Suddenly, a host of products allowing accredited individuals to invest in life settlements is coming to market. Since Day One, which only dawned this decade, the booming market where insureds sell unwanted policies has been dominated by institutional and foreign money. Wealthy individuals had limited access. Now that is changing.

Investing in life settlements could be attractive to far more of your client base than selling a contract is, says Curtis Cole, president of a Dallas field marketing organization for Life Partners Holdings Inc., a public U.S. company that has quietly been offering accredited individuals direct investments in life policies for years. "Selling requires clients in their 70s with compromised health who don't want their policies," says Cole, whose FMO is New Asset Advisors. But as an investment, life settlements' advantages offer broad appeal, he says.

The primary one is diversification. Life contracts could be The Next Big Non-Correlated Asset. Their cash flow-namely, death benefit proceeds-is driven by mortality, not whatever's going on with global financial markets. (A cataclysm that causes carriers to fold in lieu of paying off is excepted, of course.)  Moreover, those who tout life settlements tell investors to expect double-digit returns, even if the market is so young that little actual return data exists.

But with potential reward lies risk. Investing in life policies might appear safe: You buy the policy at a discount and collect the face amount when the insured dies. That will happen, right? Yet, "it is possible to lose money," says Glenn Daily, a fee-only insurance consultant in New York City and operator of www.WhatsMyPolicyWorth.com, a life settlement evaluation service for policyowners.

A Beginner's Guide To Investing In Life Settlements
Ignoring for now the logistics of actually acquiring policies, suppose your client wishes to buy and hold until policy maturity (read: death of the insured). In order to collect at death, the investor must pay the policy premiums until the insured dies. An insured who lives beyond her estimated life expectancy thus drives up the investment's cost late in the game, potentially to the point of equaling or exceeding the death benefit. Did someone say, "Upside-down?"

Investors hoping to profit from changes in policies' market values face other risks, Daily says. Several variables affect a contract's worth in the marketplace. Some are systemic-that is, they inure indiscriminately to the entire life settlement market, or large swaths of it. Thus, they cannot be diversified away.

For instance, changes in interest rates. Like any asset, a life contract is valued by discounting its cash flows at the investor's required rate of return for the investment. When interest rates rise, investors' required returns likewise increase, and discounting at a higher rate lowers policy valuations, QED.

A change in how Fasano and the other life-expectancy appraisal firms estimate insureds' longevity could also cause the marketplace to reprice policies en masse, Daily points out. "Your policy loses value if a change in methodology lengthens life-expectancy estimates across-the-board," he says, adding, "We don't yet have much empirical data on life settlement mortality rates."

Still another way to lose is if capital flows to the market diminish or completely evaporate and demand for policies falls. Wall Street's woes have trickled into this cranny of financial services, according to attorney Jonathan Forster, who represents players from end-to-end of the life settlements industry as chair of Greenberg Traurig, LLP's wealth management practice and co-chair of life insurance. "The institutions have pulled back a bit. But there's also a lot of cash on the sidelines," Forster knows.

Next comes regulatory risk. Historically, policyowners were prevented from selling their contracts within two years of issuance because of the contestability period.  A model act proposed by the National Association of Insurance Commissioners and supported by the insurance industry aims to increase the no-sell period to five years. Chicago attorney Scott J. Bakal, a partner in Neal Gerber Eisenberg's Private Wealth Services Practice Group who represents policyowners and insurance brokers as well as investors in life contracts, says, "If you purchase a policy in a state that subsequently adopts the NAIC five-year lock-up model, it will be very hard to sell that policy during the first five years" after issuance.

But that may not be a major concern, at least for now. Earlier this year a tide of bills containing the five-year rule swept into statehouses across the land. Few became law. Forster says, "The NAIC model has largely met with resistance from the states, and the important ones-New York, California, Florida-all have refused to pass it, seemingly because they believe it is anti-consumer and solely for carrier benefit." Then again, legislatures reconfigured by this fall's elections could harbor different sentiments next year.

At least one other risk to consider is how the policy was originated and funded. Bakal says, "The market is discriminating against policies that weren't originated by the insured herself. They are worth less in the marketplace, if you can sell them at all." This includes contracts purchased with 100% non-recourse financing and in so-called "beneficial interest" deals, where individuals bought insurance through trusts and then immediately assigned their trust interests to investor groups.

Policies originated in these and other ways that insurers view as inappropriate bear rescission risk-the possibility that the carrier may refuse to honor the death claim. This is real. Lawsuits are in full swing. "The carriers are arguing there was not an insurable interest at the time the policy was originated," Bakal explains.

Forster adds, "The lawsuits are complicated and often involve many parties. The investors may only get back the premiums they paid-in other words, their initial investment with little or no interest-or they might get their premiums minus the commissions paid to the agent who sold the policy to the insured."
Investment Management Needs And Product Attributes

As products debut, expect little liquidity and high minimums. High fees, probably, too. Advisors of clients who are nevertheless game to play will have to determine how the various ways to invest-via funds, by acquiring individual policies such as with the Life Partners program, or through new-breed products like the much-anticipated Legacy Loan (see sidebar)-address important investment-management concerns.

Take achieving diversification. It requires harnessing the law of large numbers. In contrast to a portfolio of domestic equities, where perhaps 20 carefully selected stocks can provide adequate diversification, "you would need to invest in significantly more than 100 policies, depending on the insureds' age ranges and medical conditions, in order to expect to receive some death benefits in the near future," says Kiri Parankirinathan, president of Life Product Developers Inc., an insurance product manufacturer and actuarial consultancy with clients that include life settlement funders and financiers.

After policies are acquired, premiums have to be paid, claims for death benefits filed, and other administrative duties handled. Of course, who will maintain the contracts becomes an issue only after you've acquired them, which itself is quite the challenge.

"Successful institutional investors reject more than 90% to 95% of the policies they are presented," Parankirinathan notes. Finding the number and amount that's necessary for diversification after the wheat has been separated from the chaff requires access to a policy flow that is diverse, high-quality and substantial.

A critical part of investment selection is paying the right price. Policy valuation hinges on many factors-many more than we've discussed. Buyers of policies have to know how to account for all of them.

Investors who acquire policies directly, according to Bakal, "should work with a very sophisticated insurance advisor who can accurately value contracts using the (actuarially-based) Milliman pricing model." The insurance advisor also needs to be able to ascertain how the policy was originated, to mitigate your rescission risk, Bakal says.

Just Some Of What's Out There
The conventional wisdom is that for accredited individuals, investing in life settlements is best accomplished through a pooled or packaged structure.  That makes the direct investments available from Life Partners Holdings, Inc. all the more intriguing.

The Texas-based life settlement provider offers fractionalized, undivided interests in specific contracts that it buys - 10% of the Jones policy, for instance.  The minimum investment is $50,000, although as little as $10,000 may be put in any one policy, says Tim Harper,  head of BG&S Management Consultants in Grapevine, Texas, a field marketing organization for Life Partners.  The contracts are discounted to a mid-teen target return and are managed for the investor after acquisition.  A third-party escrow agent handles the money.

If someone else is buying the contracts-a fund manager, say-dig into the assumptions being used. For one thing, there is a feeling that some purchasers are being too aggressive with their mortality assumptions in order to project higher returns. Further, you could discover variability in buyers' levels of expertise.

"Investors should be asking managers a lot of technical questions to make sure they know what they are doing," says Daily, the Manhattan insurance consultant. He typically works the sell-side of the biz and frankly, he's a little taken aback by some of what he's seen across the table.

"Some funders cannot model exotic features such as return-of-premium riders and no-lapse guarantees, and therefore they don't factor those into the purchase price," Daily says. "In a sense, that creates opportunities on the buy-side because it means policies with those features are actually worth more than the market thinks and can be picked up at bargain prices."

Eventually such inefficiencies will be wrung out of this still-developing market. As it becomes more rationalized and commoditized, Forster predicts investors will enjoy greater certainty and transparency. But the investment returns? "They will likely be lower," he says.   

Another unique offering is the new Legacy Loan.  It allows policy owners to raise cash by borrowing against their life insurance, rather than selling it.  The loans are then packaged and sold to institutions including hedge funds that accept accredited high-net-worth investors. For more information, visit www.LegacyLoan.com.