Life insurance carriers that buy life policies back from policy holders who need cash now are starting to issue a new type of bond to investors. Known as L bonds, these bonds offer much higher yields than publicly-traded, fixed-income offerings. Companies such as GWG Holdings, the parent company of GWG Life, are offering bonds and preferred stocks to investors who are seeking higher yields than can be found in the traditional marketplace.

How L Bonds Work

These bonds are not rated by the ratings agencies and have maturities that run from two to five years. GWG’s two-year bond currently has a yield of 5.5%, while its three-year bond has a yield of 6.25% and its five-year bond has a yield of 8.5%. However, these bonds are illiquid and investors have no way to access their principal in them until maturity. (For more, see: Alternatives for Low-Yielding Bonds.)

The company also issued preferred stock with a conversion option and a dividend rate of 7%. These bonds can also be called at any time by the issuer, and their payouts correlate with the proceeds of the life insurance policies that the company has purchased from seniors. If the insurance carrier does not accurately predict the life expectancies of its sellers, or if the other insurance companies that will pay those death benefits go bankrupt, then the company may not be able to make its interest payments, which could in turn affect the prices of the L bonds and preferred stocks.

GWG’s fact sheet on these investments states that: “Investing in L Bonds may be considered speculative and subject to a high degree of risk, including the risk of losing the entire investment.” The sheet also warns investors that the investment of funds into life insurance in the secondary market carries higher risk because the market is still undeveloped, and the company’s ability to invest in those assets at a good price is dependent upon the market’s continued growth.

Nevertheless, L bonds are attractive to investors not only because of their high yields and relatively short maturities but also because they are not correlated with either the equity or fixed-income markets at large. This stands in contrast to other types of alternative investments that are highly correlated to certain segments of the market, such as the correlation between REITs and the real estate market or business development companies and the high yield market. Since the returns on L bonds are driven by the life insurance market, there is no correlation with any of the major market indices. (For more, see: Are Dividend Stocks a Good Substitute for Bonds?)

Gaining Steam

GWG issued another billion dollars’ worth of L bonds in January of 2015 after issuing $250 million of them in August of 2012. The first issue was fully subscribed by December of 2014. The company has managed to sell about $400 million worth of these bonds by using the independent broker-dealer channel with its 5,000 advisors. The bonds are sold on commission and there is typically a $25,000 minimum investment.

Sales of these bonds may pick up because they are now available through the Depository Trust Company (DTC), which will provide sellers with access to a much larger market. GWG does not feel that the Department of Labor's new fiduciary rule will impede the sale of their bonds, but did note that the brokers who sell them will have to do so under the BICE requirements, according to Thinkadvisor.

The Bottom Line

L bonds may provide-fixed income investors with a nice alternative to the low-yielding offerings that are available in the conventional markets. But these bonds do come with their own set of risks, and the secondary life insurance marketplace is still largely in its infancy. (For related reading, see: What Advisors, Clients Should Expect from a Low-Return Future.)