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For investors that are still wary of investing in the stock market but frustrated by returns from low interest rates, life settlements are an interesting alternative. They are life policies are that purchased from people expected to die soon who want to access the cash in their policies before their demise. Buyers purchase policies at a discount to the sum assured and take over paying policy premiums. The returns are dependent on when the insured dies — the profit is the final value of the policy, less the price paid for the policy and the premiums paid.
The concept is similar to the traded endowment policy (TEP) market except that, with TEPs, the term of the investment is known but the final value is not. With life settlements, the term of the investment is unknown but the final value is.
Life settlements used to generally be known as viatical settlements. Viatical comes from the Latin ‘viatcum’ meaning provision for the journey — Roman soldiers were given their viaticum before going into battle, which was most likely their final journey. Actual viatical settlements can trace their history to 18th century London when individuals would hawk their own life policies by standing on boxes in City streets and allowing passersby to make their own assessments of how long the person might live before bidding for the life insurance. Financial auctioneers Foster & Cranfield began auctioning life assurance policies in London at this time. But viaticals fell out of fashion and did not resurface again until the 1990s, this time in the US, when AIDS victims started selling their life policies to fund new and expensive treatments.
These investments only returned to the UK in the last couple of years. A distinction is now made between viaticals, which are policies bought from terminally ill people of any age, and traded life policies (TLPs), which are policies bought from elderly people in ill health. TLPs are seen as a safer investment than viaticals as a supposedly terminally ill person could have been misdiagnosed or advances in medical treatment could mean that a condition formerly considered fatal may no longer be so — meaning that the purchaser of the life settlement would have to continue paying premiums for much longer than expected, reducing the gains from the investment, perhaps entirely. But by buying a policy from an elderly person (usually considered from age 78 or 80), the risk is not a medical one but an actuarial one — and we all die eventually.
Also, policies are now less likely to be bought individually; instead, policies often are pooled into funds, in which investors purchase shares. This reduces risk to individual investors and also makes the investment feel less sinister — you are not waiting for one particular person to die in order for your investment to be realised. features funds available to UK investors.
Growth of the market
From its early days in the US, the life settlement market has grown from $50m in 1990 to $2.5bn worldwide in 2003. The US is still the main market for these investments as well as the main source of life policies. US research consultants Conning and Co estimates that Ameri-cans over the age of 65 hold approximately $467bn in life cover and of that $167bn is potentially available to the TLP market. Additionally, Surrenda-link, the investment manager for the first London-listed TLI (traded life investment) fund, Alternative Asset Opportunities, says that more than $1,000bn in life insurance either lapses or is surrendered annually and of that, $135bn is eligible for the secondary market.
The US is the main source of life settlements as Americans typically carry much higher life cover than people in other countries — the average American life insurance policy is for $1.4m. Americans also usually purchase whole of life policies. In the UK, term assurance has been more common, which obviously would carry more risk to investors as they would not only have the usual worry that the claim would be realised too late for the investment to be profitable (as in whole of life) but in addition that the policy would expire before the claim arose, in which case they would lose all of their investment.
The UK and Europe are unlikely to become sources of life settlements as there has been a rise in the number of critical illness and PHI (permanent health insurance) policies, which pay out if the insured develops a terminal illness or is unable to work because of serious illness. And many new life insurance policies in the UK now include terminal illness cover, which pays out the full amount if death is expected within a year. However, this type of cover has not developed in the US, where life policies are still used as a catch-all, often bought not just to provide life cover but also to fulfil a similar purpose to critical illness and PHI cover.
Not only are life policies more plentiful in the US, they are also more attractive. While the life settlement market is not regulated in every US state, insurance companies are heavily regulated. With life insurance policies, there is a contestability period, usually two years, during which time the life office must check that all of the information supplied by the insured is correct. After this period, the life office cannot contest the life cover by claiming that the insured misrepresented his or her medical situation — even if the insured did — and the policy must be paid out on a claim arising. But in the UK, life offices can contest that the insured knew he or she had a disease or failed to declare something at any time — there is not the certainty that the policy will pay out and in a timely manner.
Scandal and risk
Most funds that hold life settlements now make sure that they only purchase US policies that are past the contestability period in order to secure the investment. In the past, there were issues with people taking out life cover and supplying incorrect medical information in order to boost the value of the policy — known as clean-sheeting. Another scam, called wet ink or wet paper, saw people taking out life insurance with the specific intention of quickly selling it.
But not all of the problems with life settlements have stemmed from people selling their own life insurance. Mutual Benefits Corporation (MBC), a US life settlements broker, has been accused, by both the SEC and securities regulators in several US states, of engaging unlicensed sales agents, misrepresenting investment returns and misleading investors about the life expectancies of its clients. MBC had been a supplier of TLPs to some funds offered to UK investors but those funds quickly distanced themselves at the first sign of scandal.
MBC also fell foul of securities regulators in Florida, where the company was based, because it was treating life settlements as insurance products rather than securities. The policies are either treated as insurance or as securities depending on the state in which a purchaser of life settlements is headquartered; the regulation of the securities industry is considered to be more onerous than that on the insurance industry. (MBC has now been shut down by the regulators).
Most funds now have stringent standards for the companies that supply them with life policies. Some will only deal with brokers that are located in states that treat life settlements as securities so that they are more heavily regulated. And the Viatical and Life Settlement Association of America (VLSAA) has done much to protect buyers of life policies from fraud and many funds will only source policies from buyers that comply with the VLSAA’s anti-fraud plan. Now, companies that buy policies usually require two independent medical assessments of the insured (rather than just relying on the insured’s own doctor’s evaluation) and the more conservative life expectancy will be used as the basis for the purchase price and expected investment returns.
And it is really the prediction of how long the insured will live that is the main risk of this type of investment. By only buying policies that are past the contestability period from elderly individuals, requiring independent medical assessments, and basing investment returns on the most conservative life expectancy, funds have tried to take as much risk as possible out of the investment.
Regulation and taxation
Whether life settlements are regulated by the FSA is a confusing area to many because while they are insurance products in the hands of the original owner, once they have been sold to a third party, they are investments. When asked if life settlements fell under its jurisdiction, the FSA itself appeared unsure. However Bridford Personal & Corporate Planning, which provides direct investment in life settlements through SGAT III (see Table), approached the FSA about the regulatory status of life settlements and in November 2003 the FSA agreed that they are indeed regulated on the basis that they are contracts sold as investment products.
However, life settlements are only regulated by the FSA in that the advice given by the IFAs and providers selling them is regulated. Therefore investors would have recourse to the Financial Ombudsman Service and the Financial Services Compensation Scheme, but only if the product was mis-sold. Investors having problems with a fund itself would still be out of luck if the fund were based in an unregulated offshore location, as many TLI funds are (many are based in the Cayman Islands). And as the insurance policies are coming from outside the UK, they too are not FSA regulated.
Recognising that not everyone is comfortable investing in offshore funds, Surrenda-link launched the first London Stock Exchange-listed TLI fund in March 2004 as already mentioned. So Surrenda-link and the fund itself are authorised and regulated by the FSA.
Most funds are not listed but the Select High Security Fund from Shepherd’s also listed on the Cayman Islands Stock Exchange in November 2004. Shepherd’s gained approval from the Inland Revenue (under S.841 of the UK Income and Corporation Taxes Act) to offer the fund through SIPPs and Alternative Asset Opportunities, another listed fund, would also be eligible for inclusion in SIPPs. All life settlements are permitted investments for SSASs.
The tax implications for those investors that do not hold life settlements in SIPPs or SSASs are straightforward. Although the payout from a life insurance policy is tax free for the beneficiaries of the original owner of the policy, once the policy is sold to a third party it is treated as an investment for tax purposes. And like most investments, any gains from investing either directly in life settlements or in a fund are subject to capital gains tax. If the money is from an offshore fund or from a policy outside of the UK, the gains are still liable for CGT, even if the money has not been repatriated. CGT is charged (above the personal CGT allowance of AGBP8,200 for the 2004/5 tax year) at 10% for individuals that are in the starting rate tax band, at 20% for those paying basic rate tax and at 40% for those in the higher rate tax band.
Types of funds
Most life settlement funds will invest in a range of life settlements with staggered life expectancies to produce a stream of income. Some funds are closed but most just have a recommended investment period (usually of five or six years) and may charge exit penalties if the investor wants to leave the fund earlier.
Funds will require minimum investments of AGBP5,000 to AGBP50,000 and charge management fees of 0.3% to 1.5% (some also charge performance fees if annual returns go above a set percentage). Expected returns generally range from 8% to 12%, but up to 15%. Most of the funds listed in Table 1 launched this year (SGAT III, Alternative Asset Opportunities, Assured Fund) so actual returns cannot be quoted, but Centurion’s Defined Return Fund has performed slightly above the expected returns in each of the classes.
There are several different types of funds: standard growth, guaranteed and income. Standard growth funds are the most straightforward — they buy policies, people invest in the funds and when the policies pay out (or when the fund closes), investors get their share. Guaranteed funds are similar except that they are underwritten by a third party and guarantee an annual return within a period after the anticipated maturity date (usually one year), but the investor sacrifices some returns to pay for the guarantee. Income funds pay income, usually of about 6% pa, by using a proportion of the investment to purchase a fixed annuity and the rest of the investment is put into a growth fund.
Investing in a fund usually means that the investor is not responsible for paying the premiums on the life settlement: a fund will have a premium reserve to ensure that it can pay the premiums on the policies held. If the reserve is mismanaged and the premiums not paid, the policies would lapse, making them — and the investors’ shares in the fund — worthless. To avoid this, funds will have anywhere from six months to two years’ worth of premiums, held by escrow agents that specialise in TLPs.
Most funds also reduce risk to individual investors by hedging the currency risk. As most life policies are bought in the US and the final payout will therefore be in US dollars, there is a risk to UK investors that the investment may not pay out as much as expected due to currency fluctuations.
Some investors see the currency risk as just another variable in the investment, which could actually increase the value of the investment if the dollar rises against sterling, (which it was certainly not doing at the time of going to press, namely mid-December)
Another safety feature that many funds employ is using reinsurance as a stop-loss. The reinsurance, offered by the Lloyd’s insurance market, guarantees payment of an assured sum if the life policies held do not pay out within 24 months of the predicted life expectancy.
So if a life expectancy prediction was inaccurate and the claim has not bee paid 24 months past the prediction, the reinsurer will pay out. This guarantees that even if life expectancy predictions are way off, investments still have an end date and cannot go on indefinitely, requiring premium payments to keep the investment active.
Future of the market
The market for life settlements has grown dramatically and is predicted to rise to at least $10bn by 2005. )
But the industry still seems to be going through growing pains as it works out its own standards and regulators decide how these products should be treated. And in the UK at least, life settlements still do not seem to be on the radar for many investors and their advisers.
However, the number of options open to UK investors is growing and the launch of a LSE-listed fund (Surrenda-link’s Alternative Asset Opportunities TLI fund) is sure to make life settlements more familiar to the investing public.
And with equities still not performing well, interest rates still relatively low and the property market slowing down, investments in another asset class, which is completely uncorrelated with others and produces potential returns of 8% to 12% annually, are worth a look.
Article from Money Management 01/01/05 as seen on Preferred Asset Management.

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