriting or health advancement. More commonly, simple misinterpretation of the available data around possible outcomes.
You need to remember, Life Expectancy (LE) calculations are exactly that, an estimate. They offer a range of possible outcomes based on a historical mortality experience of 1000 medically similar lives at a certain date. They are used to project how long investors must pay premiums before the death benefit is collected. Short LE’s translate into higher offers to sellers, while long LE’s typically result in lower offers. The timing of maturities directly affects the value of the portfolio by affecting the timing and size of cash flows.
Remembering that in the life settlements market the concept of “market value” is not clear (except and only when a transaction is physically closed). Policies are individually underwritten. It is based on the insured’s unique health condition and the pricing characteristics of the particular policy. Recognising risk and opportunity on a per-policy and portfolio basis is key for an investor in building a high performing investment. Investing in a large pool of policies also dramatically improves the risk profile of the fund. Remember insurance calculations are normally based on tens of thousands of data points.
Conclusion
The key component of any business is the management of risk. Buying the best-fit policy types is crucial in the case of life settlements. This is particularly important from a risk management standpoint. Constructing a portfolio that has the best mix of policies and the elimination of acquisition errors, will determine the success of returns. Also, it will limit the effects of longevity risk.
As always we wish you well with your life settlement investment opportunities and if you want to learn more about investing in this asset class please contact us. Additionally, if you want to understand initial poor performance cycles in life settlements we would be happy to discuss.
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 a number of 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). 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.
References
[1] A mortality curve is supplied by the Medical Underwriter. For each life policy, it shows the Historical mortality experience of a pool of lives resembling the health characteristics of the insured life.
[2] Anti-Selection bias is the phenomenon where individuals with a positive outlook on their health are more likely to sell their Life Policy.
[3] Life Insurance Settlements Association, http://www.lisa.org/consumer-advisors/life-settlement-basics/defining-life-settlements
