The market for alternative investments offers a broad spectrum of possible sources of return, beside the traditional equity and fixed income market the various hedge fund strategies. When having a closer look at the funds included in the Nordic Hedge Index (NHX), Ress Capital does stand out being by design truly uncorrelated to the development in the traditional markets.
Ress Life Fund invests in the secondary market of American life insurance policies, known as life settlements. Since 2011 the fund has been building a diversified portfolio of US life policies. The Swedish company previously was the advisor to its Luxembourg subsidiary, but in April Ress Capital AB received the authorisation by the Swedish Financial Supervisory Authority to act as alternative investment fund manager under the AIFMD regime. We met with Ress Capital’s CEO Jonas Mårtenson (pictured), and here is what he had to say:
HedgeNordic: The trading strategy Ress Capital follows is somewhat different from what we usually come across in the hedge fund space. In a nutshell, can you tell us how your strategy works and describe it “for dummies”.
Jonas Mårtenson: As an example, Mrs Smith is 75 years old and lives in Florida. Her children are grown up and all have good jobs. Her life insurance policy was very important when the children were young, but she has now decided that the policy is no longer needed. She can (i) lapse the policy and receive nothing, (ii) surrender the policy to the insurance company, or (iii) sell the policy in the secondary market at a higher price than the insurance company will pay for it. Thus, the secondary market offers a better alternative for the seller. Once the fund has bought the policy it will continue to pay future premiums and the future payout is received by the fund. The market is highly regulated in the US and legislation stipulates fee transparency, broker regulation and that all beneficiaries (usually the children) have to agree to the transaction.
HedgeNordic: How the secondary market for US life insurance policies works, and why it exists and how big it is?
Jonas Mårtenson: The secondary market for US life insurance policies, also known as life settlements, has existed for many years. It really took off in the late 1990’s when institutional investors and banks began buying policies. The market offers consumers the possibility to sell policies at a higher price than the surrender value offered by insurance companies. Another positive aspect, which is less known in Europe is that life settlement transactions are regulated in 42 states.
HedgeNordic: What effect did the financial crises in 2008 have on the market, and how has it developed since then?
Jonas Mårtenson: The market grew strongly until the financial crisis in 2008, after which volumes declined sharply. Since then volumes have gradually recovered and during 2015 various estimates indicate a market size of around USD 4 billion.
HedgeNordic: In what way does Ress Capital create returns for your investors, and how do you invest? What does the typical investment process look like?
Jonas Mårtenson: The fund buys policies at a discount to face value and then continues to pay premiums for a number of years. When the policy pays out the fund receives the insurance payout. We have a systematic investment approach together with independent medical underwriting and a proprietary portfolio management system which gives a quantitative edge.
HedgeNordic: You mentioned that you have a quantitative, systematic approach to your investments. Could you elaborate a bit more on this.
Jonas Mårtenson: We have built a proprietary portfolio management system that allows us to review large numbers of policies. We have four independent brokers in the US that send us policy data electronically. We look for a number of different criteria when selecting policies. To date we have reviewed over 6000 policies and bought approximately 200 policies since the fund was launched in 2011.
HedgeNordic: What does your yield curve look like? It sounds like you start with a big investment, where you buy insurance policies, and then nothing happens until the person who took the policy dies, maybe years away. Isn’t that something that will create a somewhat “jumpy” yield curve?
Jonas Mårtenson: Our performance to date looks like a J-curve. The fund was launched in 2011 and the first policy paid out in 2013. In the past 12 months several policies have paid out which has led to a net performance of 5.7% in that period. Initially, the fund also suffered from high fixed costs in relation to assets under management, but increasing assets under management has reduced the cost drag.
HedgeNordic: What are the driving forces for the returns that you can expect when investing in the life insurance market?
Jonas Mårtenson: The key driver is of course insured individuals getting older and policies paying out, but we’ve had positive contributions from mark-to-market effects and negative contributions from revised life expectancies and premium changes. In the end the most important factor is having correct life expectancy assumptions.
HedgeNordic: Is this strategy in some way comparable with, e.g., afforestation, where there is an initial investment and then you wait a couple of years for the time when it’s time to harvest?
Jonas Mårtenson: To some degree the comparison can be made, since investing in life settlements is only suitable for long-term investors that do not require liquidity. Nevertheless, insurance portfolios are frequently transacted between funds and there are a number of active brokers.
HedgeNordic: Rather than buying in bulk, you purchase individual policies, one at a time. How do you find policies to buy, how do you evaluate them, perform due diligence to sort out “the good, the bad and the ugly”, to paraphrase the film world?
Jonas Mårtenson: We look for a number of different criteria when selecting polices, such as low premium levels, long life expectancies, high credit ratings of the insurer etc.
HedgeNordic: What are the risks involved when moving around in these markets in general, and with Ress Capital specifically?
Jonas Mårtenson: Longevity is the key risk in investing in life settlements. If our life expectancy assumptions are too short, the fund will pay more premiums and the return will decrease. The asset class is also illiquid and is only suitable to long-term investors. Another important risk is that future premiums increase, this has not been an issue in the past, but recently some insurance companies have increased premiums so this is something we monitor carefully.
HedgeNordic: In your presentation you describe the so called ”tail risk” (i.e. ”when the impossible happens”) that some policies can cause. Can you describe how and when ”tail risks” occur and how to avoid them.
Jonas Mårtenson: In this asset class tail risk has a special meaning. Individuals may outlive their life expectancies significantly even though the mortality in the cohort is in line with expectations. Such scenarios may have a significant impact on the fund since cost of insurance increase exponentially from very low levels. Hence, we prefer to buy policies from healthy individuals with normal mortality and long life expectancies, since we believe that longer life expectancies are inherently more accurate. We also prefer to buy policies which are free of premiums after a certain age (usually age 100). We believe this strategy will reduce the tail risk in the fund’s portfolio.
HedgeNordic: Who are the players in this market and how can a relatively small portfolio manager from Sweden create a competitive advantage compared to the others?
Jonas Mårtenson: There are only a few life settlements funds in Europe. Most other funds are managed by larger US managers, including Apollo, Blackstone, Kohlberg & Co etc. They mainly buy large existing portfolios in bulk. Being a small niche manager allows for buying single policies in the secondary market with a careful selection process. We only buy around 2% of the total number of policies we review.
HedgeNordic: There must be an ethical dilemma involved in this industry? Buying insurance policies at a discount, from individuals that probably need to sell. And then make the money when someone dies.
Jonas Mårtenson: This market would not exist if insurance companies bought back policies from consumers at a fair price. The secondary market offers US consumers a better alternative, since we pay a higher price to sellers. This was even confirmed in a study made by the US Government Accounting Office a few years ago. Hence, the life settlements market is beneficial for the consumer.
HedgeNordic: Any words of wisdom from the market that you would like to share with us?
Jonas Mårtenson: We believe this asset class offers a true risk diversification for long-term investors since the longevity risk is truly alternative.
©HedgeNordic, reproduced with kind permission
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