The collapse of UK fund provider Keydata and the high-profile under performance last autumn of two Deutsche Bank funds have highlighted the need for greater transparency and education around life settlement investment risk.
They tainted an asset class that can provide the steady, predictable returns for investors seeking an antidote to stock market volatility.
A Code of Practice was launched last month designed to provide greater protection to investors in this expanding asset class. It provides firm guidelines for all market participants to follow. If adhered to, these will help prevent further failures.
There are a number of areas - all of which are addressed in the Code - that potential investors should check before making an investment.
Has longevity risk been assessed conservatively?
Longevity risk is the single greatest risk of investing in life settlements, as was demonstrated by the product under-performance at Deutsche Bank, flowing as it did from longer-than-expected survival rates.
Investors should be satisfied that they have had the risks pertaining to longevity clearly explained to them and that the company is taking a "conservative" approach to its measurement and management.
Things to check are that the fund has used more than one company to estimate longevity, as well as the methodology used to calculate average projections. Investors should also be informed how the fund has performed against initial life expectancy forecasts. And what is the fund's investment strategy to take account of people living longer than originally expected?
What is the liquidity and cash flow position of the provider?
As life settlements are relatively illiquid assets, investors need to be satisfied that the cash position of their provider is both sufficiently liquid and clearly explained.
The illiquid nature of life settlements limits investors' ability to redeem their investments but also means timing mismatches of cashflows can lead to liquidity problems within the life settlement portfolio itself – an issue with which Lifemark, one of the two special purpose vehicles underpinning Keydata's life settlement products, is struggling to contend.
Following the collapse of Keydata in June last year, the Luxembourg financial regulator stopped Lifemark from issuing new bonds. With no bond issuance since April last year and no new monies from fund inflows having been injected into the portfolio, the £350m fund now faces the prospect of being unable to pay the premiums on some of its policies, despite having already stopped income payments to investors at the end of January this year.
Not only should providers be up front about their cash position, but they should also provide a clear explanation of any financing facility. If no liquidity facility is to be deployed, the marketing literature should clearly explain why this is not required. Fund managers should also tell investors the expected time period until an insolvency event would occur, assuming no new cash flow was committed to the product.