A Trade Mission designed to bring together the life settlement industry with institutional investors examining the idea of entering the market brought its message here on February 25.

That message was one of optimism for the asset class tempered by a realization that work still needs to be done to instill investor confidence in a product that offers solid returns but is also in the process of putting past problems behind it, according to speakers of the Mission which is jointly sponsored by the Life Insurance Settlement Association, Orlando, Fla., and the European Life Settlement Association, London.

Life settlements are one of the best investment opportunities in the last two decades, according to Jose Garcia, chief executive officer of Carlisle Management Company. Garcia noted that life settlements offer a great opportunity and Luxembourg’s flexible regulatory and tax environment offer a great place to enter the market. Luxembourg, he continued, manages over two trillion Euros in investments.

From a risk and return perspective determined by the Sharpe ratio, a ratio of three offers four times the benefit of the market, according to Jeff Mulholland, a consultant with Fasano Associates. The Sharpe ratio uses standard deviation to determine risk-adjusted return. It is a cheap, relatively stable, uncorrelated asset, he added.

Brian Casey, a partner with Locke Lord Bissell & Liddell LLP, said that there are signs of interest from pension funds and private equity firms are calling asking for information about life settlements. The interest in life settlements should be no surprise, he added, because it is simply a broader transference of insurance risk to capital markets similar to life insurers securitizing books of business through reinsurance and property-casualty companies reducing risk through catastrophe bonds.

Indeed, during the dialogue, a fund of funds manager was in the audience learning about the product. What he and other attendees heard was that the product is complex and due diligence is a must.

Perhaps the most basic reason is that life settlements are generally large assets, according to Andrew Murphy, chief operating officer of Mosaic. “I highly recommend investors do their due diligence. We don’t sell $10 widgets.” These are large assets that are often equal in size to the purchase of a home, he continued.

The case for performing due diligence is reflected in the fact that if mortality projections are too short, the buyer overpays and if they are too long, the sellers do not get what they should for their policies, according to Roger Tafoya, executive vice president and chief underwriter with ISC Services.

Several other speakers described how due diligence can be performed.

Michael Fasano, president of Fasano Associates, discussed underwriting risk, noting that it is important to use mortality tables based on data that is similar to the life settlement industry. So, for instance, Medicare databases do not have mortality data that is similar enough to life settlements, he said.

And, even with life insurance mortality tables, there is a difference in income and lapsation as well as face amounts of policies which on average are between $1-2 million for life settlements, higher than in the life insurance market, he noted. Life settlement mortality is lower and insureds in this market generally have higher income levels, Fasano added.

Life settlement underwriting is more complicated than life insurance underwriting, he  said because life insurance is often purchased by younger and healthier consumers while the life settlement space is populated by older people who may have different impairments that move at different speeds.

Fasano said that there should be a dialogue between the client and an LE firm because there can often be significant differences between LE providers. So, a client should talk with LE providers, even outliers, because the investor may come to the conclusion that the outliers are correct.

Mullholland said that the conservative approach is to throw out the extremes but he would advocate for finding out why those extremes exist. The client should always be provided with all LEs, he added. “It is important to have that look [at all LEs] because investors should no longer leave it to providers.”

Meir Eliav, president of Legacy Benefits LLC, discussed a number of considerations that should be taken into account before purchasing a life settlement. Among those considerations are ensuring that there will not be a contestability challenge and that there is an insurable interest as well as questioning how financing is done so that the policy is not a stranger-originated life insurance (STOLI) contract. If the policy is financed, the investor should make sure that the insured has a financial responsibility.

And, Eliav continued, there should be a check of medical records and other information submitted to ensure that there is not fraud. “It is very important to conduct extensive due diligence with a broker or agent to make sure that you are not dealing with someone who is involved in something that is not desirable.”

And, Eliav added, fee disclosure is very important. Although it is not always required by states in the United States, it is a practice most life settlement providers have adopted and one that goes a long way to making a transaction transparent, he said.

The investor needs to do due diligence on the provider to make sure that there is an acquisition of clean collateral and that there is transparency in both fee structures and any information about the policy, according to Brian Smith, CEO of Life Equity, LLC. That due diligence is necessary on each policy, he added. “In this marketplace there is not a lot you don’t want to buy but you want to make sure that you find out which ones you don’t want; you want to make sure you use forms in place in each of the states; and have providers who operate in most states.”

Source: Jim Connolly, Life Settlement Review from Luxembourg

When an official from the Financial Services Authority, London, spoke before the life settlement industry on February 24, he raised the issue of investor safeguards that the FSA would like to see in place, echoing efforts to strengthen the life settlement market which had been discussed in earlier panel sessions during the Life Settlement Trade Mission here.

Peter Smith, the FSA’s head of investment-the policy department, cited concerns that included product design, the mitigation of risk and offering well developed products with properly detailed risks.

Prior to Smith’s luncheon discussion, executives in the life settlement industry participated in several panel discussions on how to make the industry better by strengthening areas including  education and transparency.

The panel sessions are part of the four day Trade Mission effort to reach European investors in London, Luxembourg and Zurich from Feb. 23-26. The Trade Mission is being jointly sponsored by the Life Insurance Settlement Association, Orlando, Fla., and the European Life Settlement Association, London.

Simon Erritt, a managing director with Coventry, cited three guiding principles during a panel on best practices to help ensure understanding of the product: education, transparency and objectivity. Education, he says, should be both for potential sellers as well as investors, both current and potential. That education should include information about changes in law, the value of investment and any other points that will help make the market more transparent, Erritt, continued. He also urged investors to take the time to learn about the market and its risks, or to find a trustworthy representative to help ensure that there is an understanding.

Both Scott Gibson, a vice president with Lewis & Ellis Actuaries & Consultants and Bryan Freeman, president of Habersham Funding, LLC, said that life settlement companies are not doing anything differently than life insurers who sell annuities and government and pension plans which benefits from earlier deaths.

Brian Smith, CEO of Life Equity LLC, discussed ways to mitigate origination risk and, thus, help strengthen the industry’s perception. He said, for instance, that it is important to understand who the provider by conducting due diligence on that provider. If a provider is only licensed in one or two states that should be a flag, according to Smith. For a better understanding of providers, Smith also suggested that sources may be banks that operate as trustees and LE underwriters.

And, Ian Cotgias, a senior actuary with SL Investment Management, cited the importance of maintaining sufficient liquidity in a portfolio and added that the way liquidity is maintained also needs to be thought through. For instance, he noted that if a bank facility is being used, there is always the risk that the terms may be changed or the facility withdrawn.

Larry Simon, president and CEO of Life Solutions International, said that with securitizations around the corner, it is important to ensure the quality of originations. If quality can be ensured, then securitization can be a steady source of funds, he added. Simon said that to properly securitize a portfolio it is probably necessary to have 300-400 policies at a minimum and that the diversity of carriers and their ratings are also important.

Choosing partners is key, according to Steven Shapiro, president and CEO of Q Capital Strategies, LLC. “Over the years, I have seen that not all origination is created equally.” He added, that one can’t underestimate due diligence done on a policy by policy basis. For instance, he said if an agent presents three policies in a row, it would be worth picking up a phone and finding out what is going on. He also recommended working with licensed providers.

The lack of transparency that occurred in the early years of the industry is being replaced with better information for the investor and better sales practices, according to Mark Goode, CEO of Secondary Life Capital. It was not a failure of an asset class but a failure of a structure in which fractionalized policies were sold, he continued.

Source: Jim Connolly, Life Settlement Review

Q Capital Strategies, LLC has been accepted as a member of the Bundesverband Vermögensanlagen im Zweitmarkt Lebensversicherungen e.V. (BVZL).  BVZL, based in Munich, Germany, is a life settlement trade association focused on protecting investors’ interests in the secondary market for life insurance policies.   BVZL’s primary objects are developing branch standards for transparency and comparability of the various investment segments (British, German and American life insurance policies) and improving investor and consumer protection in Germany.  The BVZL serves as a uniform representation of economic, legal and political interests for initiators, service providers and investors engaged in the secondary market for life insurance policies.

Q Capital’s President and CEO, Steven Shapiro, commented, “the market for life settlements continues to grow internationally, particularly in Europe, and we believe the BVZL has the right mission and audience to advance the burgeoning marketplace.  Q Capital looks for new ways to reach the global investors in life settlements, and by joining BVZL, we hope to help educate European investors on the opportunity that exists in life settlements.  We are honored to be joining such a fine association.”

A major initiative to create a dialogue between American and European investors launched today with the start of the Life Settlement Trade Mission here.
At the start of the weeklong Mission which will reach out to investors in London, Luxembourg and Zurich, 150 attendees listened to experts in the industry address some major issues that ranging from the growth of the industry to tax issues. The Trade Mission which runs from Feb. 23-26 is being jointly organized by the Life Insurance Settlement Association, Orlando, Fla., and the European Life Settlement Association, London.
Doug Head, LISA’s executive director, greeted well over 100 European investors and 38 attendees of the mission by noting how far the life settlement industry has come. LISA’s Head kicked off the first day of dialogue by noting that the life settlement market is much better regulated today with 34 states including large states such as California, Illinois and New York regulating the market. There are greater stability, regulation and transparency of the life settlement market today than previously, he noted. And, he noted that in the proposed U.S. budget of President Barack Obama, it was estimated that the life settlement market was anticipated to grow by a factor of 10.
Patrick McAdams, an investment director with SL Investment Management, Chester, United Kingdom and the newly elected ELSA chairman, discussed the importance of the investor and how without their capital, the market would not exist. “The investor has been overlooked, and in some cases ignored and taken for granted,” he told attendees. He noted that while there are many large institutional investors, there are also smaller investors who invest between 3,000-5,000 Euros. While the life settlement market is a win for policyholders who are given another option to sell an asset they either can’t afford or do not need anymore, there have been more mixed results for European investors, McAdams added. There needs to be better education and more well informed investors as well as more care paid to whether a life settlement is suitable for an investor, he told the crowd.
Brian Casey, a partner with in the Atlanta office of Locke Lord Bissell & Liddell, said that the industry is in a growth spurt, a teenager that has not yet reached adulthood. In the last five to six years, there has been both investor and product maturity with the growing interest of hedge funds and investment funds which have been key to establishing a healthy tertiary market. Pension funds, he continues, are trying to “crack the nut” with some interest from state and labor union pension funds. And a couple of private equity firms have expressed an interest to receive basic information about the life settlement market, according to Casey.
Casey spoke of the different ways in which life settlement products are being developed, from the use of synthetic life settlements to talk of using life settlements for collateralized bonds. He said that the industry needs “fair regulation and not overregulation and called for an effort to get the STOLI (stranger-originated life insurance) issue on the table. “To me [STOLI] is nothing more than a violation of insurable interest from the get-go.” He said that STOLI doesn’t help anyone in the life settlement market and that what will help is the greater transparency which the industry is starting to see.
Michael Crane, managing director-capital markets, with Coventry’s London office, said that life settlements offer benefits to potential investors including a lack of correlation with other assets for an attractive return both on an absolute and relative basis that can run in the low to mid-teens. And, if in a pool of life settlements, volatility can be low, he told Mission attendees. While life settlements are an attractive investment, he cautioned attendees against fractionalized policies, noting that larger pools of 200-300 policies reduces risks such as concentration and risks from certain impairments as well as risks from certain physical impairments.
Other speakers offered input on what it takes to move the industry from being a teenager to adulthood. Michael Fugler, head of global capital markets with Welcome Life Financial Group, LLC, noted that in with the complex issues such as the threat of STOLI, life settlement companies need to use technology.

“Companies need technology to manage [their businesses] or they will die.”
And, Mark Todd, senior vice president of capital markets with Maple Life, noted the importance of examining everything that is being done in your behalf because “you don’t want a 60 Minutes experience.” He noted that in the U.S. the life settlement market is highly regulated. He described a market conduct review conducted by Florida Insurance Commissioner Kevin McCarthy’s office noting that the department’s representatives can look at any file and most of Maple Leaf’s files are six to eight inches of paper each. “You as investor should be very happy that they do that. There is no way an investment bank would have two [people] sitting in [an] office unless there was some sort of trouble.”
“We screen everyone in the food chain,” he said. In fact, Todd continued, his firm screens potential sellers in an exit interview between Maple Life and the seller without the representative. “We need to hear and tape the transaction,” he said.
The first day of the Trade Mission also included a discussion of the tax implications of investing in life settlements. Kirk Van Brunt, a partner with Locke Lord Bissell & Liddell LLP, explained to attendees that there are two basic parts to the issue: U.S. withholding taxes and income taxes on businesses. With careful planning and work through countries with U.S. treaties, the tax issue can be minimized, according to Van Brunt.

Withholding taxes became an issue in May 2009 when the IRS issued a ruling which said that death benefit paid outside of the U.S. to non-U.S. investors may be subject to withholding taxes. Unfortunately, he continued, there is no reliable way to convey basis paid to a life insurance company and there is concern that there might be an over withholding. If a transaction is done in a country that does not have a tax treaty with the U.S., there could be a 30% in withholding taxes on the death benefit, he noted.

So, Van Brunt continued, the question becomes “how to get out of the tax trap the IRS put into effect last May.” One option is to work in countries that have treaties while other options include using derivatives, swaps and debt structures to shape the character of death benefits. So, for instance, he continued, debt vehicles that pay out dividend income can be created, although he noted that this is not necessarily easy to achieve.
Andrew Quinn, a partner with A&L Goodbody, said that the limitation on benefits rule is a way for the I.R.S. to protect against non-Irish investors from using Ireland to avoid tax rules. Most countries, according to Quinn, maintain that it is sufficient to be a tax resident but the U.S. goes one step further requiring an LOB test that includes requirements such as an ownership and base erosion test in which it must be proved who is the owner of the Irish company claiming the benefit to avoid the double tax as well as a base erosion test in which the company must prove that it is not paying too much out to those who do not have as good a treaty with the U.S. There is also a derivative benefits test, according to Quinn, which must be satisfied by proving that if an investor is not in a country with a similar treaty with the U.S.
A third way of satisfying the U.S. LOB test, according to Quinn, is to determine if you are a quoted company with regular dealing in shares defined as at least 6% turned over on a yearly basis and a listing on a recognized stock exchange. A fourth test, he continued, is an active trade test which states that if a company is in an active business, then ownership rules can be ignored which in practice can be difficult in the investment business if assets have to be turned over regularly. This rule can be forgiven by applying for a confirmation, Quinn added. But the one benefit of these rules, he noted, is that they are mechanical, so if you can satisfy them you can have access to a treaty.

 Source: JIM CONNOLLY, Managing Editor, Life Settlement Review