Establishing the correct methodology in estimating gross market return is a common discussion for the life settlements asset class. The science around medical underwriting continues to evolve in the dynamic environment of human longevity. The discussion around appropriate methodologies for uniform financial analysis is timely, post GFC environment. Given the lack of suitable robust analysis was the root of many a financial failure.
The recently published ELSA paper on estimating gross returns is another refreshing step in the right direction of bringing uniformity of methodologies and expectations in assessing the emerging Life Settlement Asset class.
It correctly brings into focus the disciplines of uniform medical underwriting and uniform methodologies of financial analysis. These assists investors (and Managers) in making more informed decisions in the crucial decision process of allocating capital to asset purchases.
However, you can have the finest underwriting and the best return analysis tools but unless you have the skills to select the best policies these will be wasted.
Essential in Estimating Gross Market Return
Disappointingly, the paper did not address the missing “Third Leg”. This is the application of correct policy data in any calculation. This is of paramount importance in the life settlement asset class. Unlike a bond or stock price analysis the information for input into the analysis calculation is not uniform or generic. In fact, every new life policy you pick up to analyse will potentially have features and data idiosyncratic to that case alone. Even when potentially comparing different policies on the same insured life and issued by the same insurance company.
Whilst the example cited in the case study uses data from the real world and this is admirable, it makes two tellingly simplistic assumptions;
- That all policies in the market with the stated characteristics (Age, Gender, Smoking Status, LE, Policy Type,) will have the same average premiums, and
- Therefore, in some cases, the same Assumed Purchase price.
An uninformed investor may mistakenly draw these two conclusions.
Now for the purpose of a simplistic financial comparison exercise, it may well be appropriate to make these basic comparisons.
However, this should not be the case in a practical acquisition. Accordingly, an investor (or Manager) should be careful to assess purchases on each policy’s individual merits and not on a generic portfolio basis. Hedge Funds have acquired portfolios at apparently bargain-basement rates only to find that large sections of the assets are worthless. Many of these portfolios are IRR negative or will do so in a very short space of time.
These factors also go a long way to explain why the “Synthetic” longevity products never really became popular. They missed so many of the value opportunities in the physical market quite apart from the usual synthetics issues of credit concentration, opaque fees, lack of liquidity etc.
Why Would Price Be Different?
Here are seven reasons (and the list is not exhaustive) why the price you pay for one policy of identical Age, Gender, Smoking Status, Life Expectancy and Policy Type could be justifiably quite different to another.
- Prices in the Secondary Market can differ from the Tertiary Market. Reasons include differing sophistication of the counterparties, Anti-Selection Bias in the underwriting, Size and Number of bidders in the market at sale.
- Policy Size: It is well established that larger face value policies often attract fewer bidders. Hence, this lessens the ability to bid up the price through competition.
- Policy Documentation and Wording (ie Rider Clauses or Contract type) A policy with a “No Lapse Guarantee” clause will price differently to one without. Some Policies have Escalating or De-Escalating Benefit clauses over time. Joint Life Policies will price differently to single life policies and even two Joint life policies may price differently. It will depend on the approach to LE Calculation applied to the two lives.
- Premium Optimisation Calculations: Has the forward premium stream been optimised? What methodology? A short term holder (Trader) may use different optimisation targets to a long term holder.
- Policy Metrics: Some policies simply have stronger metrics than others and therefore (in theory) should command a higher price.
- Carrier Risks: Some insurance carriers have more risks around potential claim challenges and premium hikes than others. Accordingly, these policies should be bid down.
- Legal Risks: Some policies have significant risks attached to them around how they were originated or sold in the first instance. Investors should attempt to account for these risks in any pricing methodology. Or, simply avoid them if their appetite for risk is breached.
Simplistic Comparison is not Recommended
One final point as to why we believe simplistic comparisons on pricing (and hence attempts to somehow Index the Life Settlement Market) are fraught with danger.
Life Settlements are a US-based, denominated and regulated asset class and hence it is not unreasonable to look to US accounting practices and standards for guidance in the general handling of the asset class. Under US GAAP accounting principles there is a three-level hierarchy for assessing “Fair Value” in an orderly transaction. Tier One uses quoted prices in active markets for identical assets or liabilities for comparison. Tiers two and three use valuation techniques and data inputs some of which is directly observable and some not. Tier three is where the amount of directly observable market data is less than the unobservable content.
Life Settlement Portfolios are typically valued under Tier 3 guidelines. Hence they are clearly not identical securities trading in deep observable markets. Hence benchmark comparisons are problematic without understanding the underlying assets and the validity of comparisons. “Apples with Apples!”
Is this, therefore, a bad thing?
Emphatically the answer is no! Life Settlements are one of the few genuinely uncorrelated assets for precisely these reasons. The value opportunities presented by this market are compelling as well as the opportunity to further diversify a larger asset allocation.
Mercer rightly pointed out;
“One of the fallouts of the global financial crisis was the realisation that many of the more traditional alternative, such as hedge fund of funds, asset classes failed to provide adequate portfolio diversification. We believe investors should continue to investigate the use of investments such as life settlements to gain exposure to real alternative risk premia.”
“Insurance Linked Strategies: Life Settlements”- Mercer April 2010
If you wish to learn the best process for purchasing and valuing techniques which may affect your life settlements investment, we would be more than happy to outline the best approach to suit your needs.
As always we wish you well with your life settlement investment opportunities and if you want to learn more about investing in this asset class please contact us.
About Global Insurance Settlements Funds PLC (GISF)
Global Insurance Settlements Funds PLC (GISF) is an umbrella type investment company with segregated liability between sub-funds. The fund is incorporated in Ireland. The first sub-fund launched GIS General Fund (the Fund). It is listed on the Irish Stock Exchange.
This structure is aimed at Sophisticated / Institutional investors. Additionally, it provides tax clarity by ensuring there is no tax leakage. It enables a number of different investment options to suit the specific needs of our investors.
The Fund’s core activity is to actively manage a large and diverse portfolio of life insurance policies (life settlements). The Board of GISF selects those that best meet the Fund’s policy purchase criteria.
This information is intended for qualifying investors only. It was correct at the time of preparation. It has been prepared to provide general information only and should not be considered as a “securities recommendation” or an “invitation to invest” in any jurisdiction. Potential investors should consider the relevance of this information to their particular circumstances. Before proceeding, investors must obtain the prospectus and take their own legal and taxation advice. If you acquire or hold one of our products we will receive fees and other benefits as disclosed in the prospectus and relevant offering documents.