Adding alternative investments to your wealth practice with PPLI

In the wake of the market turmoil of 2022, when both stock and bond markets experienced negative returns simultaneously, some high net worth investors began seeking diversification opportunities beyond these markets. Continuous interest rate increases by the Federal Reserve have compounded the problem, as access to real estate, a common diversifier, has been limited by mortgage rates moving from below 3% to over 7% in many U.S. markets.

Accordingly, many high net worth investors are increasing their allocations to private equity, venture capital and other alternative asset classes. Cerulli estimates that high net worth investors will increase the portion of their portfolios allocated to alternatives by almost 25% over 2020 levels by the end of 2024. However, in addition to these investment strategies' additional potential returns (and potential risks), many investors find that simply qualifying to invest in these vehicles is only part of adding these sources of return to their portfolios.

Investing in alternative funds, even the most straightforward “hedge funds,” requires substantial research, detailed due diligence before investing, and a significant ongoing monitoring burden. Also, for high net worth investors investing directly into these vehicles, the tax impact of the strategy on returns can be substantial and challenging to forecast accurately.

Insurance products can be an access path to alternatives

Using an insurance product to access alternatives has several benefits to qualifying customers, including:

• Potential deferral of taxation on capital gains and income incurred within the fund(s) held.
• Access to a pre-screened set of investment opportunities managed by the underwriting carrier.
• The ability to transfer between alternative funds on the platform with minimal administrative effort.
• Preferred terms (such as fees, liquidity,) relative to those available to other investors by leveraging the carrier’s buying power.

The most common product in the space is private placement life insurance, also available as a variable annuity from some carriers.

Investors who can meet the eligibility requirements of the underlying funds (typically several million dollars in net worth) and the minimum premium investment requirements of these products (typically $2 million) may find the PPLI and PPVA products to be efficient ways to access the broader investment universe at a reasonable cost.

Investment options commonly available in these products include:

• Private credit strategies such as senior or mezzanine loan funds.
• Funds of hedge funds, which may include strategies closed to new investors.
• Multi-asset or multi-strategy funds.

In addition, the rapid growth in this space (estimated at more than 10% per year through 2030) continues to attract new and innovative investment products to the market. For example, Castle Analytics recently announced that their digital asset index fund, a fund tracking an index of five digital assets or “cryptocurrencies,” has been made exclusively available to the private-placement insurance markets.

Why should advisors consider adding alternatives to their practices?

Adding complex products such as PPLI and PPVA to a practice represents a substantial investment of time and effort on the advisor’s part. The products are differentiated by their customizability, which offers significant benefits to the policyholder but, of course, makes those products different from the other, more commoditized products in the advisor’s existing book of business.

However, given the increased interest in alternatives from this set of investors, providing access to these scarce investment opportunities can clearly differentiate an advisor in the minds of their clients.

Given the nature of these investment vehicles, adding these products to an existing practice can increase an advisor’s share of the client’s investment wallet and add a more stable revenue stream to the advisor relative to other insurance and investment products.

Finally, furthering their role as trusted advisors in these complex matters can assist the advisor in establishing cross-generational credibility as wealth plans are executed over time.

What does a sample PPLI or PPVA case look like?

The target market for PPLI and PPVA products is limited by the regulatory requirements governing both the insurance contract itself and the underlying investment vehicles. Typically, this means that policyholders must be sophisticated “accredited investors” or “qualified purchasers” with a liquid net worth above $5 million. Although product requirements vary across carriers and product types, the cost structures of the products typically incentivize premium investments of $2 million or more.

A typical investor will look to place these substantial amounts onto a platform with a well-rated carrier, either from outside investments or via Section 1031 exchange from a more limited/retail-oriented insurance product.

For example, an investor with a substantial balance in a universal life or variable annuity product may be frustrated by the limited investment options and high fees associated with these structures. An exchange into a private-placement product could offer this investor the control and transparency they are used to in their legacy product concerning investment options and changes but also lower fees and a broader range of investment options available in the alternatives market.

Dan Hoover is chief operating officer, Castle Analytics. He may be contacted at [email protected].

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