UK - Traded Life Policies (TLPs) could become a successful new asset class and provide a "firm foundation" for the development of the wider life market in trading mortality and longevity-indexed securities and derivatives, according to research from the Pensions Institute at CASS Business School.

However, the report - entitled 'And Death Shall Have No Dominion: Life settlements and the ethics of profiting from mortality' - suggested for TLPs to continue their rapid growth, the market needs to become "well-regulated" and more transparent for both policyholders and investors.

TLPs are US whole-of-life insurance policies which are sold on by the policyholder - most commonly those aged over 65 with between two and 15 years' life expectancy - to a life settlement company who either uses the policy for its own investment purposes or sells it on to a third party, including institutional investors such as pension funds.

The report, written by Dr David Blake and Debbie Harrison, revealed this secondary market was valued at $13bn (€8.3bn) in 2005 but is now estimated to reach $160bn within the next few years.

The report revealed pension funds are showing more interest in TLPs as a way of diversifying its investment strategy - through an average portfolio of around 300 life policies - as life expectancy is not correlated with either equity or bond market returns.

In particular, the research stated Germany was one of the first investment markets to be attracted to the product, and some larger pension plans in the Netherlands have started to invest in life settlement policies, while it suggested UK defined benefit (DB) scheme may soon start considering the asset class as part of a liability-driven investment (LDI) strategy.

However, the report pointed out while TLPs have benefits for investors, there are also some key concerns, such as the lack of standardised regulation in the market.

This is because US life policies are regulated at state rather than federal level - so each state can make its own regulations, with some such as New York, California and Illinois not regulating TLPs at all except for those relating to the 'viatical' market - where policyholders have less than two years to live.

In addition, the research warned while there appears to be no particular ethical issues associated with investing in TLPs, the market needs to become "fully transparent" to ensure investors are making an informed choice.

Blake, director of the Pensions Institute, said: "Policyholders who sell into the secondary market must understand that a third party will profit from their death, while investors must appreciate their return is based on the successful prediction of the date of death of the original insureds whose policies are held in the fund or portfolio."

As a result, it suggested disclosure could become an important issue for institutional investors such as pension funds, as it is investing on behalf of private individuals who might have ethical objections to the investment.

To try and avoid this, it suggested institutional investors should consider the ethics of investing in TLPs in relation to any socially responsible investment strategies it has adopted, such as the UN Principles for Responsible Investing (UNPRI).

And it warned, "given the 'youth' of this asset class, institutional investors might need to review their existing SRI principles to consider if their principles should include provisions relating to life settlements".

Although Blake said: "Provided appropriate safeguards are in place, life settlements should not raise ethical issues that are not present in other mortality-linked investments, such as pensions, annuities or reverse mortgages."

In addition, the report highlighted the importance of accurate life expectancy reports when investing in TLPs, as it suggested "overly optimistic" mortality assumptions could inflate the cash price paid to policyholders and reduce returns to investors.

That said, it admitted there is now a growing interest in synthetic replications of the TLP market, described as "life-linked" exposures rather than "policy-linked", which Harrison, as senior visiting fellow at the Pensions Institute, said "could eliminate exposure to policy-related risks, such as reputational risks in relation to how policies are sourced, and cross-border tax risks".

The research warned, "going forward, the success of this asset class, irrespective of any ethical investment concerns, will depend on the purchasers' expertise in portfolio construction, the accuracy of life expectancy reports, and robust standards in the regulation of purchase and resale processes."

However, it added if standard regulations are introduced across the US then the life settlement market will provide a "welcome new asset class for investors" and would provide a "firm foundation for the development of the wider life market".

If you have any comments you would like to add to this or any other story, contact Nyree Stewart on + 44 (0)20 7261 4618 or email nyree.stewart@ipe.com

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