Positively Skewed Fixed-Income Alternative

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Stockholm (HedgeNordic) – Many Americans rely on life insurance policies as a critical safety net to ensure the economic security of their families through the loss of a loved one, and most often, the primary breadwinner. However, most policies never pay out since policy owners stop paying premiums and allow their policies to lapse.

Older policy owners that have kept their policies have been increasingly opting to sell their policies to third parties in the secondary market for life insurance policies for an amount greater than the policy’s cash surrender value but less than the expected payout to the beneficiary upon the policy owner’s death. This secondary market exploits an inefficiency that enables both policy owners and third parties to achieve a mutual economic benefit. An alternative investment fund, Ress Life Investments, run by Resscapital’s Stockholm-based team has been snapping up such policies in the U.S. secondary market for life settlements since 2011.

“In our view, long longevity in itself is not a risk, the biggest risk comes from how our fund managers are able to estimate and control longevity risk.”

The success of a life settlements strategy requires accurate estimates of longevity. “In our view, long longevity in itself is not a risk, the biggest risk comes from how our fund managers are able to estimate and control longevity risk,” explains Jonas Mårtenson (pictured), the founder of Resscapital. “We have to make sure that our portfolio managers actually understand longevity and understand how to mitigate the risk by selecting lower-risk policies that still provide an attractive return.”

Resscapital’s approach to mitigating longevity risk involves buying policies from healthy retirees with long life expectancies and choosing conservative estimates of life expectancies. “For us, the name of the game is to buy policies with long life expectancies, based on conservative estimates,” Mårtenson tells HedgeNordic. “We require at least two estimates of life expectancies when buying policies, and we try to be very cautious by working with niche medical underwriters that tend to provide somewhat conservative, longer life expectancies,” he continues. Resscapital’s risk-aversion has resulted in more policies paying out than expected in recent years, providing a boost to the fund’s performance.

Positively Skewed Fixed-Income Alternative

Ress Life Investments has generated an annualized return of 7 percent in the past five years, just in line with its return target of 7 percent net of fees in U.S. dollars. “The fund is completely uncorrelated from equities, fixed income and other asset classes, because the main risk we take is longevity,” explains Mårtenson. Over the past five years, Ress Life Investments has exhibited a correlation of 0.07 with the MSCI World and 0.04 with the S&P 500. “It is very difficult to find investments that are quite uncorrelated to the major asset classes.” With an annualized return of 7 percent in the past five years, Mårtenson views Ress Life Investments as a perfect alternative for fixed-income investments.

“The fund is completely uncorrelated from equities, fixed income and other asset classes, because the main risk we take is longevity.”

“This is a high-yielding fixed-income replacement with a very high credit quality,” says the Resscapital founder. “We have policies issued by close to 60 different U.S. life insurance companies with a minimum rating of A-,” he continues. “Although the credit risk that we take on U.S. life insurance companies is real, there are no known cases in the United States when policy beneficiaries did not receive death benefits,” says Mårtenson. “A life insurance policy will pay out even if the life insurance company goes bankrupt. Bankruptcies have happened many times in the past, but the actual portfolio of life insurance policies from a bankrupted insurance company may then be sold to another life insurance company. The death benefits have always been paid out.”

“From a diversifying point of view, this is a great counter-cyclical allocation to most other investments.”

Although Ress Life Investments represents an alternative to fixed-income allocations, its return characteristics differ from those of equity, fixed-income or other investments. “Ress Life investments is not only uncorrelated, but also exhibits return characteristics that are very different,” argues Mårtenson. The fund tends to exhibit a distribution of returns that is positively skewed. “About 70 percent of monthly returns are positive and 30 percent are negative. But if you look at the way our performance is derived, we have periods of very flat performance just like this year where nothing much happens,” says Mårtenson. “But when the policy pays out, the net asset value will increase quite a lot, which is an interesting and somewhat unique return characteristic. From a diversifying point of view, this is a great counter-cyclical allocation to most other investments.”

Inflation

With inflation dominating investing conversations so far this year, Mårtenson still views his team’s life settlements strategy as an attractive alternative in an inflationary environment. “Since we are delivering a nominal return, increasing inflation does have a negative effect because our returns may become less attractive. Also, of course, the big policy payouts in many years to come would also be affected by inflation,” acknowledges Mårtenson. “On the other hand, we would also pay less relatively speaking in premiums. We have the cash outflows in the form of premiums, which are becoming worth less and less because of inflation.”

“Compared to a bond strategy, we are less affected by interest rates shifts,” argues Mårtenson. “We are picking up quite a lot of extra yield if we buy policies at an expected IRR of 12 percent in U.S. dollars in spite of inflation. There is quite a big cushion here,” he adds. “If we can deliver on our target return of 7 percent or even higher, that is still attractive versus many other fixed-income strategies even in an inflationary environment.”

Ideal Portfolio Size

Ress Life Investments gained 2.8 percent in the first nine months of 2021 after booking a gain of 7.2 percent last year, about 8.0 percent in 2019 and a record 9.9 percent in 2018. “The performance is lower than expected so far because we only had a few policies paying out this year,” explains Mårtenson. “The portfolio is still rather small with approximately 400 policies, so we still see periods of time when fewer policies pay out,” he continues. “Even a 12-month period is quite a short timeframe.”

“A portfolio of 1,000 policies could provide a much more stable and less volatile performance.”

“A portfolio of 1,000 policies could provide a much more stable and less volatile performance,” argues Mårtenson. Its $282 million in assets under management are currently invested in over 400 policies with a total face value exceeding $1 billion. “We have had record buying in the last 12 months, with the team buying probably around 100 new policies in the last year. So our aim is to continue to increase the portfolio and generate similar but more stable performance for our investors.”

Tertiary Market Journey

In addition to the mature and growing secondary market for life insurance policies, the so-called tertiary life settlement market, which enables the purchase and sale of larger portfolios of life policies, has also become more active. Resscapital is now planning the launch of a “closed-end fund investing in the tertiary market for larger institutional investors in 2022.” According to Mårtenson, “the fund is going to be much more like a private equity fund, a 10-year closed-end fund with minimum ticket sizes probably around $25 million.”

“We will be launching a closed-end fund investing in the tertiary market for larger institutional investors in 2022.”

Stockholm-based Resscapital has all the ingredients needed for successfully navigating and investing in the tertiary market. “We have built a great ten-year track record, we understand and have deep knowledge of the asset class, and we are a well-established player,” says Mårtenson, who is the only non-U.S. board member at the Institutional Life Markets Association (ILMA). “We have also developed our own internal portfolio management systems that enable us to filter and review large quantities of data. All our systems and portfolio management are well adapted for the launch.”

 

This article featured in HedgeNordic’s “Diversification” publication.

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Eugeniu Guzun
Eugeniu Guzun
Eugeniu Guzun serves as a data analyst responsible for maintaining and gatekeeping the Nordic Hedge Index, and as a journalist covering the Nordic hedge fund industry for HedgeNordic. Eugeniu completed his Master’s degree at the Stockholm School of Economics in 2018. Write to Eugeniu Guzun at eugene@hedgenordic.com

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