Hinging on life and death
Baby Boomers in the United States are worth roughly US$30-trillion, setting the stage for a humongous transfer of wealth over the next few decades. But those shamelessly banking on a nice inheritance from their Boomer parents face a brewing threat to their expected riches.
Calsi Management Inc., a private company in Toronto, is attempting to raise between US$20-million to US$30-million from Canadian investors to buy life-insurance policies from ageing Americans. Investments don’t get much more alternative than this.
The basic idea is to acquire large policies at sizeable discounts to face value. For example, a buyer might pay US$300,000 for a US$1-million policy. Policyholders get cash to use while they’re still alive and can typically get more money from a third-party investor than selling or surrendering a policy back to an insurance company.
The buyer pays the premiums on an acquired policy and collects the face value from the insurer when the seller dies. While this alternative investment sounds a little morbid, it has a sanitized, inoffensive name: “life settlement.”
Life settlement has not yet taken root in Canada. But worldwide, it has grown into a US$13-billion industry, according to Bernstein Research, with the potential to reach US$160-billion a year.
Several major financial institutions in the U.S. and Europe are investing in life settlement. Even Warren Buffett, who has pledged to bequeath most of his US$40-billion fortune to his charitable foundation, is keen on the sector.
Calsi argues that buying the life-insurance policies of the aged can provide a predictable, low-risk yield to investors. In a marketing presentation to potential investors, Calsi said it is gunning for a 12% compound annual return, after fees. The projected return is based on a seven-year lifespan for the fund. If it raises US$30-million, Calsi will attempt to buy policies with a total value of US$62-million that will start paying distributions in the third year.
Another selling point is that life-settlement returns hinge on the cost of acquiring polices and paying premiums and how quickly policyholders die. Returns aren’t affected by fluctuating equity markets, interest rates or commodity prices.
But Calsi and other life settlement outfits still face a few challenges.
A big one is disassociating life settlements from their ghoulish and sometimes fraudulent predecessor, viatical settlements.
Emerging in the 1990s, viaticals involved the purchase of life-insurance policies from the terminally ill, mainly people afflicted with AIDS that needed money to pay for treatment. These sellers were expected to die quickly.
The rush to exploit this group spurred all kinds of “fuzzy-wuzzy” business, said Bernard Grybowski, chief executive of Calsi. In some cases, companies raised money to buy policies but never followed through. And with the arrival of new treatments for AIDS, people lived longer than expected so investors lost money.
Calsi is not involved with viaticals and insists it will adhere to all regulations. But it still has to deal with the perception that life settlements are equally controversial.
For example, lobbyists for the U.S. life insurance industry have raised concerns about investors buying insurance for healthy older people and paying the premiums just to collect the payout when they die.
When pricing policies, insurers also assume that a certain percentage of policyholders will stop paying premiums and give up the death benefit. If the life settlement industry keeps growing, the insurers whose profits hinge on large numbers of policies lapsing could suffer, according to a recent report by Moody’s Investors Service.
Furthermore, tiny Calsi not only has to raise money for its fund, it has to find policies to buy. Calsi said it has developed a network of life-insurance brokers and others in the U.S. to buy policies. But if the industry takes off, there will be competition for the most attractive policies.
That could drive up commissions on policy purchases. And sellers could demand higher prices.
At the same time, life settlement is relatively new, so there are no historical returns to look at.
That being said, life settlements might be a perfect investment for a pension fund. Faced with big deficits because investment returns and contributions aren’t keeping pace with projected benefits, life settlement investments could be a way to hedge this risk.
Pension funds can park money in illiquid investments, like private equity, for long periods of time, although retirees might be put off by their pension funds profiting from Boomers kicking the bucket.
While institutional investors are warming to life settlements in the U.S. and Europe, it will likely take more time in Canada.
Calsi is looking to attract money from wealthier investors, but it must compete with yields offered by income trusts even though it is looking to raise only a small amount of money. But given the infancy of the life settlement industry, and the infamy of its predecessor, Calsi’s management team have their work cut out for them.
Source: Keith Kalawsky, Financial Post
