Controversy over life settlement investments, a relatively young market in Europe but already established in the US, has developed into an international war of words over the actual or alleged risks of this asset class.

The European Life Settlement Association yesterday criticised a recent call from the American Council of Life Insurers for policymakers to ban the securitisation of life settlements. The European group has announced a trade mission to help educate the market about what the ELSA called the benefits of the sector.

Life settlement-backed investments – which turn US life insurance policies into tradable assets - have expanded rapidly, with proponents arguing that their returns are weakly or even negatively correlated to assets such as listed equities. Typically, funds buy life policies from people who wish to sell their policies before they reach policy expiry. For example, the industry developed from sagas such as the HIV crisis in the US in the 1980s as many terminally ill people chose to sell policies to get money.

However, the financial turmoil in the US and elsewhere has encouraged industry groups to put any asset class, even one that is touted as low-risk, under a harsh spotlight. The issue of people selling policies before maturity also raises ethical issues about whether people are wise to cash in such policies.

“Securitisation of life insurance settlements exposes senior citizens and investors to increased risk of fraud and the practice should be prohibited by legislation or regulation," the American Council of Life Insurers said in a statement earlier this month. The ACLI argues that allowing life settlements to be packaged into securities increases the risk of fraudulent policy applications being filed. The group also suggests that investors do not understand the risks when committing their capital.

In reaction, ELSA said it was “essential those in retirement are given the right to treat an unwanted policy as an investment that they can cash in on the secondary market”.

“ELSA also points to growing interest and understanding exhibited by financial intermediaries, institutions, discretionary wealth managers, and high net worth investors,” it said.

“It is absurd to suggest that all life settlements securitisation should be banned – it is through the issuing of bonds and shares that the secondary market operates. You would never dream of suggesting other big-ticket purchases such as a house should not be transferable, so why a life insurance policy that is no longer wanted or has simply become unaffordable?” said Patrick McAdams, investment director at SL Investment Management and joint chairman of ELSA.

“Rather than call for a ban, it is time for the life insurance industry to provide proper, transparent disclosure about the levels of both surrendered and lapsed policies among the elderly, many of whom simply cannot afford to maintain their life insurance.

In its critique, the US lobby group says securitisation will lead some settlement promoters to target senior citizens and induce them to commit fraud in connection with illegal stranger-originated life insurance (or STOLI) transactions.

“In STOLI transactions, investors or middlemen approach seniors and encourage them to purchase life insurance policies they otherwise would not buy solely to sell the policies to investors. STOLI transactions have been outlawed in 28 states and most other states are considering anti-STOLI legislation. Seniors caught up in STOLI schemes face potential legal and tax liability,” it said.