The Financial Services Authority (FSA) has said it intends to ban traded life policy investments (TLPIs) from being marketed to UK retail investors, arguing they are 'high risk, toxic products'.
It said that evidence of the its work to date showed there were significant problems in the design, marketing and sale of the investments.
FSA managing director Margaret Cole (pictured) said: 'The failure of these products in the past has led us to significant consumer detriment and we fear new investors will suffer unless we take the necessary steps now to prevent their sale and distribution.
'We are issuing a strong warning to the industry not to market these products to UK retail investors. Ultimately we aim to ban TLPIs from being marketed to UK retail investors, and we intend to consult on this next year to help erase the risks they pose.'
It said the investments were typically 'complex and opaque' and that the underlying assets exposes investors to high levels of risk. Liquidity problems were also an issue, and investors had limited or no recourse to the Financial Services Compensation Scheme, it said.
The FSA reminded advisers in its proposed guidance not to recommend products unless they understood them. Where advisers identified that life settlements would be suitable for a retail investor detailed and robust justification for this decision would be required, according to the FSA, which believed this scenario was unlikely.
The regulator added it would be ‘extremely’ difficult for execution-only firms to promote life settlement funds in a way that was fair, clear and not misleading.
The FSA said it had found evidence of life settlement investment schemes failing because the distributor did not secure appropriate regulatory permissions, purchased term assurance polices rather than whole of life cover, and in some instances, pooled investors’ money so those who redeemed earlier received a larger return.
It outlined six key risks presented by the funds:
- Longevity – inaccurate estimation of life expectancy of the lives insured by the policies could negatively impact on the investment return and liquidity of the investment scheme.
- Liquidity – traded life settlement policies are illiquid and have a limited secondary market which means their value could be significantly discounted if funds are required at short notice.
- Structure – yields are promised to previous investors which can only be sustained by using new investors’ money, which appears to share some of the characteristics of a Ponzi scheme.
- Location of the underlying asset – Investors face exchange rate risk on the ongoing policy premiums and the final pay out on maturity.
- Offshore distributors – Investors will have limited or no recourse to the Financial Ombudsman Service or Financial Services Compensation Scheme
- Counterparties – The failure of the insurance company underwriting the policy will mean that claims will not be paid on the death of the original policy holder.
FSA head of investment policy Peter Smith warned advisers in February 2010 that the regulator had serious concerns about the marketing of life settlements. The FSA issued the warning following the collapse of Keydata Investment Service which left financial advisers and fund managers with the £326 million bill for compensating clients of its two Luxembourg-based life settlement investment vehicles.
The life settlement market has been racked with scandals stretching back to the collapse of the Shepherds Select fund in 2005 while Arm Asset Backed Securities, which was marketed by Catalyst Investment Management, has ongoing liquidity problems.
Life settlement funds have proved popular with some advisers who invested client money with providers like EEA Fund Management and the Assured fund, which offered returns uncorrelated with equities.
EEA Fund Management marketing director Peter Winders said: 'We agree with the FSA’s desire to ensure that investors understand product risks and are placed into suitable investments. That’s why our investment minimum on the EEA Life Settlements Fund is £25k and why we make clear this is for sophisticated investors under advice.'
SL Investment Management recognised that the life settlement sector had been dogged by high profile fund failures but argued that the FSA had over simplified the situation and that the asset class offered benefits to institutional investors with the resources to assess the potential risks.
‘In the UK, the life settlements industry is less than 10 years old, making it a very young asset class. Although the returns can be attractive, the success of the fund depends significantly on the Investment Manager and it is not realistic – or fair – to expect retail investors to know the difference between good and bad. SL is entirely supportive of the FSA’s stance to keep life settlements in the institutional domain,’ said Patrick McAdams, investment director of SL Investment Management.