Every year in the US, an estimated $1 trillion's worth of life insurance policies are surrendered by holders unable to afford premiums or who are in need of cash.
American life assurance companies have just two years to investigate whether proposals have been filled in truthfully and cannot contest them after that timeframe - unlike in the UK or in many European jurisdictions where taking up a dangerous hobby could put the policy at risk - meaning holders have a veritable asset on their hands.
Over the years, surrendered policies in the US have proven increasingly attractive on the secondary market, particularly senior life settlements - life insurance policies of people aged 65 that have been sold on.
Senior life settlements involve investment groups buying policies that are no longer wanted in return for an amount greater than the cash value offered by the insurance company, but lower than the face value (the sum insured).
As the new policy owner, the investment group will then be responsible to make future premium payments and will collect the insurance benefit on maturity. Life expectancy can vary between three to 15 years on average.
Extensive due diligence procedures, risk assessment and life expectancy analysis is usually undertaken. Investment groups usually diversify their pool of senior life settlement policies by age, gender, health, region and issuing company.
Insurance is a key feature in US economic culture - the total life insurance market in the US is worth around $18 trillion - and there are safeguards in place to protect policy holders. The National Health and Life Insurance Organisation ensures that there are guarantee funds to meet residual claims to policy holders should a life assurance company default. Policies are covered to $300,000 in many US states and for higher amounts in others.
As life expectancy is totally uncorrelated to equity or bond markets, senior life settlements are an alternative asset which investors could consider when looking to diversify their portfolio.
Major investment banks, insurance companies, asset managers, hedge funds and pension funds have been attracted to this alternative asset class and have used it to back investment instruments, particularly bonds, also referred to as asset-backed bonds.
To provide a level of added protection for investors, asset-backed bonds require an asset cover at all times through an amount of face value of SLS policies. The ratio is usually 1.25 times as a minimum.
Msida-based financial management company MFSP Financial last Friday launched the ninth tranche of the ARM Asset Backed Bonds, which is backed by US senior life settlements. The bonds have a coupon of 7.5 per cent per annum and mature in 2014. They are issued by ARM Asset Backed Securities SA as part of the $250 million ARM Asset Backed Securitisation Programme listed on the Irish Stock Exchange.
Andrew Wilkins, executive director, and James Haupt, head of sales of Catalyst Investment Group of London, the primary distributors of ARM Asset Backed Securities, also addressed the launch event at the Hilton Malta and confirmed the renewal of the exclusivity agreement with MFSP.
MFSP Financial managing director André Micallef explained that ever since its inception in 2007, the company focus was to offer low risk, uncorrelated investment solutions. Through its relationship with Catalyst, MFSP introduced the SLS asset class to Maltese investors.
"When people think of investments they usually think cash, bonds or shares," Mr Micallef told The Sunday Times. "We would like to broaden that vision. Life settlements make up an alternative asset people might consider but there are others like student accommodation in the UK, oil and gas, and currency trading. Life settlements target the lowest of risks in alternative assets."
Mr Micallef explained that tranches are issued quarterly - MFSP has offered seven to Maltese investment so far - and are closed to be then offered on the market when a substantial basket of policies are collated. There are plans to extend the programme - currently sized to total $250 million - to $1 billion.
According to Mr Micallef, Maltese investors have responded positively to previous offerings and clients have not seen a decrease in value on their investment, notwithstanding the recent market turmoil. The dividends investors were promised have remained stable. Unlike other bonds, this bond can be sold every six months, should investors opt for early withdrawal.
"This investment option is not for clients who are looking for a liquid asset," Mr Micallef cautioned. "The investment must be held full-term; there are exit fees which decrease on an annual basis. It is for people who are looking for a regular payment as it pays quarterly. It is also an asset that is passported. When client receives the income, we are able to deduct the 15 per cent withholding tax, which is important for the local client base."