Life Settlements: A Premier Uncorrelated Asset Class

“Uncorrelated alternative investment with low volatility and predictable returns”

For investors seeking an uncorrelated alternative investment with low volatility and predictable returns, there are few investments that deliver on this profile as well as life settlements.


Life settlements are an investment vehicle where investors purchase life insurance policies on seniors with a life expectancy of 3 to 15 years for an amount higher than cash surrender value and less than the policy face amount.


HISTORY

  • 1980’s AIDS crisis: The life settlement industry was born in the 1980’s AIDS crisis, as afflicted individuals sold their life insurance policies for cash to pay for medical bills and enhance their final days. As AIDS treatments improved, the industry then focused on old-age mortality.

  • 1990's–2000's: Major Wall Street firms such as Goldman Sachs, Credit Suisse, Deutsche Bank, Berkshire Hathaway, and AIG discovered the non-correlated nature of life settlements, along with healthy gross returns in the 14%-18% range.

  • Increasing regulations in licensing: The industry became regulated in the majority of states, where licensing of life settlement brokers and providers became mandatory, along with the transparency of the entire process and fee structure.


WHY SHOULD AN INVESTOR INVEST IN LIFE SETTLEMENTS?


Pros:

  • Uncorrelated Returns: Life Settlements give a yield bump in an alternative asset class that is not correlated to stocks, bonds, currencies, interest rates, etc. - a risk that is not correlated with other markets because the value of an investment in life settlements depends on life expectancies of the policyholders. While short life expectancies create the expectation of a high return on investment, long life expectancies do the opposite.

  • Low Volatility: Volatility in life settlements is impacted by the size of the policy, pricing, life expectancy, and premium schedule and not traditional macroeconomic factors. The biggest factors are the size of the policy and life expectancy estimates. Therefore, because the underlying assets of a life settlement investment fund are life insurance contracts and life expectancy is generally a more stable rate than others, the fund has low volatility compared to other financial markets.

  • Diversification: Due to the uncorrelated returns as an alternative asset class, life settlements diversify investors’ portfolios, therefore reducing beta.


Cons:

  • Long Holding Period: Since life settlements have a typical holding period of 7-10 years, investments in life settlements have a higher than average lock-up period than other asset classes. Investors need to consider a long-term plan when making such investments.

  • No Recycling of Capital: Some fund structures pay maturities as they occur, and there is no recycling of capital.


MARKET SIZE: “The market is large”




LIFE SETTLEMENTS FUNDS



Most of these funds are large and are forced, by their size, to deploy capital principally in the tertiary market (investor to investor) because the secondary market (policyholder to investor) is too small. Larger funds aim for returns based upon the mortality curve and seek to reduce exposure to any single policy by holding a large group of policies. Instead of carrying risk to any particular policy, they have the risk that changes to the mortality tables adjust the mortality curve the wrong way, in which case the prices of all their policies are affected. Historically, changes to the mortality tables have always extended life expectancies rather than shorten them (thereby reducing prices) and all the big funds rely upon the same mortality tables to price their assets.


We believe that funds should not try to hit the mortality curve, but to beat them.


RETURNS OF INVESTMENTS

  • The typical life settlement affords the buyer with a 10% - 14% gross IRR. Net returns to investors’ expectations of 10% are realistic. Importantly, the rate of return is wholly contingent on people dying on time. Best practices require a life settlement “pool” of at least 400 policies so that the actual results track the expected mortality curve, and volatility is reduced.

  • The typical lock-up period of 7 – 10 years.

  • Backed by the benefit value of the life insurance policies, which are underwritten by the A+ credit ratings of the writing life insurance companies.


Illiquidity Premia: Holding Periods and Annualized Net Returns Profiles (Illustrative)




TYPES OF LIFE SETTLEMENTS

Types of Life Settlements:

  • Viatical Settlements: a situation where the insured has a life expectancy of <2 years

  • Life Settlements: a situation where the insured has a life expectancy of <20 years

Transactions of Life Settlements:

  • Direct Purchases: require a large outlay of cash with the expertise to buy the right policies

  • Direct Fractional: larger policies are divided into smaller portions and sold individually to investors

  • Life Settlements PE Fund: involves purchases of portions of a fund comprised of hundreds of policies


FUND STRUCTURES

  1. Hedge Fund Structure

  2. Private Equity Fund Structure

  3. Hybrid Structure: a mix of Hedge Fund and Private Equity Structure

  4. Debt Structure:

  • Payout a variable coupon based on returns

  • Payout a yearly/quarterly fixed coupon after some time

  • Payout a yearly/quarterly coupon at the end


TYPES OF PLAYERS


Sell-Side:

  • Policyholder: The life insurance policyholder has a policy he/she would like to sell as a life settlement, and obtain the highest bid possible in the market.

  • Life Settlement Broker: Life Settlement Brokers are licensed and regulated by the states. The brokers represent the policyholders and hold auctions with institutional buyers in order to obtain the highest bids for their clients. Life Settlement brokers collect medical records, prescription drug history, life expectancy reports, copies of the life insurance policy, and perform dozens of process-driven tasks in order to compile a complete life settlement package that is ready for auction. There are approximately 20-30 life settlement brokers nationwide representing the majority of policyholders who are seeking life settlements.

Buy-Side:

  • Life Settlement Provider: Life Settlement Providers represent the institutional funds and large private investors who are seeking to purchase life settlements from policyholders. Providers, like their broker counterparts, are state-licensed and regulated entities. Providers bid competitively to win their bids on behalf of the funds they represent and then help the funds complete the transaction by transferring ownership from seller to buyer.

  • Institutional Funds: There are many institutional buyers of life insurance policies in the secondary market for their own portfolios, including banks, hedge funds, private equity funds, pensions, foundations, endowments, and single/multi-family offices.


EXAMPLE


A male aged 77, with a life expectancy of 8 years based on his current and historical medical conditions, owns a Universal Life insurance policy with a $1 million death benefit. Because he no longer needs, wants, or can afford the policy, he understands that he can sell the policy in the secondary market instead of lapsing or surrendering the policy back to the insurance carrier for little or no cash. He contacts a licensed life settlement broker, who holds an auction on behalf of the insured with a life settlement Provider, also a licensed entity that represents institutional investment funds that purchase life settlements for their investment vehicles.

The Broker and Provider agree on a price, and the insured receives a lump-sum cash payment of $225,000, and the fund that purchased the policy becomes the owner and beneficiary of the policy. The fund then pays the policy premium until the death of the insured, when the fund receives the $1 million death benefit.

Institutional buyers pool thousands of these policies, with the goal of having the actual mortality results track the expected mortality curve. Life Settlement pools are non-correlated to the general markets, provide low-volatility, predictable returns, and are most typically held in a passive “buy-and-hold” strategy. The fund purchases pools of these policies at an average projected gross internal rate of return (IRR) of 13% - 15%.



Special Thanks to our Contributor

RiverRock Funds, LLC

RiverRock is a dedicated life settlements investment manager with over ten years of experience managing pooled investment funds investing in the secondary and tertiary markets for life insurance policies.


Áine O Cronin

Director of Investor Relations

Office: +1 737.881.7590

Mobile: +1 603.953.6340

acronin@riverrockfunds.com

www.riverrockfunds.com



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