The Traded Endowment Policy Market in the United Kingdom is slowly coming to an end. Changes to taxation of these policies means that investors shied away and coupled with insurance companies writing less of these policies over time, means that what was once a robust secondary life market in the U.K. is no more. Life Risk News spoke to Roger Lawrence, Managing Director of WL Consulting, to learn more about the industry’s demise.
LRN: Roger, 2022 marks the maturity of endowment policies sold in 1997, the final year that these policies were written; it spells the end of a market that dates back to the middle of the 19th century. How have we got here?
RL: Yes, the market dates back to 1843 when auctioneers H E Foster & Cranfield started auctioning pure life risk policies alongside esoterica. This expanded into other assets with an element of life risk, such as will trusts that might have a life tenant, usually a spouse of the deceased, living in a property or receiving an income form an investment portfolio for life before reversion to the children. This developed into the endowment assurance market in the mid-1980s when the levels of new policy origination suddenly boomed in 1983 as a tax-efficient means to repay house purchase mortgages.
A staged reduction in those tax breaks from 1988 through to final abolition in 2000 put paid to all of that. However, as you say, by 1997 the small tax benefits that were left and an increasingly difficult task to generate a positive return spread over mortgage interest costs put paid to policy sales.
At that time most mortgages were for a 25 year term, meaning this year marks a sad moment for me, having worked in the policy trading industry for 27 years. There remain a small population of longer termed policies still to run off and a few small mutuals do continue to offer new policies as savings vehicles but this will never be enough to sustain a Traded Endowment Policy or TEP market going forward. All we have left now is a small mainly intra-fund tertiary market.
LRN: Has the tontine effect occurred in practice as many predicted it would?
RL: The rapid contraction in both the number of open insurance funds over the last 20 years to barely a handful has meant a lot of closures, consolidations and run offs. For many, their endowment business was huge and during the 2000s many commentators were predicting a sort of tontine effect occurring. Insurers carry substantial surpluses, for their own and regulatory purposes and as the liabilities run off the surplus mushrooms as a percentage of the remaining liabilities.
There were a few cases of early fund closures reaching this point, notably Phoenix Assurance, National Employers Liability and Reliance Mutual and in a belated attempt to distribute the surplus, policy payouts were enhanced by two, five and even ten times the basic policy asset share. This was good evidence of a tontine effect in the making. However the UK regulator (the FSA at the time) was becoming much more pro-active and was determined that some of these extreme distortions should not be repeated. Their guidance was for life offices to distribute surplus as evenly and early as practical and this began being implemented in the early 2010s.
Having bought policies before the start of this distribution process would mean secondary policyholders got to enjoy enhancements of 10%-40% equating to a 1%-4%pa kicker to annual returns. If one were to buy a policy around 2010 through to 2012 and maturing 6 or 7 years later, the life offices’ underlying return on assets of 5%pa or so would have been boosted so that TEP investors would be generating 9%pa or more. Against a backdrop of interest rates at near zero and inflation around 2% that would have been pretty good.
LRN: The United States has the life settlement market, and Germany has a traded life policy market. Is there any kind of appetite for something similar to return to the U.K., or do you think that it is the end, at least for the foreseeable future?
RL: Ironically our retail investment arm is experiencing record interest from investors scratching around looking for alpha just at a time when there is nothing to satisfy them. For insurance, there has always been a very small market in Whole of Life policies, very much on the same terms as the US market. Lives assured need to be elderly, typically 75+, or need to be viatical cases with a doctor certified terminal disease in order to attract investors. Investors themselves tend to be retail because the market size is far too small to attract institutional money.
Otherwise, we have pretty much reached the end game over here. For pure life risk, the UK is very under-insured compared to the US and most cover tends to be term which carries a lot more investor risk. Many of the larger Whole of Life policies were established for estate planning for the landed gentry but increasingly these families are setting up family offices and using decreasing term assurance to top up the build-up of their own asset pools.
Regulatory aversion to insurance concepts like guarantees which require such substantial levels of capital is making issuance of new products unattractively expensive. Regulatory requirements for insurers not to charge penalties to customers for breaking long term contracts has removed most of the margin for secondary market arbitrage and you can see the UK is a difficult place for secondary markets to operate. In Germany, by contrast, there remains a margin in which to operate, though not through surrender penalties but through mitigatable tax penalties. Even there, the reductions in guaranteed interest rates on new products is going to be a market constricting factor moving forward.
LRN: Are there any other opportunities for investors to access U.K.-based longevity risk secondary market investments? If so, what are they and how attractive (or not) are they when compared to the TEP market in its heyday?
RL: Who knows what the further future may bring. Increasingly complex taxation may open doors. But in the here and now, the UK longevity markets are fairly confined to pension annuity risk, which is set to become bigger than ever, and equity release products. However, regulatory caution is unlikely to allow these markets to spill over into the retail investment sector as the TEP market once did. It may be conceptually possible to package equity release mortgages into a collective and sell that on to fund managers seeking diversification. Annuity business is currently all about the reinsurance market as investor, but for capacity’s sake that must spread to capital markets.
Both assets are a natural partial hedge for pension funds, but the correlation is far too tenuous to ever turn them into a retail product to help individuals protect against their own longevity.
LRN: Finally, Roger, what’s the message to investors who are looking for secondary market opportunities in the U.K? Is there anything to get excited about at all?
RL: I said earlier that I thought it would be difficult to find opportunities in the future as we had in the past. Certainly not in the small-time retail space which the TEP market served. The regulatory mood is against providing alternatives and following some very recent non-mainstream investment failures that have used the “sophisticated investor” exemptions there may be an attempt at further rule tightening. However, it is hard to see how any open society can forbid the wealthy from doing what they like with their money.
There may still be some opportunity for intermediated offerings such as being part of a fund of funds structure.
Ironically all this ramp up in regulation over decades has coincided with the biggest risk transfer of them all – individual longevity risk parked onto the shoulders of the individual. Pension provision has never been so frightening for consumers – not a great result for government and regulators. Hybridised annuity and drawdown solutions are being sought and if way can be found to provide deferred annuities for later life without the current intensity of capital there would be an opportunity for investors to take on this longevity risk.