Funds specialising in life
settlements are under heavy fire from the UK’s Financial Services
Authority (FSA) which has labelled them “high-risk, toxic
products”.
The FSA’s warning sparked a rush
for the exit door by investors in one of the largest of these
funds, the EEA Life Settlements Fund, forcing its managers,
Guernsey-based EEA Fund Management, to halt redemptions.
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FSA MD
Margaret Cole spelled out the regulator’s concerns in no uncertain
terms, emphasising the damage caused by past failures of life
settlements products.
“The failure of these products in
the past has led to significant consumer detriment and we now fear
new investors will suffer unless we take the necessary steps now to
prevent their sale and distribution,” Cole stressed.
Applying a heavy dose of moral
suasion, Cole said: “We are issuing a strong warning to the
industry not to market these products to UK retail investors.
“Ultimately we aim to ban TLPIs
[traded life policy investments] from being marketed to UK retail
investors, and we intend to consult on this next year to help erase
the risks they pose.”
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By GlobalDataCole did not refer to any failed
life settlements fund in particular. However, there can be no doubt
that the collapse of UK life settlements firms, such as Keydata
Investment Services in June 2009, has played a key role in the
FSA’s thinking.
Prior to its collapse, Keydata
purchased bonds on behalf of investors which were issued by special
purpose vehicles (SPV) incorporated in Luxembourg.
The SPVs were used to purchase life
insurance policies issued in the US.
In January 2011, the Financial
Services Compensation Scheme announced that financial
intermediaries and fund management companies would have to pay a
total levy of £247m ($390m) to compensate the 19,000 investors who
suffered as a result of Keydata’s collapse.
Not an easy
task
Cole conceded that putting a halt
to the sale of TLPIs is easier said than done. Many are based
outside of the UK, and are thus outside the FSA’s jurisdiction.
There are also considerations under European Union law that will
affect what the FSA can do, she noted.
As an interim step, the FSA has
issued a consumer guidance paper highlighting what it perceives as
being the big risks posed by TLPIs.
Among the risks, noted the FSA, is
that product structures are complex and opaque, involving several
firms working together, often in different jurisdictions.
In addition, the FSA stressed in
its guidance that if the people whose lives are assured live longer
than expected, perhaps because of incorrect actuarial assumptions
or the development of new medical advances, the investments may not
be able to function as expected.
The FSA also noted that it had
found that some TLPIs lack sufficient liquidity to meet ongoing
costs if the people whose life policies they have bought live
longer than expected.
Support for
Cole
Far from condemning the FSA for its
stance, the European Life Settlement Association (ELSA) has come
out strongly in its support.
“I strongly agree with the FSA,”
said ELSA deputy chairman Michael Fugler in a statement.
He continued: “Historically many
product structures sold to retail, unsophisticated investors have
been complex and opaque. A number of the past products were toxic
and should have required a significantly heightened degree of
warning and clarity.”
However, he stressed that in the
early stages of the life settlements industry there were few laws
or regulations. This tended to initially attract some unscrupulous
people.
“Like other industries before it,
it [life settlements] got off to a difficult start,” said
Fugler.
The FSA’s attack on life
settlements received a mixed reception from SL Investment
Management, the UK’s SL Investment Management (SL), the UK’s
largest and longest-established life settlements investment
management firm.
SL took strong issue with Cole’s
reference to life settlements as toxic assets, noting that the
sector continues to be dogged by a handful of high profile fund
failures which have cast a shadow across the whole asset class.
Overall, SL believed that the
sector is sound and highly predictable.
However, SL was in agreement with
Cole on that life settlements are inappropriate for retail
investors.
“SL is entirely supportive of the
FSA’s stance to keep life settlements in the institutional domain,”
said Patrick McAdams, SL’s investment director.
McAdams continued: “In the UK, the
life settlements industry is less than 10 years’ old, making it an
extremely young asset class.
“Although the returns can be
attractive, the success of the fund depends significantly on the
investment manager and it is not realistic, or fair, to expect
retail investors to know the difference between good and bad.”
Solid investment
merits
The appeal of TLPIs is clear. Not
only are they uncorrelated with mainstream investments such as
equity and bonds but they also hold out the promise of solid
returns. In the case of the EEA Life Settlements Fund, EEA Fund
Management states that its objective is to generate an annual net
return of more than 9% after costs.
According to the management firm,
the average annual increase in the fund’s net asset value across
three sterling denominated classes of units issued by the fund
since its launch in November 2005 was as at 31 October 2011 9.29%
with a range of from 9.1% to 9.55%.
As at 1 November 2011 the fund had
total assets of $955m invested in 698 polices issued by 88 US life
insurance companies. The total sum insured under the policies was
$1.57bn and the average weighted age of policyholders 83.36
years.
According to SL, its flagship Life
Plus Sub-Fund 1 aims to deliver an annual return of between 7% and
10% net of all fees and costs. At the end of 2010, SL managed and
advised on life settlement assets worth £832m.
The FSA’s action and call for
comment from life settlements industry participants will
undoubtedly stir up considerable controversy.
Correctly, Fugler stressed: “Let’s keep an open mind and have a
healthy dialogue.”
