Hurdles to overcome before ILS managers embrace life settlements

Life settlements seemingly belong to the insurance-linked investment landscape, meaning that ILS fund managers should be major players in the market, but research into the asset class shows that there are hurdles to overcome before ILS managers invest meaningfully.

The opportunity to invest in a diversified, insurance-linked and largely uncorrelated asset class is something ILS fund managers are typically open to, but to date very few of the insurance-linked securities (ILS) managers have considered investing in life settlements, a survey shows.

Potential for high growth, access to new investors, a low correlation to other asset classes and portfolio diversification are potential benefits the life settlement market could offer to ILS players. However, a recent survey conducted by Christof Meier, a masters student at the University of St. Gallen, underlines several hurdles the sector must overcome if it’s to entice ILS fund management investment.

Meier surveyed 10 ILS funds that together manage roughly $25 billion of assets, most of which is invested in collateralized reinsurance ventures, and of which all the firms already held a good level of knowledge surrounding life settlements as an asset class.

Responses from the survey reveal that it is the reputation of life settlements and the asset class’ performance that are the key concerns for ILS players.

Owing to the nature of the business, which has in the past been unfortunately referred to as betting on death in the mainstream media, Meier said that life settlement market players have gained a reputation of being cowboys with dubious motives. They have also been regarded as unserious and opportunistic, and responses from ILS managers show that this view hasn’t improved much over time for the majority.

The greatest hurdle the market must overcome if it’s serious about attracting ILS managers as investors, according to the 10 ILS fund managers surveyed, is its reputation of historically bad market performance, with potential participants seemingly struggling to see how the return might outweigh the numerous underlining issues.

Beyond its questionable reputation as an asset class regarding performance, market players and the ethical matter of ‘betting on death’, several other hurdles came to light from the survey. Loss of current investors, illiquidity, a long investment horizon, information asymmetry in the market, and the risk that life expectancy estimates are too short, were other concerns expressed by ILS managers.

It certainly isn’t just ILS managers that are aware yet sceptical of the potential benefits but inherent challenges of investing in life settlements, existing ILS end-investors are too. As a result ILS managers voiced a fear that life settlement participation could result in the loss of existing investors from their funds.

Irregularities with information disclosed by the buyers and sellers of life settlement agreements further underlines a perceived lack of transparency in the sector, something that in any industry often results in low investor confidence and heightened scepticism.

Sticking with a lack of transparency, there’s also a concern in the sector with the availability and accuracy of actual to expected life expectancy ratios (A/E-ratio), with most ILS funds citing that improved access and reliability of this data from medical underwriters could make it a more viable investment.

In fact, results from Meier’s survey suggest that future life settlement valuation methods based on market data availability, which would boost pricing accuracy and transparency, and the availability and reliability of market data and improvements with A/E-ratios, are key preconditions the sector must meet for ILS fund managers to consider it an eligible investment.

Furthermore, the asset class lacks standardisation, in the survey respondents eyes, and although responses highlighted a lack of available associations as one of the least important required prerequisites, the need for an established code of practice, via increased self regulation but more notably through an external regulator or auditor, is something ILS managers feel is important to boost confidence in the asset class.

ILS investors also expressed a desire for the life settlements sector to establish a solid tertiary market, but stressed that certainty with pricing is currently more important than this. Again, this links to greater market transparency, and more reliable pricing and a developed tertiary market should serve to mitigate illiquidity concerns.

Education and knowledge of the life settlements landscape is limited compared to other asset classes, perhaps in part due to the unfortunate reputation it has been labelled with and the relatively small market size. However, Meier notes that educating policyholders along with investors is vital to changing industry perception from a bad performing asset class run by market participants perceived as ‘cowboys’, to a reputable, sound insurance-linked investment opportunity.

To further raise the reputation of the asset class’ participants, industry-wide practices need to be introduced, again underlining the importance and necessity of third-party, or improved self-regulation, states the report.

Life settlements are not too dissimilar to the practice of unlocking embedded value in life policies through different types of securitisation transaction, an area some ILS managers do invest. Unfortunately some of the mistakes and bad actors that affected the life settlements space in its formative years have resulted in a lingering perception that it is not as serious as other ILS investments.

Convincing ILS fund managers, which are the natural investors for some life settlement ventures, to invest in the asset class certainly won’t be an easy task and isn’t going to happen overnight.

The perception is changing and there are a number of ILS managers who invest in specific types of structured life settlement transactions already. However, the results of Meier’s survey show that the sector has considerable work to do if it is to attract the rest of the ILS players to invest.