All about investment

By Dave Yelken

Banks are beginning to acknowledge the elephant in the room, that many of their loan portfolios are too heavily weighted with real estate as collateral. Nationwide property sales slowdowns, a decline (sharp decline in some markets) in real estate values, and the recent subprime mortgage meltdown have led more and more banks to look for other asset categories to diversify their loan portfolios.

Enter investors who want to leverage portfolios of life settlements. Life settlements are discounted cash settlements paid by investors to life insurance policyholders. In exchange, investors later receive the full amount of the life insurance policy upon the passing of the insured; a win-win transaction. Policyholders, who choose to sell their policy, receive cash now to enhance the quality of their remaining days. Investors receive an excellent return on investment, historically a double-digit return.

Along with that, investors also receive something quite rare in today's increasingly interconnected investment world; returns that are uncorrelated to market, economic, and geo-political forces. According to a review of the Life Settlements Fund Limited (Series I) in April 2006, "Life settlements...are not correlated to any traded market - whether stock, bond, currency or commodity markets - nor to political or economic upheaval. Once invested the only variable affecting a Fund's return is the life expectancy of the policies held."

The July 30, 2007 cover story of Business Week, Profiting From Mortality states "Moreover, [life settlements are] 'uncorrelated assets,' meaning their performance isn't tied to what's happening in other markets. After all, death rates don't rise or fall based on what's happening to commodities, say. Uncorrelated assets like these are highly prized in an increasingly connected global financial system." Life settlements bring a true measure of diversification to investment portfolios at a time when most other investment asset categories are increasingly operating in parallel.

Banks have taken notice. An asset that diversifies an investment portfolio also diversifies a loan portfolio. A life settlement is essentially a contractual obligation of the life insurance company to pay a predefined amount in the future. Naturally, the big question is, when? Holding life settlements from many different individuals mitigates the risk of "when" (just like the insurance company that sells thousands of policies, not knowing exactly when any individual will pass away). The more life settlements an investor holds, the more predictable the portfolio's rate of return will be.

In the past two years, aggressive investors have pursued financing to leverage their life settlement holdings, for two good reasons: 1) to increase their return on equity, and 2) increasing their holdings further mitigates life expectancy risks, and improves the predictability of their rate of return.

Banks, just like investors, are becoming attracted to the uncorrelated nature of risks associated with life settlements. Risk to principal is low, and the likelihood of a profitable outcome is quite reasonable. Payouts are backed by insurance companies with strong reserves. Combine the recent real estates shocks, and now we have an environment where more and more loan committees are prepared to entertain an, until now, uncommon collateralization for financing. It does not fit into any pre-existing lending "box". But the need to diversify their banks' loan portfolios, the quest for secure loans, and the desire for new high net worth clients, have, however reluctantly, forced banks to look outside the box. This author's agency has participated in negotiations for investors in Texas, Arizona, Illinois, and Nebraska to arrange such financing with commercial banks.

Wall Street firms are grabbing up life settlements in bundles, securitizing them, (siphoning a bunch of value out of them for themselves), and offering them to the public with mediocre returns (reference the above mentioned Business Week article). Savvy investors have learned to hold fractional life settlements outright, finance their holdings for leverage, and achieve the "institutional rates of return" that some on Wall Street would prefer they be excluded from.