Investors must heed traded life risk, warns report

Investors must guard against a new wave of high-risk traded life products, according to a report commissioned by Managing Partners.

Merlin Stone, a visiting professor at Oxford Brookes, De Montfort and Portsmouth universities and author of the report, says funds which use traded life policies (TLPs) in securitisations or use incorrect actuarial methods could pose particular dangers.

“The horrific fallout from the securitisations of mortgages seen in the US is a clear warning of the risks”

“While the TLP sector could still be seen to be in its infancy, one of the signs of growing maturity is the growing range and sophistication of products that use TLPs as an underlying asset. These include the longevity derivatives linked to indices based on portfolios on life policies, but another, more notable example that has attracted a great deal of publicity—often adverse—is securitisations,” he says.

“The growing use of securitisations is a concern because of the ways in which they are put together and the motivation for originators to offer them. Investors must scrutinise these securitisations very closely. The horrific fallout from the securitisations of mortgages seen in the US is a clear warning of the risks.”

Managing Partners has drawn up a list of funds for investors to avoid, including funds where the risk of policy holders exceeding their life expectancies and delaying payouts is greater. (article continues below)

Funds that charge high fees or performance fees can undermine returns and skew managers’ incentives, the firm says. Funds should also be Financial Services Authority-regulated, have critical mass and a “reasonable track record”, including in managing currency risk as policies are typically denominated in dollars.

Despite the possible emergence of riskier products, Stone says traded life boutiques could become takeover targets as the popularity of the asset class grows.