What Is an L Bond?

An L bond, classified as an alternative investment, is a bond that finances the purchase of life insurance policies on the secondary market.

Key Takeaways

  • An L bond, classified as an alternative investment, is a bond that finances the purchase of life insurance policies on the secondary market.
  • An L bond is unrated and seeks to provide a high yield for the bondholder in exchange for bearing the risk that insurance policy premiums or benefits may not be paid.
  • L bond is a specialty high-yield bond issued by GWG Holdings.

Understanding L Bond

An L bond is unrated and seeks to provide a high yield for the bondholder in exchange for bearing the risk that insurance policy premiums or benefits may not be paid. The issuer uses the funds to purchase life insurance contracts that are listed on the secondary market, usually as a result of a life insurance settlement, and assumes responsibility for the associated premium payments.

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 is if 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 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.

Investors that purchase life insurance policies sometimes finance the initial purchases and corresponding premium payments with L bonds. Companies issue bonds to secure money to conduct a number of projects. Lenders who purchase bonds are normally paid a coupon rate (semiannually or annually) for the duration of the bond's life. At maturity, the face value of the bond is paid out to the bondholder by the issuing company. In terms of life insurance settlement transactions, the money raised from issuing the L bond is used to make the required premium payments to the seller of the life insurance policy.

GWG Holdings L Bond

The L bond is a specialty high-yield bond issued by GWG Holdings (GWGH), based in Dallas. 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 are used to purchase and finance additional life insurance assets.

As of June 30, 2020, the firm's portfolio held more than 1,100 policies valued at $1.96 billion in insurance benefits. Of that, roughly $883 million was for policies covering people 85 and older.

On June 3, 2020, GWG offered a $2 billion L bond issue with maturity terms ranging between two and seven years. Interest rates are 5.50%, 6.25%, 7.50%, and 8.50% for its two-, three-, five-, and seven-year bonds, respectively.

Other characteristics of the bond include:

  • The bonds are sold in denominations of $1,000 and the minimum investment value for any one investor is $25,000.
  • The bonds can be purchased either directly from GWG Holdings or a Depository Trust Company (DTC) participant.
  • An L bondholder has the same interest rate for the entirety of the bond term. If GWG changes 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 matures, the bond is automatically renewed to a similar offering unless the bond is elected to be redeemed by the investor or the issuer.
  • The bonds are callable. The firm reserves the right to call and redeem any or all of the L bonds at any time without penalty.
  • Bondholders cannot 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 agrees to redeem a bond, a 6% penalty fee will be applied and subtracted from the amount redeemed.
  • L bonds are illiquid investments. There is no secondary public market for these offerings. Therefore, the ability to resell these bonds is highly unlikely.
  • L bonds are not correlated to the market. Therefore, the volatility of the financial market typically does 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 will be treated equally and without preference.

As with all other investments, caution should be taken when considering an investment in L bonds, especially as the bonds are a high-risk investment. Their illiquid characteristic means that if the bond is performing poorly, the bondholder has to hold onto it until maturity or pay a 6% redemption fee if applicable.

Also, the interest payments on the bonds are linked to the payout if the life insurance policies are purchased in the secondary market. If the insured party lives past their life expectancy, or the insurance company that holds the policy becomes bankrupt, the value of GWG's portfolio may drop. This could lead to a situation where the firm may be unable to make its interest payments to its L bondholders.