An Asia-based advisor writes about the case for US life settlements in portfolios.

This publication has occasionally touched on the market known as life settlements. This is a relatively young asset class, first made available when the US administration of Bill Clinton signed the Health Insurance Portability and Accountability Act into law in 1996. A deciding factor in the passage of the law was the AIDS epidemic of the 1980s, continuing into the next decade, which left many Americans with steep health bills and a lack of steady income. When an inability to pay medical fees could literally turn into a life or death situation, life settlements offered a way to acquire money quickly. With the discovery of medicine that can extend the lives of AIDS patients, in recent years, focus has shifted toward senior life settlements, in which the life insured is that of a senior adult with a life expectancy of three years upwards.

The market has attracted controversy (see here). The issue of people selling policies before maturity raises ethical issues about whether people are wise to cash in such policies.

In this article, Charles Dargie, of the eponymous firm Dargie Ltd, of Penang, Malaysia, and an advisor on the US life settlements sector for Asia, gives his views about what he sees as its merits, and argues that Asian interest in this market remains relatively narrow, but has potential to grow. The editors of this publication hope this item will stimulate debate. It doesn’t necessarily endorse all the views of such contributors and invites readers to respond.

Low interest rates and turbulent market conditions continue to be a bugbear for many investors and managers the world over. To reach performance targets or perhaps even just to preserve wealth, different non traditional asset classes are being explored. In this last category come US life settlements, where returns at maturity of 8 per cent a year or more are available. Risk is low provided that due diligence is undertaken. The key concept here is the uncorrelated nature of the investment that separates it from other markets and interest rate movements.

A life settlement is the sale of an existing US life insurance policy to another party for more than its cash surrender value, but less than its net benefit at maturity. In other words, a US insured person who wishes to stop paying premiums and receive a cash benefit immediately can do so by selling his/her policy in a secondary market. Such policies, when carefully chosen and packaged professionally, can become excellent investments. In 2013, the top 15 LS providers in the US are said to have paid more than $362 million for unwanted life insurance policies valued at over $2.2 billion.

There is much information online from the viewpoints of policy sellers, LS providers as well investment managers/advisors. In Asia there is still low life settlement adoption apart from some limited activity at an institutional level.

Investors can participate either by way of a fund that purchases and manages policies, bonds created with use of financial engineering or by buying individual policies (or fractions of policies) to form an investment ladder. In the case of the latter, LS companies manage the paying of premiums and tracking of insured parties. Currently, life settlements with small face values and expectancy periods up to three year are much in vogue as these can readily be seen to compete well with regular investment products.

A life settlement standing alone can be considered low risk as the supporting asset is a policy from a leading US insurance company. The benefit at maturity of a policy is a fixed amount, which supports the low-risk assertion. What is variable is the payment time of that benefit. When a life settlement is created, professional companies are engaged to estimate a life expectancy period of the insured person. The most conservative estimate is accepted and with this an expected annual rate of return can be established. Very often a life policy is bought from a person who is 70 or more years old and in poor health.

Buying into a life settlement fund has the advantage of a spread of many policies and the disadvantage of lack of liquidity should many investors collectively wish to sell at the same time. This was the case not so long ago in the UK when a regulator made critical comments about the LS fund of EEA Fund Management, which was then obliged to cease trading. Caveat emptor applies when considering bonds tied to LS.

In the past, life settlements have been criticised because expectancy periods were quite frequently underestimated. The industry has since addressed this problem. For investors, these policies should be considered as illiquid and not a substitute for a time deposit.

Sellers of life insurance policies benefit from the fact that 42 US states and the territory of Puerto Rico regulate life settlements, affording about 90 per cent of the US population protection under comprehensive laws and regulations. Helpful information on this subject can be found from the Life Insurance Settlement Association.

Contrary to the views of some, this is not a morbid form of investment. Sellers of policies welcome the opportunity to adjust their affairs and receive cash in the hand.

The author has worked in banking and finance since the early 1960s, working in centres such as Hong Kong, Brunei, Vanuatu, Bahrain, the Turks and Caico Islands, Gibraltar, and now lives in Penang, Malaysia.