Life settlement funds will add value to retirement portfolio

We find comfort in certainty. In investing, that means a lot of comfort. It's generally associated with fixed income products. But, most of the products/solutions in fixed income are a misnomer. Except for the traditional bank deposits, one hardly finds true to the name. But fixed income or debt as a category offers a large choice for investors looking for exposure to products of lower volatility.

In the west, universal life as an investment concept is very popular. In universal life, a person is insured for life and the maturity happens as the person turns 100. The longevity of the population makes it popular as many use this also as an asset for life and part of an estate plan. However, as the premium servicing tends to become a burden during the retired phase, many choose to sell their policy.

Earlier, like in India, the plans were either allowed to be lapsed by the policyholders or were surrendered to the insurance companies. The regulations there now allow the policyholders to trade them in the secondary market. This reduces the servicing burden and allows the policyholders to cash out on their plans. Typically, over 80 per cent of the terminated policies lapse prior to the maturity.

The other reason for trading the policy is many of the aged policyholders are of ill health, if not terminally ill and cashing out the policies helps them with money. This also means that the purchaser of these policies would have lives which are sub-optimal to the plan i.e., the chances of survival till the age 100 is less and so cold turn profitable. So, investing in life settlement could turn out to be more profitable and predictable too. This is because life settlement returns are based on mortality and hence have low correlation to the market volatility. They, thus, represent excellent 'market neutral' alternative to the traditional asset classes.

To understand better, insurance business is purely based on the mortality of the population and thus the products offered and the pricing of the premium is based on this calculation. The mortality of a defined (standard) population is predictable or estimated to the least deviation of error in normal times i.e., excepting a rare natural disorder or war, etc. This is the reason why life insurance products also come with fixed premiums.

Moreover, in insurance, the provider has the highest commitment to honor the death benefit of the policyholder over the equity or bond holder of the insurer. The regulations are also skewed in favor of the policyholders and the various solvency margins are designed upon the liability of the insurance companies i.e., the final claim.

This, hence, becomes an attractive proposition to collect the final benefits (maturity or life claim) over the insurance company's (corporate) bonds.

The secondary life settlement market has shown significant growth in recent years. According to a survey, the annual number of policies traded in the secondary market increased by 186 per cent between 2015 and 2020 with a 13 per cent jump from 2019 volumes. According to Conning, there will be around $50 billion of life settlements in force within the investor portfolios. The survey also revealed that about 90 per cent of the US seniors (older policyholders) who own a life insurance policy are unaware of the option to sell their policy, indicating a huge potential for further growth. A US federal level, a General Accounting Office report in 2012 concluded that the market successfully benefits the US seniors and opined that the regulators would support both at federal and state level.

Data as on Feb '22, from the US Federal Reserve and Moody's put the yields of life settlement policy on a 10-yr average life at 8 per cent-12 per cent while an average Baa rated 10-yr corporate bond yielded 3.6 per cent. In comparison, an average Aaa rated 10-yr corporate bond yielded 2.9 per cent and the 10 yr US treasury yielded just 1.9 per cent. The question now is how to invest in these instruments.

Kristal.AI has made these innovative products available in India through their fractional offerings. They've derived this by ensuring a greater due diligence process of identifying the right set of lives as the return is dependent upon the excess of the maturity proceeds over the acquisition cost and the further premium costs. The greatest risk of these products is the 'longevity risk', the risk of an insured surviving longer than projected.

So, the selection of lives becomes critical function for the success of the investment. A valuation methodology by SL Investment Management, one of the most experienced, full service secondary life policy specialists in Europe states that returns at 21.28 per cent p.a. for 6.25yr from the life expectancy to a range of 8.56 per cent for 10.25 yrs from life expectancy. An exposure into these products would add diversification to the portfolio while providing a relatively consistent return. An allocation into any retirement portfolio would add value and better risk adjusted return.

(The author is a co-founder of 'Wealocity', a wealth management firm and could be reached at [email protected])