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Investors warned about traded life policies with inadequate risk controls

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The potential for traded life policies to deliver resilient returns during the financial crisis has attracted the interest of key large players, but increasing focus on this relatively new asset class is also creating several dangers for unwitting investors, according to Professor Merlin Stone in his 2010 report on traded life policies.

Managing Partners, the fund manager that commissioned the report, has seen assets under management in its Traded Policies Fund rise from USD176m in June 2009 to USD190m in June 2010 in terms of the gross value of policies held within the fund.

Research commissioned by Managing Partners also found that seven out of ten life settlement brokers in the US said they expected to see more policies being sold on the market over the next five years, fuelling growth in investment products.

Professor Stone’s report, entitled The market for traded life policies, says that increasing interest in traded life policies has even attracted global brand names such as Citibank, BNY Mellon, Credit Suisse, Commerzbank, Deutsche Bank, HSBC, Allied Irish Bank, Wells Fargo, Dresdner Kleinwort, Cantor Fitzgerald and Citibank to the market. He also anticipates that boutique product providers could also be taken over by larger fund managers seeking to buy up expertise on traded life policies.

But Professor Stone warns that going forward investors must safeguard themselves against the potential onset of a wave of products carrying high risks, especially those using traded life policies within securitisations and those that fail to use the right actuarial investment process.

Professor Stone, who is visiting professor at Oxford Brookes, De Montfort and Portsmouth Universities, says: “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 indexes based on portfolios of life policies but another, more notable example that has attracted a great deal of publicity – often adverse – is securitisations. Unfortunately, TLPs are still misunderstood, even by institutions. 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.”

Jeremy Leach, managing director of Managing Partners, says: “The performance of our Traded Policies Fund and some other notable performers shows that portfolios of traded life policies can indeed deliver steady, incremental returns, even throughout the financial crisis.

“But not every fund manager can deliver the full potential of TLPs. They have to be managed in a prudent manner, using the right actuarial analysis of the underlying policies and the right controls on risk. The challenges posed by currency hedging are particularly difficult given the ongoing volatility we are seeing between exchange rates. Failure to put the right management processes in place adds risk to what should be a low volatility investment if handled in the right way.”

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