What Was an L Bond?
An L bond was a high-yielding debt instrument that financed the purchase of life insurance policies on the secondary market. A type of privately issued, alternative investment, L bonds were the creation of Dallas-based financial services firm GWG Holdings, which ceased selling them on April 16, 2021.
- The L bond was a specialty high-yield bond created and issued by GWG Holdings (GWGH) from 2012 through 2021.
- A private placement, the L bond financed the purchase of life insurance policies on the secondary market—paying policyholders more than the policy's surrender value.
- Highly speculative, the L bond sought to provide a high yield for the bondholder in exchange for the risk that insurance policy premiums or benefits may not be paid.
- L Bonds were highly illiquid—there was no way for bondholders to resell them, except back to GWG Holdings at a redemption fee.
- GWG Holdings suspended L bond sales in April 2021.
How L Bonds Worked
Life insurance bought from an insurance provider is intended to protect the policyholder's beneficiaries in the event of the policyholder's death. An insured party with a life insurance contract can also sell the policy in the insurance secondary market. The most common reasons for this are that they can't afford the premium payments, are in need of cash, or no longer need coverage. The investor who purchases the life insurance policy becomes the beneficiary after the transaction is settled. The buyer is responsible for making the premium payments to the insurance company, and when the original policyholder dies, the buyer receives the payout from the insurer.
Life settlement investors buy life insurance policies for more than their surrender value but less than the death benefit of the policies, a strategy known as a viatical settlement. These investors aim to make a profit by aligning their expected returns with the life expectancy of the seller. If the seller dies before the expected period, the investor makes a higher return since they won't have to make premium payments anymore. However, if the seller lives longer than expected, the investor earns a lower return. Most investors that invest in these life insurance assets are institutional investors.
In the case of L bonds, the issuer used the funds to purchase life insurance contracts that were listed on the secondary market, usually as a result of a life insurance settlement, and assumed responsibility for the associated premium payments. An L bond sought to provide a high yield for the bondholder in exchange for bearing the risk that insurance policy premiums or benefits may not be paid.
Investors that purchased life insurance policies sometimes financed the initial purchases and corresponding premium payments with L bonds. In terms of life insurance settlement transactions, the money raised from issuing the L bond was used to make the required premium payments to the seller of the life insurance policy.
GWG Holdings and the L Bond
The L bond was a private placement, a specialty high-yield bond created and issued by GWG Holdings (GWGH), a financial services firm based in Dallas that specializes in alternative assets. The company purchases life insurance contracts from seniors at a discount to their benefit value. In a viatical settlement, for example, the company could pay a senior $250,000 for their $1 million life insurance policy and take over premium payments of $30,000 a year. When the senior dies, the insurance company pays GWG the $1 million benefit. The funds raised from the L bond were used to purchase and finance additional life insurance assets.
As of Sept. 30, 2020, the firm's portfolio held 1,081 insurance policies valued at $1.92 billion in benefits. Of that, roughly half (46%)—$882 million—was in policies covering people 85 and older.
GWG Holdings had been selling L Bonds since 2012. On June 3, 2020, GWG offered a $1 billion L bond issue, and then on July 1, 2020, announced a $2 billion offering. Maturity terms of the new bonds ranged between two and seven years. Interest rates were 5.50%, 6.25%, 7.50%, and 8.50% for its two-, three-, five-, and seven-year bonds, respectively.
Characteristics of the L Bond
- The bonds were sold in denominations of $1,000 and the minimum investment value for any one investor was $25,000.
- The bonds could be purchased either directly from GWG Holdings or a Depository Trust Company (DTC) participant.
- An L bondholder had the same interest rate for the entirety of the bond term. If GWG changed its interest rate for the bond, the investor would have the new rate applied to their bond if they choose to renew the bond upon maturity.
- When the L bond matured, it was automatically renewed to a similar offering unless it was elected to be redeemed by the investor or the issuer.
- The bonds were callable. The firm reserved the right to call and redeem any or all of the L bonds at any time without penalty.
- Bondholders couldn't redeem the bond prior to maturity unless in the event of death, insolvency, or disability. For reasons other than the dire circumstances mentioned above, if GWG agreed to redeem a bond, a 6% penalty fee would be applied and subtracted from the amount redeemed.
- L bonds were illiquid investments: There was no secondary public market for these offerings. Therefore, the ability to resell these bonds was highly unlikely. The illiquid characteristic of L bonds meant that if the bond performed poorly, the bondholder still had to hold onto it until maturity or pay a 6% redemption fee to sell it.
- L bonds were not correlated to the market. Therefore, the volatility of the financial market typically did not affect the value of the bond.
- In the event of default, claims for payment among the holders of L bonds and other secured debt holders would be treated equally and without preference.
Also, the interest payments on the bonds were linked to the payout if the life insurance policies are purchased in the secondary market. If the insured party lived past their life expectancy, or the insurance company that holds the policy becomes bankrupt, the value of GWG's portfolio could drop, leading to a situation in which GWG Holdings might be unable to make its interest payments to its L bondholders.
GWG failed to file its annual report for the year ending Dec. 31, 2020, and a Form 10-Q for the quarter ending March 31, 2021. After failing to timely file its 2020 annual report, GWG suspended its offering of L Bonds. Further, several members of the Board of Directors reportedly resigned in the second quarter of 2021.
On Aug. 1, 2021, GWG announced that its board of directors determined that certain previously issued financial statements including its annual report for the year ended 2019, and the quarterly reports for the first three quarters of 2020 “should no longer be relied upon.”
What Is a Private Placement?
A private placement is a sale of stock shares or bonds to pre-selected investors and institutions rather than on the open market. Relatively unregulated, it is an alternative to an initial public offering (IPO) for a company seeking to raise capital for expansion. If the issuer is selling a bond, private placement avoids the time and expense of obtaining a credit rating from a bond agency.
Do Bonds Pay Dividends?
No, bonds do not pay dividends–only shares of stock do. Dividends are a portion of a company's profits, distributed on a per-share basis. However, bonds do make regular payments to those who hold them. Called coupons, these are interest payments—usually at a fixed rate—on the principal amount of the bond.
Are L Bonds Safe?
L bonds are (or were) unrated by any bond ratings agency. Their issuer, GWG Holdings, stated in prospectuses that: "Investing in our L Bonds may be considered speculative and involves a high degree of risk, including the risk of losing your entire investment."