'Death Bonds' Look for New Life

NEW YORK ( TheStreet) -- Sharon Brady, a 66-year-old retired law enforcement officer in Fort Worth, Texas and her husband had spent years setting aside money for retirement. In 2009 the couple decided to invest $50,000 in Retirement Value LLC, and "life settlements."

The investment play seemed straightforward, if not macabre.

Sign with a life settlement company that buys-up life insurance policies from wealthy seniors, usually with a face value of $1 million or more, and then purchase shares in the pool of policies that will pay a steady income as people die off.

The return on the investment is based on the spread between life and death: The settlement company pays higher than cash value for the policies, but less than the face value. If the numbers are crunched correctly, investors could expect a healthy return as people died and the cash and continued premiums outstripped the value life insurance policies at maturity.

"They took out a book and showed us photos and peoples' ages, and there was a doctor who explained what was wrong with each of them and how long they were supposed to live," Brady says. "You are not supposed to wish someone would die, but you make money if they do. So you are really gambling on when they do die."

The pitch seemed based on solid, if not depressing, medical observations. Brady said that the doctor that from Retirement Value claimed to have a 98 percent success rate in predicting deaths and they were shown a list of people who were "likely to die within four years."

The upside was that Brady could expect a 16 percent annual return, according to an article in the Star Telegram.

"I felt a little strange about it. You get such a high return on the money you put down," Brady says.

But then the bottom dropped out of the life settlement market.

"The truth came out later," Brady says. "I got a letter from the attorney general saying they had shut the company down. Apparently people were living twice as long as that doctor was telling us."

Subprime "Death Bonds"

Retirement Value was one of several companies in life settlement market, sometimes referred to as the "death bond" market, that when through its own financial crisis in 2008.

Retirement Value was shut down for securities fraud in 2010, according to The Texas State Securities Board. Brady explained that the longer people lived the more money people were required to invest and apparently the company was underestimating the amount of time a person would live in order to make more money.

"It has been a very nasty experience. I feel like I've been taken advantage of," Brady said. "I don't know if we will get the money back. If we do it will probably be a minimal amount because they are using it for the lawsuit attorney and lawyer fees. They took advantage of 900 people here."

The life settlement fund may have cost investors over $65 million, according to a report by The Associated Press. Unfortunately, it is not the only life settlement company being investigated for fraudulently predicting the deaths of policy holders.

Another example of retail investors getting burned by life settlements is Life Partners Holdings, which currently being investigated by regulators, according to Securities and Exchange Commission filings. The company may also face civil charges from the SEC for how the company projects life expectancy for those people whose policies they have purchased. The company CEO admitted in court that most of the life expectancy projections were probably wrong and were acquired from a Doctor in Reno, Nevada who could not verify the accuracy of his predictions, according to an article by The Wall Street Journal. Life Settlement could not be reached for comment.

"It is an extremely risky market. We have deep concerns for investors in this market. They have to be very careful," said California Insurance Commissioner Dave Jones. "We are watching what happens with Life Partners ( LPHI)very carefully and depending on the outcome we will factor the regulations accordingly."

Because of high profile cases like Retirement Value and Life Partners, the traditional insurance industry is less than enthusiastic about life settlements.

James Avery Prudential's ( PRU) CEO of Individual and Life Insurance and Agency Distribution says that the calculations that life settlement companies often provide investors "cherry pick" the best policies, but in the end they don't add up. Avery adds that many people in the pools are living two, three, or four years beyond those predictions made by the companies.

"There is a growing number of fraudulent cases. This is so similar to the subprime market where investors are promised a 15 percent return and buyers are promised value, but this is a Wall Street arbitrage business where the middleman walks away with a profit," says Avery. "The life settlement industry has been lobbying and regulations are not as effective as they need to be. Consumers and investors wind up paying a price."

The industry, which used to be dominated by companies such as Goldman Sachs ( GS), Citigroup ( C), JPMorgan ( JPM) and American International Group ( AIG) has gradually become dominated by foreign banks, and U.S. individual and institutional investors including hedge funds, pension funds due to increased regulation. Credit Suisse ( CS), which owns PeachTree; Fortress ( FIG); Apollo ( APO); BlackRock ( BLK) and Coventry and larger investors in the market.

Life Settlements Eye a Comeback

But many in the life settlement industry it has less to do with fraud, and more to do with being caught off guard by people living longer. With new changes in place, they argue, life settlements are poised for a comeback.

Alan Buerger, CEO of Coventry, a life settlement company, says that regulation has, in fact, made the industry better and more transparent. He adds that part of the problem with previous life settlement pools was that there was not enough accurate data that over the past few years the industry has acquired more accurate data on life expectancy.

"We have different requirements for reporting state to state, and we do quite a number of things including interviewing the policy owner and the insurer person before buying policies from investors," said Buerger. "The industry has much more data. We have seen what has happened and we have to be more conservative with how we underwrite. We have 70 thousand lives in our database and track the lives of those individuals."

With people living longer due to improvements in the medical field, it has become harder to calculate longevity, but data is becoming more accurate, said Darwin Bayston, executive director of the Life Insurance Settlement Association, who talked about the industry in a video with TheStreet

"In 2008 there was a big adjustment in the actuarial tables and everyone in the longevity business experienced that people are living a little longer. They did extend their payrolls a couple of years and that did impact returns, and that is where the uncertainty lies today," said Bayston. Bayston says that investors can earn eight to 10 percent returns and the upside to an investor is that it is uncorrelated to other assets in a portfolio.

Bayston explains that life settlement investments are not for everyone. He said that those elderly people who sell their life policies most often would have let their policies lapse, cannot use them or need the cash for long-term care or retirement. He added that primarily hedge funds or institutional investors get into the life settlement industry; for individual investors it is different.

"If I am an individual investor and I buy a policy then I am not going to be paid until that person dies and the sooner they die, obviously, the higher my return would be," Bayston said. "Institutional investors have put together 300, 400, and 500 to thousands of policies. For them, they are not concerned about whether one individual dies. What they are concerned about is how the cash flows from these policies. "

Coventry's Buerger says you see less individuals now buying in the life settlement market due to the risk involved.

"We are seeing a continuous increase in the amount of policies for institution investors. Right now there are a number of private equity firms and hedge funds looking for distressed pools," Buerger said.

Buerger compares the life settlement industry to the life annuity industry and long term care industry. "Life insurance companies are betting that an insured annuitant will die soon enough and they will make a profit. It is not a death bond."

--Written by Maria Woehr in New York.

To contact the writer of this article, click here: Maria Woehr.

To follow the writer on Twitter, go to http://twitter.com/newsgirlmw.

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