The life settlement market has passed the test
What would you like to know
- The great storm of 2008 raised questions.
- When the COVID-19 pandemic hit, some investors cashed in.
- In the end, the settlement-life funds took a punch and kept going.
About 13 years ago, the life settlement market underwent a massive dislocation. Changes to actuarial assumptions used by industry medical insurers combined with the global financial crisis to create a confluence of events that have left many portfolios crumbling and many investors wary of the asset class.
However, today, with market valuations near record highs and sub-zero real bond yields, the central premise of settlements life – an asset class capable of generating high single- or double-digit annual returns with low correlation with traditional financial investments – is more relevant and attractive than ever.
With this perspective in context, it is instructive to recall exactly what happened to life insurance settlements at the end of the first decade of the new millennium and to consider whether today’s market is better positioned to resist. at the next major financial shock. To the extent that the market swoon from last year’s pandemic served as a stress test for life regulations, early indications are reassuring.
The great storm of 2008
Thirteen years ago, a perfect storm impacted living establishments, and the industry was unprepared. “Hot money” was pouring into a relatively small market. Banks were loosening their purse strings to provide leverage and funding for policy premiums. At the same time, new players on the long side were entering the space, often with more capital than experience in the highly specialized asset class.
Two separate events combined in a short time to cause market conditions to deteriorate rapidly.
The first domino to fall came in late 2007, when two major underwriters in the life insurance claims industry changed their data tables. This was followed in February 2008 by an update of the Base Valuation Tables (VBT), a key mortality data used throughout the life insurance industry to calculate life expectancy. These changes had a more negative impact than expected on the asset valuation levels of many portfolios. In some cases, write-downs triggered by revised life expectancies have led to forced sales of funded assets.
On their own, valuation markdowns would have been a big development for the life insurance claims market. However, they were followed the very next month by an event that shook the entire global financial system – the collapse of Bear Stearns in March 2008 (and, six months later, by the even larger collapse of Lehman Brothers). The ensuing financial crisis had major impacts on life settlements: the leverage that financed the premiums of many portfolios either became much more expensive or dried up completely and discount rates rose sharply, creating losses on mark-to-market portfolios. The natural desire to cash in the “good assets” to pay off the “bad assets” in tough times has also had a negative effect on life settlement funds, as surrender requests have forced policy liquidation to levels. in trouble.
What a difference a decade (or so) can make.
As a result, returns for the asset class have generally declined, leading some to question whether life settlements are really less correlated with financial markets. After all, stocks and bonds fell sharply and, to a lesser extent, settlement-life assets – at least at market value.
A key distinction
The correlation, however, comes in different flavors. One is the “direct correlation” of returns between certain asset classes. For example, returns on stocks are often correlated with returns on corporate bonds, as both are linked to the operational performance of companies and the financial condition of corporate balance sheets. Likewise, the values of international stocks are often correlated to the strength of the dollar due to currency conversion.
The other major form of correlation is what is now called the “built-in beta”. This is where unrelated assets nonetheless trade lower together in times of distress due to liquidity issues and the very structure of financial markets. 13 years ago, most life settlement markdowns had little to do with a direct, fundamental relationship to other financial assets and everything to do with built-in beta.
If the upheavals of 2008 were largely the result of macroeconomic forces, it is worth asking whether these factors are still active. In other words, have lifetime settlements reduced their vulnerability to built-in beta? If this is the case, an investment in an asset class capable of generating above-market returns with a low correlation to traditional financial assets may be worth reviewing.