Lisa Reinisch

Betting on death: inside the macabre and profitable world of life settlements

Betting on the death of US citizens is a lucrative business and several London-based investment funds are reaping the benefits.

Despite the recession, fraud scandals, obscure financial products and controversial ethics, EEA Fund Management and others are getting annual returns of around 10 per cent from the life settlements business – buying and selling unwanted life insurance policies.

The business is as morbid as it is profitable. “We have had 40 consecutive months of positive performance. This month we have taken another 50 million dollars (31 million pounds) of investment into the fund, last month we had about 40 million dollars (25 million pounds)” says Peter Winders, marketing director of London-based EEA Fund Management.

It is a success story that often elicits upturned noses rather than praise. After all, investors are making profits from the premature deaths of policy holders.

The industry is already worth an estimated 7.4 billion pounds, double its value in 2006. The life settlements market will top 99.4 billion pounds within a few years, according to The Pensions Institute.

These numbers are the result of a gold-rush atmosphere surrounding the trade of creepily-named “death futures”.

The business has its roots in the 1980s, when AIDS/HIV started to take its toll and many were eager to sell their life insurance policies to fund medical treatments or simply make their last remaining days as pleasant as possible.

The industry’s ghoulish undertones have always attracted intense media scrutiny. Recent descriptions of the life settlement business ranged from the cynical (”City traders take a punt on the terminally ill”, The Times the outraged “Wall Street’s most macabre investment scheme yet”, Business Week, the darkly foreboding “The big financial scandal of the next decade”, The Independent to the sober (”An interesting alternative investment”, Daily Telegraph.

The humanitarian perspective

“Anything that gives people money when they most need it must be good for the human race,” argues Mr Winders.

“Selling policies on the open market means policyholders can reap the benefits from policies they have paid for,” says Jeremy Leach, managing director of Managing Partners Limited.

The Pensions Institute has investigated the ethics of “profiting from mortality” concluding that “there would appear to be no particular ethical issues associated with investing in this asset class [...] provided that products and processes are fully transparent to all parties and provided the privacy of the policyholder is safeguarded”.

While the business can be seen to have quasi-humanitarian aspects, there have been concerns surrounding recent cases of fraud, shady sales practices and increasingly obscure financial products.

Esoteric risk swaps are hitting the UK

Exotic financial products such as longevity swaps, which allow participants to trade or bet on how long populations are going to live, have also attracted scepticism.

In the UK, trade in such novel products started in May 2009 and is being pioneered by Goldman Sachs and Ortec Finance, whose UK clients include The Lloyds Banking Group and the fund manager Hermes, which is owned by the BT pension scheme.

“The message we want to get across is that simple solutions will not always do the job. We will provide insight into the most important risk factors and their impact on both short and long-term investments,” Ton van Welie, chief executive of ORTEC Finance said in a recent statement.

But many UK fund managers remain critical of these products due to their similarity to the credit default swaps that played a leading role in the credit crunch.

“We don’t have any derivatives in our fund. We don’t believe they are good for life settlements,” says Mr Winders. “All we do is buy life insurance policies from people who want to sell theirs for whatever reason.”

Investors warned of fraudulent investment schemes and pushy sales tactics

In January four former affiliates of Mutual Benefits Corp., a now-defunct Florida-based life settlement company, were charged with a widespread Ponzi scheme that allegedly resulted in more than 28,000 people losing about 517.6 million pounds.

Another area of concern is ‘stranger-originated life insurance’ (also known as Stolis), in which policies are taken out by investment companies or banks in the name of individuals.

“When you buy a policy, the insurance company has to tell you who the beneficiaries are. If the beneficiary is a finance company or a bank, that rings alarm bells – you know that this policy has been bought under questionable circumstances,” says Mr Winders.

Piyo Zhang, a life settlements expert at HSBC, argues that the business is likely to offer reliable returns for years to come, but is concerned about the reliability of the mortality models on which the business is based.

“The modelling required to reliably hedge the involved risks would require years of scientific research and IT development,” says Ms Zhang.

At the moment, neither investments banks nor regulators are willing to make this kind of investment.

In the long run, people will live longer lives and financial products related to life settlements will become ever more abstract. Sooner or later gambling on death is going to turn into risky business.