Nov 9, 2011

Investing in Death

One year ago, I engaged a financial adviser. We had a review of my portfolio this week. The portfolio has done well. I made about 8% over one year, which is very good, considering how disastrous the year 2011 has generally been, for stock markets around the world.

This performance has been possible, because a good part of my portfolio was not in the traditional sort of equity funds. In fact, a good part of the portfolio was not in equities at all. The advantage of being an accredited investor is that I get to invest in more esoteric instruments that may not be accessible for ordinary retail investors.

Of course, this doesn't mean that esoteric instruments always make money. They can lose money too. However, they do significantly broaden your diversification options.

My financial advisor is now recommending that I consider a life settlement fund. I already know about these. I've never invested in these before, but I've read about them. In principle, they make sense to me. However, they have been the subject of some controversy in the US (which is also the only major market for such investments). How do they work?

A life settlement fund invests in life insurance policies. Where do they get these policies? They buy them from the policyholders. Who are these policyholders? Typically, they are people with a low life expectancy. They could be very old, or they could be suffering from some terminal illness such as AIDS or cancer.

So let's say you have a life insurance policy that promises to pay $1,000,000 when you die. And you happen to be very ill. You can't get the money while you're alive. And the money will be useless to you, when you die. You would rather have the money now, which you can immediately use either for your medical treatment, or just to enjoy what's left of your life.

In that case, the life settlement fund could buy the policy from you for, say, $800,000 (I have no idea what the typical pricing is like - I'm just using the $800,000 figure as an example). You get $800,000, to spend as you please. Two years later, you die.

The life settlement fund then gets to collect $1,000,000 from the insurance company. So essentially, over a two-year period, the life settlement fund has made a $200,000 profit, out of its $800,000 investment (less the premiums that the fund paid over that period).

This is the kind of investment that a life settlement fund makes. Of course, it does not just invest in one or two policies. Instead it invests in large numbers of life policies.

It's rather morbid. The faster these people die, the more money the life settlement fund makes. Conversely, the longer these people live (and who knows, a few people may even manage to recover from their supposedly terminal illness), the less profitable the fund will be. A "good" investment is someone who is very ill, has high chances of dying soon and owns a policy with a large payout.

For the investor, what are the advantages of investing in a life settlement fund? Well, it is excellent for diversification purposes. There is very little correlation to equity markets, or bond markets, or commodities, or other more-traditional classes of financial investments. Thus your investment could continue generating good returns, even if stock markets collapse badly.

The way they did, this year.


kayangmo said...

Can we have the names of the death row people when we invest? Yeah so morbid...

Anonymous said...

Thinking out loud ..

what if the person insured is murdered (or put it nicely, die of an unnatural death)?

Gilbert Koh aka Mr Wang said...

If he was unexpectedly murdered, he probably wouldn't have sold the policy beforehand.

People who sell the policy are most likely very ill and cannot work anymore. If they don't continue paying their premiums, the policy will lapse. But if they don't have income, they can't afford to pay the premiums.

So they might as well sell the policy immediately, and collect some cash.

Anonymous said...

1. inherently inefficient due to transaction costs.

2. a secondary market in life insurance hasn't developed partly because there isn't a way to price apart from using an actuarial model which incorporates lapse rate assumptions (a group measure, as distinguished from an individual measure).

3. you would probably? make money off these products in the short run. primarily driven by i) lack of regulation/disclosure; ii) inexperienced/desperate market participants with no option dealing with experienced/informed market participants; iii) recent institutional interest rekindled fueling exponential increase in size of market.

4. primary risks are i) serendipitous breakthrough in aids and cancer care allowing people to live longer and (gasp!) lower yield (rare); ii) lapse rate study breakthroughs in pricing primary market products (pipe dream).

good to know such products are reserved for accredited investors only ;)


Anonymous said...

question - why do these people buy life insurance in the first place if they don't intend for the $ to benefit anyone?

Anonymous said...

Correct me if I'm wrong. You can't 'buy' the life insurance from a person because Singapore legislation do not allow the beneficiary to be an unrelated person. So how does one who is critically ill, sell his life insurance to the fund managers for some immediate cash?

Gilbert Koh aka Mr Wang said...

Sometimes people buy life insurance and it seems like a good idea then.

40 years later, the person has divorced twice, the kids are grown up and don't need his money anymore. He's terminally ill and he's still been paying premiums all this while.

Might make sense just to sell the damned policy away and get some money for himself. Especially if he needs it for medical treatment.

Gilbert Koh aka Mr Wang said...

In Singapore, you cannot take out a policy on someone's life unless you have an "insurable interest". Generally it means that you cannot take out the policy, except on yourself, or someone like your relative.

But after you have bought a policy, I don't think you are prohibited from selling the policy (or assigning your rights under the policy to somebody else - in our example, the "somebody else" would be the life settlement fund).

Certainly, you are not prohibited from changing the beneficiary. Eg you can probably see why a person might, over a long period of time, change the beneficiary from his mother (when the person was still single single) to his wife (when he gets married) to his child (when he becomes a parent).

Anonymous said...

I guess this would have to be a USD investment as maybe only the US allows an unrelated party to buy out the insurance. If so fx risk here in the USD going down?

Eaststopper said...

This is akin to buying a put option on someone's life. Definitely not in my investment appetite.

I guess you will also have to take into account of liquidity and counterparty risks.

Anonymous said...

From your description of the financial instrument. It sounds like there is a direct correlation between profitability of this instrument and the number of deaths that occur within a particular group.

It just sounds a bit too inhuman for my tastes.

Anonymous said...

To be an accredited investor (at least $2m net worth, even if including property) before 40 is a tremendous achievement already.

Especially if it is by your own effort, or you are not a senior PAP politician or civil servant.

So I suppose success begets more success, and it's not surprising that you also have 8% returns on your portfolio.

Well done, but unfortunately PAP did not get your vote, which you had mentioned in your blog. So I suppose not all the 40% anti PAP voters are not doing well.

Anonymous said...

1. As a retired banker, I find this nascent product very interesting. Thanks for bringing it up.

2. I find it irritating when someone says that you have had been successful in your investment because of PAP.Is`nt it the responsibility of any government to
enhance commerce, finance and investment? And especially for one
who is so handsomely paid?
How can we look forward to a day
of real democracy?
Sorry, Mr Wang to drag you into this.

Anonymous said...

Where can we have access to this kind of products?

Is it only available to private banking clients?

Really hope u can let us know more details.

Anonymous said...

It's called a derivative?

Anonymous said...

Please note that Mr Wang's financial adviser may not be the type where most ordinary folks will encounter in banks or as insurance or what not agents.

If you are not of an accredited investor status or prepared to pay to engage a good financial adviser, then it is pointless to ask Mr Wang for specific info or advice.

After all, you are not Mr Wang. Nor is Mr Wang able or be willing to be your adviser, beyond what is common sense advise.

If you want common sense financial advice, go to TanKinLian blog. He dispenses plenty of free and good ones.

And finally remember the saying. One man's meat may be another man's poison.

Anonymous said...

8% realised gain, or paper gain? Marked to market?

EL said...

Hmm .. heard of this but not very sure about this but certainly I won't be comfortable in investing this product .. Bonds are pretty good buy now .. prices are low and you can decent yield .. moreover, it's liquid!! in time like this, liquidity is very important .. :)

For those looking for insurance to handle the objections raised in your article, they should go for jumbo insurance not the retail plan. Certainly, they do not need to sell their policies ..

Eaststopper said...