When Returns are a question of Life and Death – Ethics of Life Insurance

    Stockholm (Nordsip) – Investing in life insurance policies can yield attractive risk-adjusted returns while procuring welcome diversification to any portfolio. Many potential investors however ask themselves if this is really ethical. In fact, it may be one of the reasons returns are still attractive in this asset class.

    Ress Capital is a company on a mission. The Swedish fund management firm focusing on insurance-linked securities with an emphasis on the secondary market for U.S. life insurance policies is often confronted with investors’ concerns about so-called “death speculation”. The market itself is also accused of being unregulated, and thereby predatory towards unsuspecting individuals. Jonas Mårtenson, Ress´s CEO, is used to dispelling such myths. His arguments are clear: the market is good for the policy seller since it offers an attractive alternative. It is also regulated in 45 U.S. states. These are clear examples of socially responsible investing. The firm’s Ress Life Investments Fund, which recently surpassed the $80 million mark in investments, represents an attractive risk diversification tool for any investor looking at investments with single-digit annual volatility. Mårtenson explains that the main risk in a life insurance portfolio is longevity, which is highly uncorrelated to the general economy.

    Big Questions, Rational Answers

    The big question facing Ress and other life settlements fund managers was: Is life insurance investments ethically acceptable? To investigate the question in light of its own processes, Ress commissioned a study in 2013 from TrustBrand, a Swedish brand valuation firm.  The study made recommendations on the basis of determining ethical questions on a philosophical basis (which can ultimately only be subjective). The findings showed that the U.S. secondary market indeed operates ethically. Ress however was encouraged to adopt a more activist stance to communicate its own ethical responsibilities. As Mårtenson explains, Ress has since stepped up to the challenge to ensure policy sellers and investors understand that there is no contradiction between ethical prerogatives and smart investing, and to be in a position to explain why.

    Jonas Martenson, RESS Capital
    Jonas Martenson

    “Buying life insurance policies is, indeed, ethically acceptable. Very much so,” Mårtenson says, offering ‘Mrs Smith’ by way of example: “Mrs Smith is 78 years old. The beneficiaries of her life insurance will often be her children. They are now grown up and thus the original need for a life insurance policy is no longer there. The most common thing that happens is that she stops paying her premiums, after ten or twenty years, for lack of knowledge that the policy can instead be sold. As a result of no longer paying the premiums, the policy lapses, and Mrs Smith and her children lose out on years of premium payments. Sometimes Mrs Smith’s insurance company will offer a ‘surrender value’ and allow her to cash out, but the secondary market and funds like ours pay a lot more!” Mårtenson is supported by statistics: Between 2006-2009, policy owners who sold their policies received $6.2 billion, more than ten times the total surrender value of $0.6 billion from insurance companies, according to the U.S. Governmental Accounting Office.

    That fact alone indicates how beneficial the U.S. secondary market actually is to the consumer, Mårtenson says. If this market was to disappear, consumers would be at the mercy of insurance companies who clearly take advantage of the consumers’ misinformation. Often, the policy simply lapses, where, according to the Life Insurance Settlement Association (LISA), 50% of policies lapse within 10 years. “The key is to understand that there are clearly strong economic interests against the secondary market, when ethically speaking it’s actually meant to be the other way around. Allowing the consumer to sell the policy at the highest value, empowering the consumer, not the insurance companies,” Mårtenson affirms. Many people may be negative around the hyperbole of ‘profiting from people dying’, but in effect it’s actually about giving the consumer better choices while still alive. “So on whose side are those criticising this market? The consumer or the insurance company?” Mårtenson exclaims. The bottom line remains that most policies never pay out, and very few of them are sold in the secondary market, mainly for lack of awareness about the alternatives available.

    The Secondary Market: Not the Wild West

    “European investors don’t realise that the secondary market for US life insurance policies  is a regulated market. They think it’s some sort of cowboy market. The fact is that this segment is highly regulated in 45 U.S. states, and the processes are highly transparent,” Mårtenson emphasises. To that end, the TrustBrand report Ress commissioned was in part intended to provide answers to investors in Sweden that initially regarded the market with scepticism, which meant explaining how the secondary market actually functions:

    “For example, the seller’s agent shows Mrs. Smith’s insurance documents, policy and premiums to a number of wholesalers, called providers – our brokers, so to speak,” Mårtenson explains.  “The objective now is for the insurance agent to get as high a price as possible for the seller. The agent therefore shows this to a number of buyers who bid for the policy in an auction, after which the highest bidder can buy the policy. Buyers cannot transact directly with the individual, they have to transact via regulated agents and providers. It is important to remember what this process actually looks like,” Mårtenson adds. The closing process takes 2-4 months and the fund continues to pay the premiums after it has bought the policies, relieving the seller from that obligation. The fund is now the new beneficiary and receives the policy payout when ‘Mrs Smith’ dies.

    An important aspect of Ress’s investment policy is that the fund does not buy life settlements from people suffering from a terminal illness and it focuses on wealthier and relatively healthy individuals with long life expectancies. The average policy size is approximately $2 million, underlining that sellers are not powerless people incapable of making a reasonable decision, but rather the opposite: people who are in an optimal position to do so.  Apart from the ethical advantage of this criteria, the fund benefits from a higher predictability; the healthier the individual, the less volatile the life expectancy. This means that the likelihood of a healthy person living 10 years for example may be higher than that of a relatively sick person living 3 years. For a sick person, the outcome is more binary and the average outcome may be less representative.

    Ways And Means

    The biggest risk to this investment process is the longevity of the initial policy holder, forcing Ress or any buyer of the policy to pay premiums for a longer period and delaying the payout. Determining longevity risk is therefore a crucial component.  A buyer typically receives a life expectancy report from one or several medical underwriters. For example, the seller, on average age 78, has a life expectancy of 12 years until age 90. Returns are then calculated based on the expected benefit payment within this timeframe. If the seller lives well beyond age 90, the investor will continue paying the premiums, and the payout of the policy is of course delayed; returns will be reduced. So on average, for a number of policies he life expectancy is too short, and for others it is too long, but what actually matters is the portfolio as such.

    The selection of the medical underwriter is fundamental. Based on a simple discounted cashflow calculation, one can easily understand why it is in the interest of Mrs. Smith to appear sicker than she is in reality. Therefore, Ress insists on obtaining its own life expectancy estimates from independent and trusted medical underwriters, who base their assessments more on health records  and objective criteria than on patients’ interviews. This gives Ress a more realistic view of the policy’s expected return, which means it is also more conservative (but mostly fairer) in the valuation of its own portfolio.

    “In short, the key risk is longevity, which is also indifferent to all the other risks the fund assumes, such as credit, operational, valuation and premium risk factors. To an investor looking for risk diversification alongside property, equity, fixed income bonds and so forth, this is also a good alternative opportunity to add to the portfolio, that also happens to be based on ethical premises,” Mårtenson explains.

    Consumer protection organizations have been very welcoming to life settlement buyers such as Ress, Mårtenson offers. Additionally, investors have become far more knowledgeable than they were in the past on the transparency of the U.S. secondary life insurance market. Ress has thus been able to communicate that it is indeed well regulated with more ease than previously. Mårtenson does acknowledge Ress needs to be even more proactive on a one-to-one basis, following a previous approach in which the issue wasn’t broached with investors inclined to think of the secondary market as controversial. “We’ve made the decision that this is a sustainable form of investment, we think it’s good for the consumer, so we therefore think we should be even more assertive about this,” Mårtenson says.

    Ress is now in the process of in the process of signing the United Nations Principles of Responsible Investments (UNPRI), which it expects to have completed by early 2017. Hardened old attitudes may be hard to change, but it turns out filling the gap between subjective ethical expectations and smart investments, and exposing them as two sides of the same rational coin, is one way to do it.


    Picture: (c)

    Latest Posts

    NordSIP Insights Handbook

    What else is new?