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Hedge Funds Buy Life Insurance Policies to Ply New Profit Path
For Michael Mandell, running a hedge fund is a matter of life and death.
After investors pulled 90per cent of the $US 80million ($108million) in his New Aquarian funds, starting last year amid bruising competition in the industry, Mandell sought investments that hadn't been picked over by rivals. He created a new partnership, LSF Investment Fund, and entered the life insurance business.
Other US hedge funds are now tapping the same well, buying policies from elderly people at a discount, paying premiums to the life insurers, then collecting the full value after the policyholder dies. As the funds explore new frontiers, from financing movies to buying art, the trade in so-called "life-settlements" may offer them a way to boost performance and lure investors.
"Returns in the more traditional strategies have declined over the last few years," says Mandell. Money has flooded into the funds' main business of hedging stock, bond and commodities prices, and strategies for exploiting price discrepancies no longer pay off, he says.
Annual average hedge-fund returns have dipped to as low as 3per cent since 2000 after exceeding 20per cent six times in the 1990s, according to HFR Asset Management, a Chicago-based firm that studies the industry. At the same time, the number of funds has surged. There were 8532 as of September30; in 2000, there were 3873 worldwide, according to HFR.
Sanford C Bernstein & Co analyst Suneet Kamath projects that life settlements will be worth $US160billion sometime in the next several years, up from $US13billion in March. That growth will be powered by the ageing of the baby boomers - those born between 1946 and 1964 - and greater acceptance of the settlements, he says.
Also helping is a US accounting rule that allows money managers to avoid booking large losses upon buying a life insurance policy.
Along with LSF, the new players include National Life Settlements Fund and HM Ruby Fund. Among other companies that have become involved is a unit of General Re, owned by Warren Buffett's Berkshire Hathaway.
Some insurance companies are unhappy about the new business, since hedge funds are unlikely to let policies lapse, forcing insurers to make big payouts they might otherwise have avoided. Insurers say about 35per cent of all policies lapse - a cumulative figure that life-settlement providers say is closer to 80per cent.
"Insurers are not big fans of life settlements," says LifeSettlementPro.com account executive Grant Shellhammer. His company evaluates the suitability of life insurance policies for settlements. "They know there is going to be a death benefit paid out."
Massachusetts Mutual Life Insurance chief actuary John Skar says the fees for a life settlement rob policy holders of much of the value of the sale.
"The transaction costs involved in selling a life insurance policy are very, very high," Skar says, citing a University of Connecticut study. "You are destroying between 50and 75per cent of a policy's value when you sell it."
Life settlements are based on the premise that many individuals no longer want, need or can afford to keep paying premiums on their insurance policies.
The concept of investing in other people's life insurance became popular in the 1990s with viatical settlements, which allowed AIDS patients faced with big medical bills and short life expectancies to sell policies to investors. Those instruments were rendered unprofitable by more effective AIDS drugs.
Before the emergence of life settlements, people who no longer needed insurance had two options: let their policies lapse - thereby losing the benefit of premiums they had been paying for years; or sell the policies back to their insurer for a minimal cash-surrender payment, typically about 5per cent of the policy's face value. Life-settlement providers can offer to buy the same policies well above their surrender value and still generate annual returns of 9per cent to 13per cent for investors, according to Sanford CBernstein's Kamath.
"If you look at this investment on a risk-adjusted basis, it's a very solid return," says Q Capital Strategies chief executive officer Steven Shapiro. Q Capital is a life-settlement provider.
Source: Bloomberg
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