Investors in the life settlement industry’s secondary market work with a provider to source policies; indeed, most states that have a regulatory regime for the asset class require a life settlement provider to be involved in the transaction. Those providers in turn source their policies either through the ‘direct to consumer’ channel – so, advertising on television, radio, in newspapers, or online – or through brokers who sell an insured’s life insurance policy on their behalf.
A characteristic of the policies that the brokers work with is that they tend to be higher face value, and for good reason: the broker’s costs to source medical records, pay for life expectancy reports and have the insured and beneficiaries sign off on documents necessary to bring the policy to market are similar regardless of whether they’re working with a $100,000 policy or a $1million policy.
That means that deal flow in the smaller face value end of the market from brokers has been slower. But the increase in secondary market deal flow from the direct-to-consumer channel generally in recent years has brought with it a notable increase in the volume of smaller face value policies available to life settlement investors.
Smaller face value policies offer a range of benefits to both fund managers and end investors alike. The first benefit is the classic ‘free lunch’ – namely, diversification. Best practices in life settlements portfolio construction sees the investor diversify by gender, by age, by carrier exposure, by life expectancy, by impairments, and by state, for legal risk reasons. Many funds in our market are closed ended, so a finite amount of capital goes further from a diversification perspective by investing in smaller face policies, as more policies make it into the portfolio. Instead of buying five large face policies with high-cost premiums, one could arguably purchase 25 polices with the same amount of capital with lower premiums and a diverse pool.
The second benefit is in being able to execute the job we are supposed to do. Portfolio managers are paid to (wisely) deploy their client’s capital. The life settlement industry’s tertiary market already provides a mechanism to allocate larger amounts of money, but in the secondary market, there is less activity in the smaller face end, so there’s less likelihood of delayed deployment.
The third benefit is access to a part of the market which is growing. ‘Baby boomers’ are now entering the life settlement market in the sense that many of them are now of an age where they might consider selling their policy. These seniors are more internet savvy than their predecessors – the ‘Silent Generation’ – and because of this, they have more access to information which in turn means that more of them are familiar with the life settlement option (far too many American Seniors are still unaware of the option that the life settlement industry presents to them) to access liquidity. Again, this trend will fuel increased activity in the direct-to-consumer channel.
Larger face value policies are owned by high-net-worth individuals, the healthy, wealthy, ‘1%’ of the population. The life expectancy profile of these insureds does not always align consistently with the 2015 Valuation Basic Tables used by the life insurance industry for modelling life expectancy because they have a different life expectancy profile; they typically live longer than the ‘average’ person. But the life expectancy of individuals holding smaller face value policies do align with the 2015 VBT, which, for an investor, means that our exposure to valuation risk is lower.
Life settlement investors that previously focused heavily or exclusively on larger face value policies are increasingly paying attention to the lower end of the market. The ability to buy more policies with a finite amount of capital not only supports diversification, but volatility and cash flow within the portfolio. Smaller face value policies perform because you can more easily ladder the maturities over the life of a fund which leads to more predictable cash flows from policy maturities. This is a particular benefit to an open-ended fund structure. In larger face, it’s not uncommon to have a quiet six or twelve – even more – months, where no maturities are realised, but the premiums still need to be paid.
Increased supply of policies in the secondary market is good for our industry, regardless of the policy value size. But the smaller face value end of the market is set to be a more significant contributor to that growth in the coming years. Portfolio manager interest is shifting from buying only larger face to actively seeking out good smaller face deals, which brings with it numerous benefits, as outlined above. It’s a benefit to our entire industry – asset managers, service providers, and of course, the end investor – that activity in the smaller face value end of the market is increasing.
Anna Bailey is Managing Partner at Chestnut Capital Management