Investing in death gets new life

The controversial business of investing in the life insurance policies of dying people is getting new vigor from a deal that may also help burnish the industry’s tarnished image.

Legacy Enterprises LLC, a New York City investment management firm, says it has come up with a way to give the investment stability and a guaranteed minimum rate of return.

The trick is packaging a large number of policies into a limited partnership that is reinsured by Lloyd’s of London. The reinsurance guarantees a risk-free 4% return that could go much higher depending on how the investment performs.

The catch is, people have to die early – or at least when projected – to net the higher return, and some financial advisers appear to have problems with that.

But Legacy sees a ready market for the partnerships among wealthy investors and hedge fund managers who are looking for assets that are not tied to the stock market.

“There is no market risk, no risk of losing your principal, and a potential upside of 25% or 30%,” says Charles Irwin, a broker at Kaplan & Company Securities Inc.

Kaplan, a broker-dealer based in Boca Raton, Fla., is one of the firms already signed up to sell the new Legacy limited partnership, which will be sold for $50,000 minimum investments through Series 7 broker-dealer reps.

While most financial planners agree that it would be difficult to find an investment less correlated with the financial markets than the policies, known as viaticals, some say it could still be a tough sell.

“Personally, I think it’s a very morbid way to invest money,” says Joe Petruska, vice president of estate planning at Bill Few Associates in Pittsburgh. “It’s not something that I would be comfortable sitting down and trying to sell to a client.”

Thomas Henske, an adviser at Cowan Financial Group in New York, calls viatical investing “a little sick and very speculative.”

“I see it as still being uncharted waters, where you are betting on someone’s death,” he says. “It’s true that it’s non-correlated, but how many people have gold and real estate in their portfolios right now?”

Overcoming the viatical industry’s association with fraud could also prove to be a big obstacle. But the potential for respectable non-correlated returns has spawned a sizable following for viaticals and life settlements.

According to the Viatical and Life Settlement Association of America, of the $492 billion worth of life insurance policies currently in force, $134 billion has been sold to investors.

Those are face-value figures that represent the death-benefit payouts.

Because Legacy’s product is a private placement and an unregistered investment, company officials say they are prohibited from commenting on it publicly.

But according to the offering memorandum and other literature related to the partnership, the portfolio initially will package at least 10 life insurance policies scheduled to mature over a five-year period.

The portfolio will include both viaticals – policies purchased from terminally ill individuals – and so-called life settlements, which are policies purchased from healthy senior citizens who are nearing the end of their lives.

If the policies all mature on time – that is, if the insured individuals die according to statistical mortality rates, the partnership will generate a 10% annualized return. The earlier a policy matures, the higher the return.

For instance, if a person expected to live 60 months dies in six months, the return on that policy could be as high as 159%.

The partnership is structured to invest in life insurance policies that are expected to mature in 12-month intervals.

Lloyd’s of London pays off a policy that is active two years beyond its estimated maturity date. In the worst-case scenario, if every policy in the portfolio has to be paid off by the reinsurance provider, the annualized return will be nearly 4%.

Part of the appeal of that kind of investment product, particularly with the equity markets in the midst of a volatile tantrum, is that mortality rates are considered completely unrelated to market conditions.

Mr. Irwin of Kaplan compares it to investing in a real estate investment trust that pays investors as various underlying properties are sold.

The viatical industry sprang up about 20 years ago originally to benefit people suffering from AIDS.

In its earliest incarnation, investors purchased the death benefit from a life insurance policy directly from the insured and paid the premiums while waiting for the insured to die.

The industry’s evolution spawned a brokerage middleman to match investors with people interested in selling their policies.

Bill Kelly, executive director of the viatical association, says that through 1996 – when the development of protease inhibitors began to extend the lives of AIDS patients – approximately 95% of the insurance policies viaticated had been purchased from people diagnosed with the virus that causes AIDS.

The practice of selling life settlements, offering the elderly the opportunity to sell out of their policy, is only about two years old.

Viaticals and life settlements typically acquire a policy from the insured for between 30% and 80% of the death-benefit amount, according to the association.

Mr. Kelly, whose association represents companies selling viatical investments, admits that the industry has seen its share of abuse from “some downright crooks who were operating nothing more than Ponzi schemes.”

The fraud has even spawned its own language within the insurance industry.

The term “clean sheeting” refers to the practice of submitting fraudulent medical information in order to be approved for a life insurance policy. And “wet viaticals” is a reference to policies that are purchased by senior citizens and immediately sold to investors.

While the Securities and Exchange Commission has yet to step in on the issue of viaticals, the industry is feeling increased pressure at the state level. And the insurance industry is doing all it can to see to it that regulatory oversight comes sooner rather than later.

Jean Gora, manager of research at Loma, the international trade association for insurance and financial services companies, describes the investment as “massive incentives to murder people.”

Ms. Gora, author of a December report entitled “Viatical and Life Settlements: The Challenge Facing the Life Insurance Industry,” admits she has no specific evidence of murders. But she points out that investing based on mortality rates can be a dicey.

“I would look for fraud,” she says, “and if not fraud, at least creeping dishonesty.”

Of course, no matter how clean the product, there is still the association with death.

“There’s nothing about viaticals I’d be the least bit interested in,” says Robert Levitt, a financial adviser based in Boca Raton with $130 million under management. “It leaves a bad taste in my mouth.”