THE process of buying an insurance policy to cover your life or as a form of savings through an endowment plan is a fairly familiar one to most people. But the prospect of investing in “second-hand” policies takes many investors into unfamiliar territory. The so- called second-hand insurance market refers to existing policies that the original policyholders have sold to investors, who may be individuals or a company.
These policies are packaged into investible instruments. There are broadly two types: One is the traded life plan (TLP) which mainly originates in the US. These are typically whole life plans in which the insured may be elderly or may suffer illness that shortens their life expectancy.
There are broadly two segments in this category. Life settlements refers to whole life policies where the insured is elderly. Viatical settlements are policies where the insured is terminally or chronically ill. The policy is purchased at a steep discount to its face value. Returns are realised when the insured dies – hence, the monicker “death bonds”.
The second type is traded endowment plans (TEP), which are with-profits endowment plans that typically originate in the UK, which is the most established market for this type of asset. Returns are realised when the endowment matures. There are attempts to get a traded endowment market going in Singapore.
Traded policies have taken off in the US and the UK because there was a need in the marketplace for more options for policyholders who wish to give up or terminate their plans. They could, of course, surrender the policy with their insurer but the surrender value is typically very low. The TEP/TLP market steps in by offering to purchase policies at a premium to insurers’ surrender values.
There are many reasons a policyholder may want to give up a policy. Life circumstances may have changed, for example, and he may no longer need the cover. Or, he may not be able to afford to maintain the policy. In both types of traded policies, the policies will be assigned to investors who take over premium payments.
In mature investment markets such as the US, UK, and Australia, the TEP/TLP asset class is seen to be attractive as its return and risk profile differ from traditional financial assets such as stocks and bonds. Correlation with financial markets is low and the return profile is seen to be stable.
The policies that form the underlying assets for TEP/TLPs are typically with-profits policies, which means that the policies’ premiums are invested by insurers in their respective life funds. Returns are smoothed and are reflective of life funds’ experience. This is preferred as the value of unit-linked or investment-linked policies is subject to the vagaries of financial markets.
TEP/TLPs are fairly complex assets with a disparate set of risks for the policyholder and for the investor. TLPs in particular are causing concern. The UK Financial Services Authority last year “strongly” recommended that they not be sold to retail clients, citing TLPs’ complexity, inherent risks, and that they are often inappropriately sold. Here is what you should know.
The policyholder view
There are companies that have approached Singapore policyholders and offered to buy over their endowment policies for resale locally or overseas. While the company may offer an attractive realisation value that is certainly higher than the plan’s quoted surrender value, this is a decision a policyholder should weigh carefully.
Insurance is a long-term commitment where value is realised only after many years. Among Singapore whole life plans, you typically do not break even on premium payments until the 17th year or longer. If you had bought the plan when you were much younger, you will not be able to purchase an equivalent protection at the same price.
As for endowments, a 10-year plan’s breakeven point could be in the eighth or ninth year. The plan may also be structured with maturity bonuses that can significantly enhance the maturity values.
The endowment may also have been purchased a few years ago when interest rates were higher. Even if there may have been bonus cuts, the quoted returns are likely to be much more attractive than today’s crop of endowment policies.
Examine your needs. The sum assured of a whole life policy may be substantial. There may also be critical illness riders giving you an element of health cover. The big question is – do you need the policy’s protection value? You may have developed pre-existing conditions that make you uninsurable, or may subject you to higher premiums.
If you face cash flow issues and find it difficult to continue to pay premiums, you can typically avail yourself of a number of options from the insurer. You may, for instance, be able to convert the policy to a paid-up one where there is still a sum assured, but you need not pay further premiums.
There must be enough cash value in the policy for this option to be viable. You can also take up a policy loan for a period of time, or take a so-called premium holiday. These options should be discussed with your adviser and insurer.
In the UK where TEPs are an established market, insurers are required to inform policyholders who wish to surrender their policies that there actually is another option – to sell their policies in the secondary market.
Obtain advice. Given that the TEP/TLP market in Singapore is nascent, yet another challenge is to ascertain whether you are offered a fair price for your endowment or life policy. In the UK, the Association of Policy Market Makers (APMM) says on its website that the amount that its members pay in excess of an endowment’s surrender value is between 3 and 15 per cent on the average.
The traded endowment market is said to have peaked in 2008-2009 when policyholders could get up to 15 per cent above the surrender value. The current rate is reportedly between 5 and 10 per cent. APMM represents the UK’s leading endowment policy trading organisations which deal with the buying and selling of second-hand with-profits endowment policies.
The investor view
An investor in TEP/TLPs will grapple with a vastly different basket of risks from a policyholder. Here is a bird’s eye view:
Asset allocation and financial planning. You should view an investment in TEP/TLPs in the light of your overall portfolio. For instance, are you already heavily invested in endowment plans? While endowments are typically seen as low-risk, they are not risk-free. A poor market environment could cause the insurer to cut expected returns.
Arguably, an allocation into TEP/TLPs – particularly if they are offshore and single policy in nature – should be considered as part of your allocation into alternative investments given the fairly unique set of risks. This suggests that you should not be too heavily weighted in this segment. Do seek advice from a financial planner.
If you invest in a single policy, you also have to weigh your financial and cash flow circumstances. You will have to be able to maintain premium payments, perhaps for longer than you expected in the case of TLPs, as will be discussed further in this piece. This can be a heavy burden should you be near retirement, in retirement, or you lose your job.
Fraud risk. This is a very real risk in TEP/TLPs and one which is also a challenge to ascertain, particularly if you invest in a single offshore policy. Fraud can occur in a number of ways and the incident rate appears to be higher among TLPs than TEPs.
In life policies, a policyholder could lie about his health and take up a policy with the objective of eventually selling it to a life settlement company. A policyholder could also claim to be in a worse condition than he actually is so the policy could fetch a higher price. In TLPs, a shorter life expectancy suggests that an investor could profit over a shorter holding period.
Investors risk losing part or all of their capital should an insurer deem policies to be null and void due to fraud. When fraud occurs at the point of sale of TEP/TLPs – such as the sale of non-existent policies – the investor could lose their entire principal.
In the case of TLPs, there is also very little that an investor can do to independently verify the claims made by actuaries and doctors about the original policyholders. While investors are typically advised to deal with licensed entities – market makers and/or distributors, even that may not be an adequate safeguard.
Last year, the US’ Securities and Exchange Commission (SEC) charged a life settlements brokering firm and three of its senior executives for their involvement in a fraudulent disclosure and accounting scheme involving life settlements. The broker is Nasdaq-listed.
The SEC alleged that the firm’s senior executives misled shareholders by failing to disclose a significant risk to the business – that the company was “systematically and materially” underestimating the life expectancy estimates used to price transactions.
In a separate case in 2010, the SEC obtained a court order to temporarily freeze all assets and appoint a receiver to take control of an entity, which the SEC alleged had defrauded investors in life settlement policies to the tune of US$3.5 million.
In the UK, the Financial Services Authority fined a company £35,000 (S$65,755) and imposed a partial ban on two directors and an adviser for failing to provide suitable advice to clients of retirement age. The clients were offered a senior life settlement policy that did not provide a capital guarantee but was marketed as “low risk”.
Life extension risk. Pertaining to TLPs, this is the risk that the policyholder could live longer than expected and thus significantly delay the realisation of returns. This risk is material, as advances in medicine are helping people to live much longer. If this occurs, investors have to bear with paying premiums longer than they may have initially expected. Returns will be reduced or may even be negative.
Insurer’s financial strength. Once you invest in a TEP/TLP directly, you will take over the premium payments. The financial strength of the insurer and its ability to pay promised benefits should be of concern to you. If you are investing in a single policy, you should satisfy yourself in this regard.
Should the insurer be unable to pay the benefits due to solvency issues, or it cuts endowment plans’ payouts, then you could suffer a loss or a substantially lower rate of return. If you invest in a fund which pools together TEP/TLPs, this risk should be mitigated by diversification. That is, a fund will be exposed to a number of insurers and policies, which should cushion the impact of failure in any single insurer.
Legal risks. The TLP and TEP products sold to Singapore investors are mostly based on policies acquired overseas. Should there be issues or grievances, investors will need to enforce their contracts against life insurance firms overseas and deal with overseas legal jurisdictions. This can be costly and complex.
Liquidity risk. Investors who buy single TEP/TLPs may not find it easy to re- sell the policies should they decide not to hold to maturity. This is a risk that should be weighed carefully in the light of life extension risk where you may have to continue to fund premiums for more years than you bargained for.
Foreign exchange risk. Offshore TEP/TLPs will be quoted in a foreign currency. You will be subject to forex risk on the benefit or maturity value at the time that you decide to convert it to the local currency.
If you invest directly in an offshore policy – as opposed to a collective investment scheme or fund – your regular premium payments to maintain the policy will also be subject to forex risk. That is, if the foreign currency strengthens and you need to convert local currency for every payment, you will suffer higher costs. A weaker foreign currency will have the opposite effect.
Unregulated area. The sale, purchase, and distribution of TEP/TLPs are not regulated by the Monetary Authority of Singapore (MAS). Individuals or companies involved in the purchase of policies, and repackaging and reselling them as TEPs or TLPs do not fall under MAS’ regulatory ambit, whether they are based in Singapore or overseas. Distributors of the policies are also not regulated by MAS, whether they are based in Singapore or overseas.
This means that should you have a grievance against the product or the way it was sold to you, you will have no recourse under MAS and the rules in place for the sale and distribution of investment products.
One exception is if a collective investment scheme (CIS), fund or a corporate entity is already regulated by MAS under the Securities and Futures Act, and TEP/TLPs form the underlying assets of the fund or entity.
Consumers can look up the financial institutions directory on MAS’ website to see if an entity is licensed or authorised by MAS. To find out if a CIS is authorised or restricted, consumers can look up the CIS on OPERA and CISNet, respectively.