Even though bankers’ last foray into securitisation pushed global economies into a tailspin, following the collapse of the subprime mortgage market, they have not given up on these types of investments.

Banks including JP Morgan and Credit Suisse are considering the conversion of life insurance policies into securitised bonds. Just as subprime mortgages for low-income borrowers were bundled and traded, life insurance policies are being purchased and their revenue streams sold again as debt issues.

But this week, concerns about the suitability of these investments were raised at a US congressional subcommittee hearing.

“The securitisation of complex financial instruments that few people understood helped lead to the current economic crisis,” remarked Democratic congressman Paul Kanjorski, who chaired the hearing. “It therefore astounds me that financiers are eager to return to the casino culture before they have even settled up the bad bets they made on subprime mortgage-backed securities.

For now, any market in the US is likely to be small. “There’s a worry that there’s going to be a flood of transactions in this area,” says Daniel Curry, president of DBRS, a ratings agency. “But life insurance policies aren’t like mortgages. They are not a natural securitisation product.”

However, so called ‘life settlement’ bonds have been available to UK investors for some time – from smaller providers such as Policy Selection, Managing Partners, EEA Fund Management and Keydata.

These products aim to offer a high income, or capital growth, by buying up life insurance policies from older US citizens, maintaining the premiums and receiving the proceeds when the policyholders die. Their projected returns therefore rely heavily on life expectancy estimates.

But the market is under examination in the UK as well. Earlier this year, a Financial Services Authority (FSA) investigation into “potentially misleading advertising materials” used to promote Keydata’s Secure Income Bonds raised concerns over the structure of life settlement products. Three weeks after Keydata was forced into administration over its tax liabilities last June, PwC auditors found that the £103m-worth of cash and secondhand life insurance policies backing its Secure Income Bonds 1, 2 and 3 had been liquidated and the proceeds “misappropriated”. These assets were managed by SLS Capital, a Luxembourg-domiciled investment vehicle.

While the disappearance of the life insurance policies at SLS is being investigated as fraud, fund managers say the Keydata case highlights the risks attached to life settlement investments.

Andrew Walters, financial director of Policy Selection, says: “An income bearing product, such as that offered by Keydata, is wholly dependent on the portfolio generating sufficient cashflows to meet coupon expectations once any liquidity line has been expended, which is acutely challenging if the life extension risk has been underestimated.”

According to Patrick McAdams, investment director of Surrenda-Link and co-deputy chairman of the European Life Settlement Association, a lack of transparency over policy valuations adds further risk. Reputable managers may use a consensus of four life expectancy figures to calculate future payouts, but others may use the shortest life expectancy of four. “There is flexibility for fund managers to manipulate valuations and, as result, illustrations of performance may be unrealistic,” McAdams explains.

Chris Taylor, CEO of Blue Sky Asset Management, also warns of opaque charging structures. “Many of the retail propositions in the UK favour the investment managers and distributors over the investors – with extraordinary ‘performance’ fee arrangements.”