The longer the seller lives, the less that investors will make
Kate Hughes looks at 'death futures', the funds that seek a profit on the policies of the terminally ill
Sunday 17 August 2008
For most of us, our investments are simply a series of numbers. We're happy if they go up and unhappy if they go down, and we don't have much regard for the underlying activities that produce these effects. But when it comes to one investment vehicle, dubbed the "holy grail" due to its gold-star performance, exactly how your cash is generated is hard to ignore. "Death futures", more palatably known as life settlements, in effect make or lose money by betting on how long a person will live.
The idea is that life insurance holders, usually terminal ill, no longer have a use for that policy. They wish to use the cash, often for medical expenses, but the surrender value of the cover is tiny. So instead a third party buys the policy from the holder and continues to pay the premium.
The individual gets a lump sum, determined by their life expectancy, and the buyer holds on to the policy until that person dies, at which point is is cashed in.
The profit is made when the new holder gets more from the policy payout than the combination of the purchase price and the premiums. So to put it bluntly, the sooner the original policyholder dies, the bigger the return. If they survive beyond their life expectancy, the investor could lose out.
The moral question is huge, but a recent review of life settlements by the Pensions Institute suggests the deal can work for policyholders as they get hands on cash when they most need it. The institute adds that the option of being able to sell on a life policy when a terminal illness is diagnosed may actually encourage more people to take out life insurance.
"If a holder is going to surrender the policy anyway and gets a better deal from the sale, then everybody wins," says George Groves, of First Choice Insurance Consultants.
But bear in mind that any sale will rarely be worth a significant proportion of the cover – which will otherwise go, in full, to the policyholder's beneficiaries.
This morbid investment opportunity started in the US, and although UK investors now have access to the market, the underlying policy sales take place exclusively in the US and are regulated on a state rather than national level. The level of regulation varies from state to state, which means the original policyholders are not offered consistent protection when they decide to sell, regardless of how much or how little they agree to accept for parting with the cover.
Independent research carried out in the US suggests policyholders generally receive around a quarter to a third of the cover's value, though this can be higher or lower depending on life expectancy.
For the investor, the profits appear impressive, particularly in a challenging economic period. "Life settlement funds like the one managed by EEA have returns of 16 per cent a year," says Mr Groves. "And because you are betting on life expectancy, there is low volatility and low risk. The funds usually only deal with those with short life expec- tancies as the predictions are usually more accurate."
"We invest in policies with life expectancies of up to a maximum of eight years, but the average is around three," says Peter Winders, director of EEA Life Settlements. "This means our life forecasts are far more reliable and our returns are better. With this type of investment, you know exactly what you are getting. It is just a case of knowing when."
Mr Groves recommends buying into the funds. "Private investors are desperate to diversify away from shares because of the current market," he explains. "Life settlements are an attractive alternative because they are not heavily linked to other sectors, so when one sector goes down, your death futures investment should not be significantly affected."
"There is no doubt these funds have done very well recently," says Danny Cox of independent financial adviser Hargreaves Lansdown. "But it seems a little too good to be true. Life settlements make me nervous. I want to know what the catch is. The question is whether the investor will continue to see these returns, or will it go to the market-makers doing the trading? If you are keen, only invest small amounts in death futures."
And, Mr Cox warns, investing in life settlements can be expensive. "Buying and selling these policies is not cheap because of things like medical check-ups on the person selling the policy. EEA, for example, charges investors 1.5 per cent in management fees and a huge 75 per cent performance fee on anything over 8 per cent a year."
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