• Report claims asset class will become more mainstream
• Managing Partners Limited, a leading provider of TLP funds, sees an xx% growth in assets under management over the past 12 months

A new report by Professor Merlin Stone of the Bristol Business School predicts that over the next five years, there will be a surge of money from retail investors flowing into funds investing in traded life policies.  These are US-issued, whole of life assurance policies sold before the maturity date to allow the original owner to enjoy some of the benefits during their lifetime. 

During the first eight months of 2007, Managing Partners Limited, which commissioned the report, has seen an 80% increase in the amount of retail investment money invested in its traded life policy funds when compared to the same period in 2006, and 120% higher than in 2005.    

Professor Stone believes that one of the main reasons why funds investing in TLPs are likely to grow in popularity amongst retail investors is that they could be a strong replacement for with-profits based investments.  MPL research reveals that only 7% of IFAs have a positive view on with-profits based investments and that a staggering 57% of investors with these investments are unhappy with their current performance, with 21% intending to stop investing in them.  Funds investing in TLPs are relatively low risk and offer attractive returns of around 8%, meaning that they could be a viable alternative to with-profits based investments.   In addition to this, Professor Stone’s paper identifies a number of key reasons for rapidly growing demand from retail investors for funds investing in TLPs: 

Greater choice: The TLP market was worth around $13 billion in 2005, but it is expected to grow by on average around $5.92 billion a year between then and 2030, when it could be worth around $161 billion.  This means that there is much greater choice and opportunities for TLP fund managers when deciding which policies to buy which should have a beneficial impact on performance. 

Reduced risk: TLPs are guaranteed to grow in value because in the vast majority of cases, the maturity value is known at the outset and the price offered for policies is always at a substantial discount.  This certainty means that TLPs remove some of the risk associated with more mainstream investment asset classes.  

Improved life expectancy estimates: The TLP fund management industry has dramatically improved its life expectancy estimates.  The industry has been able to develop more robust claims data and improve its actuarial models, improving the quality of TLPs held in their funds. 

Low correlation: The performance of TLPs is not tied to other asset classes such as equities and bonds.  This provides investors with another opportunity to diversify and reduce risk. 

Track record of attractive returns: TLP funds have been able to deliver consistently attractive returns for less risk. For example, The institutional US dollar share class of Traded Policies Limited, an open-ended investment company managed by Managing Partners Limited (MPL), has returned 28.35% in the three years to 1 July, 2007, significantly outperforming its benchmark, the 10-Year US Government Bond Index, which returned 8.54% over the period, and the Fed Funds Effective Rate, which returned 12.768%. The $60m fund’s return represents an annualised return of 8.78%, net of all charges.  The fund did not suffer a single negative return in any quarter during that period. 

Improved regulatory environment: New regulatory codes covering the TLP market have recently been passed in a growing number of US states which will contribute to the growth potential of the market by providing an environment in which it can flourish. 

 Professor Merlin Stone said: “Investors are becoming more open to alternative asset classes and also want greater clarity in terms of the risk associated with their investments.  Funds that invest in TLPs meet both of these requirements and as they develop their track records, demand for them will grow.  The market is starting to show signs of maturity as a major investment class because both institutional and retail investors are showing a growing appetite for it.” 

Jeremy Leach, Managing Director of MPL said: “Returns from funds investing in TLPs have been impressive which, given the low level of risk associated with these, makes them increasingly attractive.  If the TLP industry grows as predicted, and the fund management industry can continue to improve on its risk management and provide attractive returns for relatively low risk, demand from institutional and retail investors will grow stronger.” 

However, in reviewing the TLP market, Professor Stone has identified a number of risks that investors need to be aware of.  These include: 

Life expectancy estimates: If the life expectancy estimates turn out to be inaccurate and the average life assured lives longer than predicted, the return on that policy will be lower.    The fund manager needs to purchase a large number of policies so that the risk of inaccuracy is balanced by spread.  They need a strong claims experience which can be factored into a robust actuarial model to ensure that the returns on their fund are smooth as opposed to spiked.   Fund managers should obtain at least two life expectancy estimates on each policy that it plans to purchase and reject them if there is too much disparity between them. 

Premium Liability:  In addition to the impact on yield, if the average life expectancy on a policy turns out to be inaccurate and premiums must be paid for longer than anticipated, this will reduce the net asset value. 

Currency Risk: TLPs are US dollar-denominated assets. However, any fund that has non-USD share classes can be hedged to reduce currency risk.   

Liquidity: The TEP market is similar to most other financial markets in that assets are freely traded. However, the timing needed to settle a trade is longer than in many financial markets due to the specialized nature of this asset class. For this reason, liquidity risk may arise if the sale of one or more policies takes longer to complete. 

Counter party risk: There is a risk that the insurance company that issued a policy which a fund has purchased may default on its obligations to pay out upon maturity of a policy. This risk is reduced by policy spread or by diversifying across a range of insurance companies’ policies and also by the fact that each US State operates a compensation scheme that indemnifies policyholders against insolvency of the issuer.  Professor Stone says that a fund manager has to demonstrate a spread of assets, and in the case of TLPs, this means a spread of insurance companies taking into account their different credit ratings.   

Contestability law - In the US, contestability law prohibits an insurer from repudiating a claim on any grounds once a policy has been in force for at least two years. This risk can be avoided by not buying contestable policies. However, there is a risk that the two-year period may be extended to five years at some stage.

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