Life Settlements

A Big Fish in a Big Pond: How Institutional Investors Have Affected the Life Settlement Industry

by Gordon Taylor

Institutional investors have been eying the life settlement market with great interest since it emerged in the late 1990s. Bigger fish have started to make a splash as the smaller fish have become successful in a growing life settlement pond. What is the attraction? How has the industry changed? How does it affect brokers and their customers? Let's take a look.

Institutional investors, such as closed-end funds, hedge funds, pension funds, investment banks, and private equity groups have been interested in the life settlement market from the start; this also includes international groups.

They are driven by the industry's many benefits and by its growth, which experts believe will reach $161 billion in policy face amount over the next several years, according to Bernstein Research. Institutional investors have taken steps to enter the market. They purchased $10 billion to $15 billion in policy face amount last year alone, according to a report by A.M. Best Company Inc. These institutional investors include many top tier financial institutions and other firms.

The popularity of the life settlement market has attracted the interest of international groups as well. Starting in 2002, several international funds were introduced, including a German closed-end fund. This laid the groundwork for a variety of other funds and investment options. This class of funds now makes up the fourth largest investment vehicle in Germany, according to a report by Wizard Traded Insurance. It has expanded to other areas around the world including Asia, Australia, South America, The Netherlands, United Kingdom, and others.

Savvy institutional investors can find an attractive investment vehicle in life settlements. Its principle benefits include an alternative, long-term growth investment vehicle; live portfolio diversification strategy; the potential for greater certainty of returns; chances for above average yields; and tax or currency gains. In addition, institutional investors have the flexibility to determine investment parameters.

A life settlement is a non-correlated asset class with high-growth potential. As a non-correlated asset class, a life settlement is more insulated from equity or bond market volatility, interest rates, and political or global events than are other investment choices. For institutional investors, market neutrality is one of most compelling features. Life settlements offer flexible parameters and the potential for above-average yields similar to stocks, but with a lower volatility and greater certainty of return.

When the policyholder's life expectancy is the primary risk, investor returns are tied to mortality. Investors strive to mitigate this risk and other risks by building a large portfolio of varying types of policies, insureds, health conditions, and carriers. The returns of high-yield corporate bonds are often linked to riskier companies. But, as insurance policies, life settlements are generally pooled in a portfolio. Also, each policy is issued by an insurance carrier that is regulated and rated, which gives investors more confidence.

Industry Changes Bring Opportunities

The needs and demands from institutional investors have spurred changes to the life settlement market including corporate-like efficiencies, transparent business operations, technology driven processes, commitments to consumer protection, and industry compliance among leading companies.

Corporate-Like Efficiency

Many providers operate with corporate-like efficiencies, complete with call centers, account representatives, and online forms and resource materials for quicker and more accurate transactions and better customer service.

Transparent Business Operations

Institutional investors face numerous regulations regarding shareholder protections, corporate governance, disclosure notification, and financial reporting. As a result, providers are incorporating transparency into their own operations, especially producers that have undergone a rating process in which operational transparency is a major component.

Technology Driven Processes

Providers that have invested in technology will have a competitive edge in the near future when market demand is expected to increase significantly. Processes that are streamlined, automated, and backed by flexible infrastructure will allow quicker, easier, and more reliable transactions, and will differentiate market competitors.

Consumer Protection And Industry Compliance

Although providers generally represent the interests of institutional investors, the most successful will be those that help protect all parties in a transaction. Industry leaders have instituted anti-fraud and other security measures since they take consumer protection and industry compliance very seriously.

Broker Impact

Because of these changes, brokers and their customers have an easy and sophisticated way to conduct life settlement transactions. Strong customer service, consumer protection, and industry compliance are to be expected from leading providers. As more institutional investors enter the market and new providers emerge, what should a broker consider before engaging in a life settlement transaction? Here are some questions to ask:

¥ Is the provider institutionally owned and funded?

¥ How long has the provider been doing life settlements?

¥ Is the provider properly licensed in multiple states?

¥ Has the provider ever been rated?

¥ How many employees does the provider have?

¥ Does the provider have immediate access to the investors' capital?

¥ Are funds deposited into an independent institution's escrow account before the seller signs final papers?

¥ Does the seller receive payments within one to three business days?

¥ Does the provider engage in sound business practices?

¥ Is the provider involved in any state insurance department complaints or legal action or has it been involved?

¥ Does the provider have an in-house legal and compliance department?

¥ Does the provider strive to protect all parties in the transaction?

¥ Are HIPAA compliant forms required and procedures followed?

¥ Is E&O coverage provided to brokers?

¥ Which life expectancy pricing model is used to determine offers?

¥ Does the provider use due diligence, anti-fraud, and consumer privacy measures?

¥ Does the provider offer a rescission period and escrow services even in states where they are not required?

¥ Is beneficiary approval required?

¥ How is mortality verified and by whom?

¥ Is the provider committed to supporting industry associations and organizations?

¥ Does the provider offer educational outreach?

¥ Does the provider offer program management including portfolio servicing?

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Gordon Taylor is chief financial officer and chief operating officer for Maple Life Financial, based in Bethesda, Md. You can reach Gordon at 301-951-2151 or gtaylor@maplelf.com.