The Financial Services Authority (FSA) has issued guidance to warn that traded life policy investments (TLPIs) are high risk, toxic products that are generally unsuitable for the majority of UK retail investors and should therefore not be promoted to them.
TLPIs are known as ‘death bonds’ because investors are putting their money into a pooled investment or fund which invests in US life insurance policies. Basically, a TLPI investor is betting on when a particular set of US citizens will die and if these people live longer than expected then the investment may not function as expected.
Evidence from the FSA’s work to date has found significant problems with the way in which TLPIs are designed, marketed and sold to UK retail investors. Many of these products have failed, causing loss for UK retail investors.
Margaret Cole, FSA managing director, said:
“TLPIs are toxic products which pose significant risks for retail investors.
“The failure of these products in the past has led 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.
“Firms should not be selling these high risk products to retail investors, and so our guidance reminds firms of the importance of assessing whether a product is suitable for a customer and whether promotional material makes risk warnings clear enough.
“Products such as TLPIs are not a simple problem for the FSA to address as many of them are based outside of the UK, and so are outside the FSA’s jurisdiction. There are also considerations under EU law that will affect what we can do. However, the FSA is engaging in discussions in Europe around the MiFID review, AIFM Directive and with other European supervisors to find a solution to give greater consumer protection against these products.
“For now, we want to make our message about these products clear – they are completely unsuitable for most UK retail investors.”
What the FSA is asking firms to do:
- Consider the significant risks of TLPIs and be aware that they should not be promoted to UK retail investors;
- Conduct extensive research and be able to provide robust justification in the unlikely event they think TLPIs might be suitable for a particular retail investor;
- Be aware of underlying assets within the investments they recommend. For example, know whether a TLPI is an underlying asset within another investment e.g. a fund of funds; and
- They should not recommend products they do not fully understand.
- The key risks of TLPIs are outlined in the guidance paper and can be found on the FSA consumer section of the website.
Key risks include:
- The product structure is complex and opaque, involving several firms working together, often in different jurisdictions. The different roles and legal responsibilities are not always clear and so there is a risk that firms may not be meeting their obligations. For instance, offshore entities may require the approval of local regulators and it may be difficult to ascertain if the correct approvals have been given;
- The underlying assets expose investors to high levels of risk;
- If the people whose lives are assured live longer than expected, perhaps because of incorrect actuarial assumptions or new medical advances, the investments may not be able to function as expected;
- We have found that some TLPIs lack sufficient liquidity to meet ongoing costs if the people whose life policies they’ve bought live longer than expected;
- If the TLPI provider needs to sell assets to raise funds, they may find it difficult to sell the underlying policies at a reasonable price, due to the small market and its specialised nature, and this may lead to losses for investors;
- If the firm needs to sell the assets and cannot find a buyer quickly, this could also mean that investors find their money locked into a TLPI for longer than expected; and
- If the underlying assets of the TLPI are based offshore there is also an exchange rate risk, both in terms of the costs of meeting ongoing premiums and the final payout for the underlying insurance contracts.
- Investors may have limited or no recourse to the Financial Services Compensation Scheme (FSCS) and Financial Ombudsman Service as many TLPIs are located offshore.
- The guidance consultation is open for feedback until 23 January 2012.