DUTCH PLANS BREATHE NEW LIFE INTO OLD POLICIES
Stable returns draw pension funds to growing market
By Beatrix Payne
AMSTERDAM, Netherlands — Large Dutch pension plans are turning to securitized life insurance policies, or life settlements, as a new source of uncorrelated returns.
Life settlements comprise a relatively new asset class for pension plans in both Europe and the U.S., and issuance of these bondlike investments has grown rapidly over the last few years. Market issuance of life settlements totaled an estimated $23 billion by year-end 2005, up from $13 billion in 2004, the most recent numbers available, according to research by Sanford C. Bernstein LLC, New York.
Up to $12 billion was issued in 2006, said Larry Simon, president of Life Settlement Solutions, San Diego, a provider of investible pools of life settlements.
To date, investors in life settlements — life insurance policies that are surrendered early by their holders to third parties who reckon the value of the death benefits will be higher than surrender and premium payments — have been mainly hedge funds, investment banks and high-net-worth individuals.
But now pension plans are moving directly into this area, attracted by a stable source of annualized returns of between 8% and 11%.
Last August, the e20.5 billion ($26.8 billion) Pensioenfonds Metalektro, Schiphol, invested about e100 million in life settlements. The plan, also known as PME, intends to allocate up to 2% of total assets, or e400 million, to the asset class, according to Roland van den Brink, managing director, investments.
The e25 billion multiemployer pension manager Cordares, Amsterdam, plans to launch a pooled fund in the asset class for Dutch pension plans, said Jeroen Tielman, managing director, sales, strategy and innovation. It already has one commitment, for e50 million, from a Dutch pension fund client.
So far, few European or U.S. pension plans have invested directly in life settlements, although they might have had some indirect exposure through hedge fund of funds, said David Fishbaum, Chicago-based president of Mercer Oliver Wyman Actuarial Consultants Inc.
Liability match
Returns on life settlements are linked to mortality, and pension plans view them as an alternative source of return and a liability match rather than a hedge against longevity risk.
But life settlements are one of the early steps in creating a market in human longevity, according to Kevin Wesbroom, London-based principal consultant at Hewitt Associates LLC.
If the market becomes more liquid, it may be possible to create a tradable market for use by investors, said Mercer’s Mr. Fishbaum. And if that happens, it may be possible to launch derivatives on life settlements and provide a much desired hedge against longevity, said Mr. Wesbroom.
PME’s Mr. van den Brink sees life settlements as a form of fixed-income arbitrage with a 10-year investment horizon and an average annual return of between 9% and 11%. The investment is definitely not a longevity hedge in its current form, he said.
“The life expectancy of the (former) policyholders is the risk. The trick is for a pension fund to invest in a very large portfolio (of policies) in order to get to the statistical average of life expectancies. If you build a large portfolio, the longevity risk is low, compared to the additional return,” he said.
Counterparty risk is limited because investors are putting money into securitized pools of policies backed by highly rated insurance firms — not unlike mortgage-backed securities.
Cordares, whose clients include the e18 billion Stichting Bedrijfstak Pensioenfonds Bouwnijverheid plan for construction workers, Amsterdam, and Stichting Pensioenfonds voor de Woningcorporaties, the e4.5 billion Huizen-based pension plan for housing corporations, has teamed up with life settlements provider Legacy Benefits Corp., New York, to launch its fund by the summer, said Mr. Tielman.
He expects Cordares’ clients to invest up to e100 million in the fund. The fund will be based on a broad pool of U.S. life settlements with conservative life expectancy estimates and will have an expected annual net return around 8%.
Fairly conservative
Mr. Tielman considers this a fairly conservative return for the asset class and said the investment fund is designed to give investors their first taste of life settlements rather than trying to squeeze out every last ounce of alpha. But recent strong demand from investment banks for life settlements has pushed up prices and could reduce short-term yields. This short term buying could scare off long term investors who are just starting to express an interest in the asset class, he warned.
The pension plan executives he has spoken with view life settlements as an attractive investment because of the low correlation to other asset classes. “It’s a relatively new and illiquid asset class, so there could be some excess returns, and it has long-term diversifying benefits,” he added.
He said a number of Dutch pension plans outside the Cordares group are also “seriously considering” investing in the asset class and a Belgian institution was watching short-term price movements before firmly committing assets. He would not identify any of the plans.
But the life settlements market is still small compared with the investment needs of U.S. pension plans. Some Mercer Oliver Wyman clients struggle to find sufficient policies to build a diversified portfolio, said Mr. Fishbaum.
Early investors in the asset class might get the best returns, he added. When the market first launched around four years ago, some investors were getting returns of between 13% and 15%. Increased demand has seen that fall to around 9.5% now. “That’s still a pretty good return for the risks involved,” he said.
Less likely in U.S.
U.S. pension plans are unlikely to invest in life settlements to any great extent until the market becomes better regulated and more transparent in originating policies for investment, said Dan Ozizmir, managing director at Swiss Re Capital Management and Advisory, New York.
Also known as death bonds, life settlements have a somewhat tainted reputation as returns are dependent on the death of the policyholder.
But Mr. van den Brink, Mr. Tielman and other sources active in the market take pains to draw a distinction between life settlements and viaticals, a practice where people dying of cancer or AIDS sell their life insurance policies to third parties.
Life settlements are different because the policyholder cannot have been diagnosed with AIDS or cancer and cannot have a life expectancy of less than two years, said Life Settlement Solutions’ Mr. Simon.
