Among other lessons, the recent recession taught that the returns on many assets are more correlated than previously assumed. From late 2007 through early 2009, it seemed that everything moved in the same direction: down. Or almost everything. A few asset classes – or more appropriately, investment categories – remained, during the recession and beyond, resolutely uncorrelated. Litigation funding is one such investment category, as we discussed in a previous issue of the Hedge Fund Law Report. See “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns
,” Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009). Another such category is life settlements. In a nutshell, a life settlement is the process by which an investor (often a hedge fund) purchases a life insurance policy from the person who originally purchased the policy – the so-called “insured.” Specifically, the hedge fund or other investor generally pays the insured an amount greater than the cash surrender value of the policy, but less than the death benefit, in exchange for the right to collect the death benefit and the obligation to continue paying premiums for the life of the policy (and the insured). For insureds, especially those that need money today, life settlements represent an opportunity to “cash out” of a policy for an amount often greater than what an insurance company will pay. For hedge funds, life settlements offer an investment, the returns on which are driven largely by the fund manager’s ability to accurately predict the life expectancy of a group of insureds. In other words, the success of a strategy focused on life settlements has less to do with microeconomic variables (such as corporate earnings) or macroeconomic variables (such as interest rates), and more to do with demographics. It’s a different ball game, and a different skill set – the quintessential uncorrelated investment category. Not surprisingly, hedge funds are becoming increasingly interested in life settlements. Accordingly, this is the first part of a three-part series in which the Hedge Fund Law Report will provide a detailed analysis of the key legal and business considerations for hedge funds investing in life settlements. In this part, we discuss: state and federal regulation of life settlements; premium financing; pricing of life settlements; advantages to hedge funds of investing in life settlements (including lack of correlation with other assets); concerns of which hedge funds should be cognizant when investing in life settlements (including illiquidity and longevity risk); structuring of hedge funds to invest in life settlements; cash management and adequate capital considerations; specific recommended items for disclosure in the private placement memorandum of a fund organized to invest in life settlements; due diligence considerations; a brief overview of the relevant tax considerations, including the recommended jurisdictions for organizing life settlement hedge funds; the tertiary market and securitization; and opposition from the insurance industry. Part two in this three part series will focus in more depth on tax considerations relating to life settlement investing, and part three will focus in more depth on securitization of life settlements.