Participants:
William Corry, Founder and Managing Director, Corry Capital Advisors
Walter Deeter, Co-Founder, Managing Director & Chief Investment Officer, Burdette Asset Management
Patrick McAdams, Investment Director, SL Investment Management
Maurizio Pellegrini, Life ILS & US Life Settlements Manager, Azimut Investments
2022 provided global investors with one of the most challenging macroeconomic environments in years as higher inflation, rising interest rates and geopolitical instability combined to affect both stock and bond portfolios alike. Life settlements, however, tend to exhibit a low correlation to traditional markets, and Greg Winterton spoke to life settlement asset managers William Corry, Founder and Managing Director, Corry Capital Advisors, Walter Deeter, Co-Founder, Managing Director & Chief Investment Officer, Burdette Asset Management, Patrick McAdams, Investment Director, SL Investment Management, and Maurizio Pellegrini, Life ILS & US Life Settlements Manager, Azimut Investments, to get their take on how their industry did in 2022 and the outlook for the coming 12-24 months.
GW: Let’s start with a look back to 2022. Many in the life settlement secondary market say that deal flow improved last year, after a brief retreat in 2021. Do you agree, and if so, what are your thoughts about the sustainability – or not – of elevated levels of secondary market activity?
WD: Yes, we definitely saw a higher volume of origination in the secondary market, last year. That’s partly due to the recovery from the Covid-19 pandemic, but it’s also the education and outreach of the direct-to-consumer channel in our industry. Consumer awareness is very important to policy supply. The direct channel is a good thing for the consumer; if it’s done correctly, the net amount payable to the insured is often greater than might be realised in a traditional secondary market transaction because of lower intermediary costs. This trend definitely has legs – there is a substantial amount of policy flow going through that channel, and make no mistake, the consumer is shopping his policy to multiple DTC buyers.
PM: We also saw a pick-up in secondary market volume in 2022. Another factor at play is the cost-of-living increases in the U.S. and rising healthcare costs. Consumers are looking at budgets and for pensioners, their payments are flat, so they’re asking, ‘where can I cut back?’ Those that have a life insurance policy are paying a sizeable premium. Cut costs by selling the policy eliminates the ongoing cost as well as providing a lump sum. In terms of the sustainability of that trend, it stands to reason if inflation cools off and there is less pressure financially then consumers may choose not to sell. But a lot of activity in the secondary market over time comes back to a generally heightened level of awareness. Consumers will remember that they looked at selling their policy in the past and so might sell in the future. That residual demand will also drive secondary market activity.
MP: Volumes are certainly picking up and to add to what Patrick said, the cost-of-living situation is having an impact particularly in the $500k – $1mn policy value range. But it also depends on what kind of segment of the market you target. Longer term, higher value policies are less impacted by cost-of-living considerations – the decision-making process for these consumers is different. And at the end of 2022, there was something of a reduction in supply of that paper and I think that the contraction in this policy value range will remain in 2023 if the cost of funding stays high.
WC: I agree on the increase, particularly in Q3 or Q4 of last year. Sustainability-wise, I think it’s looking good. Yes, some policies with lower face values are being driven by the economic environment itself. But on the higher end, let’s say $3mn or more, that’s being driven by the education of consumers and their awareness of the life settlement option. Wealth managers are increasingly participating in the asset class, because of demand from their clients, and because of their own increased understanding of it. This trend is a particular one that I’d expect to continue to grow.
GW: Still in the secondary market, brokers say that the bidding starts too low and that is one of the main contributors to what they think is a drawn-out sales process. What’s your view?
PM: Look, this is an open auction market. Price discovery is undertaken by what an asset manager is willing to pay for the asset and the price that someone is willing to sell at. I’d also emphasize here that the term ‘broker’ suggests some kind of neutrality. In life settlements, the broker has a fiduciary duty to the seller – their client. They’re incentivised to achieve the best price. There is more bias amongst brokers in life settlement market than other markets. If I were a life settlement broker, I’d say that too. But I’m the buyer, and I only want to pay what I think the asset is worth. If brokers think that’s a lowball bid, so be it.
WC: You’re dealing with two separate fiduciary responsibilities. They have one to the seller and our job is to represent and have a fiduciary responsibility to our investors. I don’t see anything wrong with it but because of this, there’s no way to draw those two competing interests closer. Fund managers make offers at a fair price based on the provenance of the policy they look at. You’re just not going to speed this part of the process up.
WD: This has been an underlying complaint for a while. I understand the need for price discovery, but the time and resource commitment coupled with an uncertain or unattractive acquisition price is one of the reasons we are not very active in the traditional secondary market.
MP: The past few years have been a seller’s market in the life settlement space as well, so brokers have been able to keep an auction going. They had time to collect numerous bids and not leave anything on the table – that approach worked for them as many buyers wanted to buy. That’s also contributed to a longer sales process. But that is changing now – there are signs of a more balanced market returning. There is less of a seller’s market than before.
GW: More broadly, demand for alternative investment assets and strategies, like life settlements, faces at least short-term headwinds from rising yields on liquid debt allocations in the sense that the gap between the risk-free rate and the risk premium offered by alternative investments is shrinking. What’s the sales pitch for life settlements in a rising rate environment?
MP: It was definitely easier pitching investments into life settlements at the outset of last year but targeting double digit returns over the risk-free rate now is a different story. Sourcing good policies is harder and it’s more difficult to win them, and there is an upper limit to the return you might get. Previously, on low-risk policies you could promise high single digit returns because they were three times the return on treasuries. Now that’s only 1.5 times, which is a harder pitch. But diversification has always been a strength of our market, as well as compelling returns relative to other asset classes with a similar risk profile. This part of the ‘sales pitch’ hasn’t changed.
WC: For me, every investment should start with returns, regardless of the macro environment. Institutional investors should be asking how life settlement managers achieve the target returns. They should want to see the underlying assumptions – things like the stability of longevity extension and how that’s mitigated because that affects everybody’s book of business. Yes, in a higher interest rate environment, the appeal of life settlement fund earning a single digit return would be lower. And then if you use leverage, you have the chance of delivering higher returns, but that’s riskier and your returns become more correlated, which is something that our industry claims not to be. But I think the sales pitch starts with returns, and why investors should be confident you can deliver them.
WD: When treasury rates increase, the spreads of assets priced against them tend to narrow. But that shouldn’t make those assets less interesting. Life settlements provide diversification and an alternative to mainstream asset classes, so I think we need to be cautious when comparing LS to traditional markets. If we look back at 2022 and say equity markets were horrible and you needed to be in LS, when equities turn around you have to acknowledge that, too. For me, this asset class isn’t a fixed income alternative either. It’s a private equity-style asset, which may provide a shorter life cycle with more predictable cash flows for investors. Thus, returns may be more stable (albeit lower), less correlated and deserving of an allocation within the portfolio .
PM: I’ve been asked this a lot last year, when five years ago, I was never asked that question at all. Investors are most attracted to life settlements by low correlation and low volatility. Most other asset classes have suffered losses in value in the past year, but life settlements have held up. Yes, the risk premium is smaller now, but investors have concerns about equities this year and they’re unsure how high rates are going to go. Investors got used to getting 15% returns plus and they’ve had to reset their expectations somewhat, but anyone with exposure to big tech in the past had unbelievably large returns and then heavy losses last year. Investors know that you can’t go on like that because investment returns will revert to the mean over time. Life settlements offers a similar return profile to equities over the longer term; that’s a consistent sales pitch for the industry in my view.
GW: What are some of the other challenges that you think the life settlement market faces in the next 12-24 months, and is there anything that the industry itself can do to address these challenges?
WD: The inconsistencies in the LE reports from different life expectancy underwriters is one issue I have seen recently. Machine reading and summarization of meds, can cause some odd evaluations to occur. We do a significant amount of our own underwriting and I understand that we may not align with an external provider. However, it seems that as the volumes in the market have increased and new underwriters arrived on the scene, the divergence and inconsistency of LEs has increased. It makes it a lot more difficult to transact with confidence. Conversely, these inconsistencies can create opportunities for an active manager.
MP: It’s difficult to scale up and deploy capital as quickly as we would like to in the secondary market and in the tertiary market it is difficult to find good deals – many policies in that space are seasoned for long enough that the seller might have gained substantial inside information that’s difficult to evaluate in an auction. And the higher cost of funding is something that is hindering the return potential. If we were to leverage even slightly it would be super costly. Add that to the fact that it’s difficult to find safer paper means that deal flow might not be as strong this year for us.
PM: We’d all like to see more efficiencies in the market. In the 20 years I’ve been in this market there have been a number of attempts to create exchanges, for example. There are many efficiencies that can be achieved but equally there are a lot of processes pushing against that evolution, like providers and brokers being a necessary part of the transaction on the secondary side. If anyone took a real look at the life settlement market from 30,000 feet, they would do it differently.
WC: I wouldn’t use the word challenges – there’s no real attack on the industry. The ‘challenges’ are just like in any other investment – you have to find value in what you’re buying. You can’t create more policies than what there are for sale and longevity extension is pretty baked at this point. You could argue that medical advances could be challenging depending on what type of portfolio you have, for example those focused on a younger cohort of age. And institutional investors have more options with regards to other asset classes and investments now, but some of that is cyclical and it’s just a matter of when it rolls out of that. But again, to me, that’s not a challenge. I think the industry is in a very good place.
GW: Lastly, what are some of the opportunities for the life settlement market that should provide encouragement to institutional investors, both those that are allocated to the sector already, and those that are looking to dip their toe in for the first time?
WC: It’s the consistent evolution of the industry – there are simply longer track records available now, and I don’t just mean returns, I mean track records of longevity performance. The sophistication of underwriting has improved and will continue to improve with medical advances. We’re now 20 years into this asset class and there are plenty of data points that are positive.
PM: I’m very bullish on the near to medium term. There is a wider range of investors, geographically speaking, that are taking note of this asset class – wider range in the sense that they’re outside of the typical investor base in Europe and North America. Word is getting out to investors about life settlements. My only concern is if investors start to feel that stocks can really rocket again. Again, for me, that would have an impact on many alternative investments, life settlements included. But that’s also inconclusive right now. And specifically in our industry, I’m seeing positive signs in terms of increased policy volume.
WD: I’m bullish. Have been, continue to be. I do wrestle with the same thing as Patrick – does an equity market rally pull away large amounts of cash looking at alternatives right now? The Fed is looking at employment and the stock market. If equities heat up, causing financial conditions to loosen too much in the Fed’s view, more tightening could be negative for equities. Significant volatility in the equity markets creates a challenging environment for all assets, including life settlements. We’re also seeing more interest geographically; investments that deliver a stable, predictable yield if managed appropriately will always be of interest to investors.
MP: We are seeing a bit less competition this year than last – as I mentioned, pricing is becoming more reasonable so we can buy at more interesting expected returns as compared to the beginning of 2022. That’s good for all managers in the space, considering that our investors are obviously concerned with the level of return we can deliver for them. Life settlements have always offered something different for investors, and I think the outlook is generally solid for all the reasons mentioned here.
**********
William Corry is Founder and Managing Director, Corry Capital Advisors
Walter Deeter is Co-Founder, Managing Director & Chief Investment Officer, Burdette Asset Management
Patrick McAdams is Investment Director, SL Investment Management
Maurizio Pellegrini is Life ILS & US Life Settlements Manager, Azimut Investments