Cashing In On Others' Life Insurance
Sydney Morning Herald
Saturday November 20, 2004
If two certainties in life are death and taxes, it was only a matter of time before someone figured out how to make money out of one or the other.
Brisbane-based Life Settlements Funds aims to make money from people dying. It plans to do so by buying people's life insurance policies before they die, and cashing in when the insured person dies and the insurance company pays out.Second-hand life policies aren't a new concept - as recently as two or three years ago there was a thriving business in buying and selling them in Australia.But the process got at least one of the players, funds management company AM Corp, into trouble in 2002 when the Australian Prudential Regulation Authority stopped the company from buying any more policies. APRA was concerned that the policies, which it said were illiquid assets, were not suitable investments for superannuation funds. Eventually AM's LifeTrack funds were sold to IOOF.Geoff Orr, a director of Life Settlements Funds, says the latest product works differently because it invests in different policies."They were buying the investment portions of whole-of-life and endowment-type policies," Orr says."It worked really well for them until post-September 11 [2001], when the markets tanked big-time. It gave MLC and AMP - who were the issuers of 80 per cent of the policies in that portfolio - an excuse to drop their bonus rates."The Life Settlements Funds will source insurance policies from the US. The US is obviously a larger, deeper and more liquid market than the Australian one, and Orr says there are well-established firms dedicated to finding policies and acting as brokers.The key to the fund's success will be its ability to find suitable policies, correctly assess the health and life expectancy of the insured, and to buy the policies for a sum that will lead to an acceptable return for the fund and its investors when the insurance company pays out.The fund also pays any premiums. Then, when the insured dies, the life insurance company pays the sum insured and the unit holders get the proceeds.There are two main risks. The first is that the fund gets a life expectancy assessment very wrong, that it pays too much for policies, and that it has to pay premiums for longer than expected, hence reducing the ultimate return to investors.The second is a foreign-exchange risk, because while investors subscribe Australian dollars to the fund, its assets are denominated in US dollars.Orr says that for someone with a life expectancy of three to four years, the fund could pay 40 to 50 per cent of the face value of the insurance policy. For longer life expectancies, the fund will pay less. For a seven-year life expectancy, for example, Orr says it could be as little as 25 to 30 per cent.He says it's taken about four years to refine the concept and assemble the fund. A key part of the process has been to line up brokers and custodians in the US, and to engage companies which can assess people's life expectancies.Because returns depend on the supply of life insurance policies, and the payout from those policies depends on life expectancies, Orr says results are uncorrelated to (that is, they do not mirror or track) other investment markets.That's because once the fund has bought a policy, it knows how much it's going to get when the insured dies. It's more a question of when it receives the return than what the return will be. And that's why assessing the insured person's life expectancy correctly is so critical.Orr says the lack of correlation means the fund can provide diversification benefits for an investment portfolio. Nevertheless, this is a new concept for Australia, and investors would do well to seek professional advice before buying in.The chairman of Life Settlements Fund is Ian Cotton, a former partner in accounting firm Deloitte Touche Tohmatsu. He says: "It's very capital stable. The underlying security is a life insurance policy issued by a US company rated by AM Best as secure or better. "None of these companies fall over in the US, which means you have a very secure [underlying asset]."
© 2004 Sydney Morning Herald