As an Advisor, you're well-versed in the lurking financial risks that could affect your clients' investments. There are, of course, derivatives that are a form of insurance that can accompany risk capital to ensure outcomes against market volatility. Currently, there is an asset class with the permanence and predictability that investors deserve to understand that can provide a form of insurance cover that applies to their entire asset allocation. The Asset Class is Called Senior Life Settlements (SLSs).

What is a Senior Life Settlement? The Senior Life Settlement industry has become a significant source of liquidity for seniors that no longer need, want, or can afford the premiums associated with their life insurance coverage and wish to monetize their asset. An SLS is acquired from an insured at an amount greater than the surrender value offered by the carrier but less than the face amount payable as a death benefit. The new owner assumes responsibility for servicing the policy premiums and is entitled to receive the death benefit at contract maturity. The spread that remains between the contract acquisition cost and the face amount of the contract is the store of value.

In the 1911 case of Grigsby vs. Russell, US Supreme Court Chief Justice Oliver Wendell Holmes ruled that life insurance is the legal property of the insured and is freely transferable at the will of the owner. The US Legal Reserve (USLR) Life Insurance System is one of the most well-heeled, stable, and properly capitalized industry segment charters in the world. The most basic and important value proposition backing the SLS business is the claims paying ability of the carriers as defined by the USLR. Life insurance is an exceptional store of value, as there is no precedent for the outright failure of a USLR carrier to pay a legitimate death claim in the life insurance industry’s history. As a non-correlated fixed income investment mechanism, life insurance is a predictable and safe organic capital growth instrument with particular applicability in the alternative fixed income space.

The primary risks of owning the SLS asset class are time and illiquidity. Accredited mortality assessment specialist medical underwriting firms assess the projected holding period to maturity of an SLS contract by virtue of an appraisal of the insured’s expected life span. Life Expectancy assessments, of course, are not guaranteed, as precise predictions of human mortality are incalculable. The greatest challenge to managing SLS portfolio assets is the proper capitalization of reserves to service the premium obligations of the life insurance contracts to maturation.

The time risk associated with SLSs deserves further explanation. In most instances, when an investor purchases an SLS, the risks associated with the asset class are normally transferred in whole and in kind to the new owner. If the insured lives beyond the time that the Life Expectancy Assessment asserts as the probability of mortality occurring as the basis for the premium reserve, the investor alone bares the risk of continuing to pay the necessary premiums to keep the policy in force. This, of course, logically would reduce the investor's Total Yield to Maturity as the additional investment increases cost basis and shrinks the spread the investor yields at the maturation of the policy.

To carefully consider the risk of owning SLSs in your asset allocation, conservatively, one should take into consideration the effect Extended Longevity (the Insured living, in some cases, well beyond their assessed Life Expectancy) will have on the investor’s holding period and how that could potentially impact their liquid capital needs from other sources of income and capital reserves. Although the probabilistic view that one might experience early maturities exists, it is unwise to overweight this possibility. To put this in perspective, metaphorically, is it possible to flip a coin one-hundred times and it turn up heads or tails one-hundred times in a row? Yes. Is it probable that would occur? Rhetorical question.

Probability is a tool that we all use in some form or fashion to reflect, based on available inputs, our best guess as to what may happen in the future.  Once the outcome has been determined, one can compare their guess to the result and adjust thought processes moving forward.

Thanks Captain Obvious!  Bear with me here because the former paragraph is the basis for this discussion. In SLS parlance, there are two schools of thought relative to portfolio management:  Probabalistic versus Deterministic Pricing relative to Extended Longevity Risk as it pertains to reserving adequate premium to more accurately mitigate the risk of yield erosion due to Premium or Capital Calls to keep the underlying life insurance policy in force and good standing until maturity.

Probabilistic and Deterministic Pricing deserves its own separate discussion, but at the heart of the matter, would you feel more comfortable going with your best guess where your money is concerned or hedging the risk the statistical analysis might be wrong? Here’s a hint:  The Probability is wrong. One can’t be sure in which direction it’s wrong but make no mistake…It’s wrong. Do you drive a car with the belief that you probably won’t wreck or someone wreck into you or do you manage risk by buying car insurance that covers a potential wreck? Again…rhetorical question.

The SLS industry finally has a version of insurance to share the risk of your investment in this asset class. A solution has been developed to mitigate the risk that an investor’s yield could potentially be eroded or it evaporates altogether due to the unknowns surrounding human mortality.

Unlike evaluating the correlation and/or geo-political risk exposure an investor has in their risk asset allocation, mortality risk is a different metric altogether. The fact is, no matter how hard we all try, none of us are getting out of here alive. The Total Projected Yield receivable by an investor has only one element and that is the mortality of the insured. The Premium Reserve Management (PRM) Solution was engineered to mitigate the time risk involved in owning the SLS asset class.

The PRM puts measures in place to transfer the risk of Extended Longevity away from the investor by deploying a series of hedges in place to elongate the utility of the investor’s premium reserve allocation to deterministically reduce the risk of premium calls. In short, the hedging mechanisms in the PRM Solution are:

• Policy and Portfolio Mean Life Expectancies are produced by utilizing three independent assessments to remediate the risk of relying on only one or two medical underwriter’s estimates.
• The Premium Reserve is augmented by an additional two-years of premium pegged to the Mean Life Expectancy to hedge the “wrong-ness” of the Life Expectancy Assessment.
• The Premium Reserves are conservatively managed in trust to produce additional yield during the SLS portfolio’s maturation cycle.
• In the event of early maturities, any surplus premium remaining in a portfolio is retained and managed in trust to provide an umbrella of premium paying ability applicable to any policy under management to spread the risk across a larger universe of contracts than an investor may own in a particular, segregated portfolio.

The PRM Solution is designed to make an SLS uniquely have a known-cost, a known-yield and a quantifiable value receivable in the future. Given the fact that the SLS asset class has these characteristics and is unaffected by risks typically associated with capital market based products, it has tremendous value as an overall investment risk hedging strategy.

We would like to invite you to download Capstone Alternative Strategies' proprietary Premium Reserve Management (PRM) White Paper to see how we share the risk with you to usurp the maximum value from your investment in this exciting new asset class.

For more information, please contact Jason Bokina at (404) 504-7006 or email us at contact@capaltstrategies.com. 

Michael J. Bradburn

Michael Bradburn started his career as President and General Manager of a small automotive sales conglomerate, where he oversaw and managed several domestic and Asian manufactured retail dealerships. After selling the dealerships, Michael then worked with Prudential Preferred Financial Services in life insurance and annuity sales.  He later advanced his career in private wealth management at Morgan Stanley-Dean Whitter and subsequently Merrill Lynch. Following that, Michael served as Chief Financial Officer of a metals manufacturing and distribution startup, where he was instrumental in securing patents and developing a completely virtual, vertically integrated, manufacturing and distribution technology serving the global powder metallurgy industry. At Capstone Alternative Strategies, he oversees marketing and advisor development. Michael attended Indiana University where he became a member of the Sigma Chi fraternity and later earned his BS from Ball State University.