Description

ABL: Highly Strategic Asset in the Life Insurance Industry with an Unusual Trading Set Up

Why Care Now?

Abacus Life (ABL) completed a SPAC merger on July 3, 2023. Abacus’s SPAC merger generated very little in proceeds to ABL. Abacus does not currently have research coverage and is generally undiscovered. We spent time trying to understand Abacus’s business, and we came away with an appreciation for a business that could generate 20% ROE durably for five years.

We think ABL is an attractive long-term investment. We also think it is prudent to be aware of shorter-term trading dynamics. As we researched Abacus, we noticed that there are only 1.5 million shares in the float. Insiders own the remaining 61.8m shares and have a tiered lock up (as outlined in the Dec 29, 2023 8-K) with only 15% of insiders’ shares unlocking on June 30, 2024 and the remaining 85% of insiders’ shares unlocking on June 30, 2025. So, only 1.5 million shares are available to trade. Further, Abacus announced a $15 million share repurchase on December 12, 2023, which was greater than the size of the entire float at the time of the announcement. Therefore, we thought there was potential for ABL’s repurchase authorization to potentially ignite a squeeze in the stock.

Abacus has 17.25 million public warrants (ABLLW) that trade on Nasdaq. These warrants expire in July 2028, have an exercise price of $11.50, and are callable if the stock trades over $18 for twenty out of thirty consecutive days. We think ABL’s warrants are attractively valued at $0.70/share considering the merits of the operating company. ABLLW has the potential to increase by approximately 9x if ABL’s stock does, in fact, squeeze higher. Warrant exercises could generate almost $200 million of proceeds to ABL, which would allow ABL to aggressively grow its book. We think ABL could be worth $12.15 on a fundamental basis right now absent a short-term squeeze, but we thought it was an interesting dynamic that was worth noting for shorter term traders. We think ABL could be worth $17.60 if ABL does squeeze, and Abacus deploys cash from warrant exercises at current ROICs.

Life Settlement Overview

Abacus Life operates in the life settlement industry, serving a key role in the broader $13 trillion life insurance industry that benefits carriers and consumers. First, what is a life settlement? A life settlement is the sale of an existing life insurance policy. Amazingly, 90% of life insurance policies never pay a claim primarily because of policy lapses (the policy holder stops making premium payments). Unfortunately, most beneficiaries fail to realize that when they lapse their policy, they forfeit the equity that has accumulated in their life insurance policy (generally specific to universal life, whole life, and convertible term life policies). Instead of lapsing the policy and forfeiting the equity, the policy holder can either take the cash value out of the policy (less fees paid to the insurer), or the beneficiary can sell the life insurance policy to Abacus or another financial investor. In 2022, Abacus paid 8x the cash value to policy holders. After buying the policy, Abacus can either sell the policy or hold it to maturity (mortality event for the beneficiary).

We will come back to ABL’s business model in greater detail later. Let’s first cover why life settlement is an attractive asset class. Life settlements are similar to zero coupon bonds with a maturity date driven by mortality. Therefore, life settlements are generally a-cyclical, uncorrelated assets. Importantly, there is very little counterparty risk because most carriers have A-rated or better paper, and the policies are heavily cash collateralized. With these characteristics, one might expect these assets to carry mid to high single-digit percent returns; however, life settlements average IRRs are in the mid-teens. Why? Supply is hard to accumulate due to regulatory burdens, contractual complexity, and a lack of awareness.

Regulatory Burdens

Insurance is regulated at the state level, and Abacus is licensed in 49 states. New participants need to go through the licensure process in every state in which they intend to do business. Abacus recently commented at the Stephens conference that it would likely take a new participant two years and $10 million to obtain the necessary licenses in every state. This part of the moat is material, but not insurmountable.

Contractual Complexity

Abacus recently highlighted that it receives 10,000 inquiries per month, and ultimately only buys 30 to 40 policies each month. Abacus underwrites each beneficiary including obtaining an up-to-date bill of health of the beneficiary, which informs a new estimate of the life expectancy of the beneficiary. Abacus shares this information with the beneficiary and educates the policy holder and financial advisors on how the life settlement works; that process can take “on average, 30 minutes to 45 minutes.” Doing that 10,000 times per month to only yield 30 to 40 policy acquisitions requires extensive expertise, process, and labor. Goldman entered life settlements about 10 years ago and failed in large part because Goldman didn’t dedicate resources to answering financial advisor’s questions about life settlement.

Awareness

Beneficiaries and most financial advisors are largely unaware of life settlements. In other words, just because an industry participant has the necessary licenses, expertise, process, and labor to participate in the industry, doesn’t mean they can get meaningful volume. To be clear, there is no shortage of paper. Roughly $233 billion of life insurance policies lapse annually versus $13 trillion of face value. Remember that 90% of policies don’t pay claims principally because they lapse. Beneficiaries are clearly unaware of the options available to them. Additionally, Abacus highlights in its investor presentation that 49% of financial advisors are unaware of life settlements. There is a significant education/awareness problem for the life insurance industry. Abacus has just scratched the surface of penetrating this industry. Abacus recently started to disclose capital deployed but hasn’t yet disclosed face value acquired on a quarterly basis. Abacus disclosed that it deployed $51 million of capital (or $204 million annualized) in Q3 2023; capital is obviously deployed at a discount to the face value. Even if we assume that Abacus is buying policies at 10% of face value, Abacus is buying less than 1% of the $233 billion of face value that lapses annually. Another way to look at this is that Abacus has acquired $2.1 billion of FV since 2019 (Investor Presentation) compared to ~$1.1 trillion that has lapsed over the same time. Abacus offers a better financial outcome to policy holders that decide to stop making future payments on their policy. We believe more policy holders would choose to sell their policy into the life settlement industry if they knew about this option.

I’m Going to Lapse My Policy, What are My Options

Why do policy holders sell their policy, and why would they sell to Abacus? The life insurance policy seller either has a liquidity need (i.e, fund retirement, pay medical bills, afford long-term care) or no longer needs the life insurance policy because it functionally served its need (security for family members in the event of an early and untimely death). The policy holder has 4 functional options: continue to make rising premium payments, lapse the policy, take the cash-value out of the policy and allow it to lapse, or sell the policy to a life settlement company. Rising premium costs can be prohibitively expensive, so we’re going to focus on policy holders that have made the decision that they do not need life insurance for whatever reason.

Policy holders that allow their policy to lapse forfeit accumulated equity when stopping premium payments. The policy holder could take the cash value out of the policy (less fees), or the policy holder can sell the policy to a life settlement company directly or through a broker. Abacus has paid out 8x the cash value to the beneficiary; that’s certainly a lot better than the other two alternatives. Why sell to Abacus vs. another life settlement provider? Theoretically, the only real reason is price. In reality, there is probably some combination of price and awareness. If a beneficiary is in the market to sell a policy, the two largest buyers he or she would come across are Abacus and Coventry. Abacus has significant reach, a better reputation, and it claims to offer more transparency on pricing. Abacus sells through three channels: agents (increasing), direct to consumer (increasing), and brokers (deemphasizing because the other two channels have better margins). Abacus has relationships with over 30,000 financial advisors and has a 70-person origination team. Coventry is reputationally viewed by some industry participants as a gray actor. They have had brush-ups with regulators and insurance carriers. Some financial advisors may choose to work exclusively with Abacus for that reason. Abacus claims to have only had four pieces of litigation against it in 19 years of operations.

Abacus’s Role in the Insurance Ecosystem

Let’s also consider how Abacus can benefit insurance carriers. In general, carriers don’t like the life settlement industry. 90% of life insurance policies lapse, which is obviously highly profitable for insurers. A life insurance policy that is sold to a financial institution (like Abacus) is most likely going to result in the insurer eventually paying a claim. That’s not good for the carrier. However, there are cases in which carriers benefit from life settlement companies, and those cases represent the largest market opportunity for Abacus.

A couple decades ago, carriers started writing some extremely bad paper, and now carriers are reaping what they sowed. The two most problematic kinds of paper are Guaranteed Universal Life (GUL) and Secondary Guarantee Universal Life (SGUL). As we understand it, the paper is problematic because the cash value can be close to zero and the insurer is still on the hook for the death benefit as long as the minimum premiums are being met. Carriers issued a lot of this paper in the early 2000s. Generally, Universal Life policies that aren’t guaranteed have a lapse rate in the 5% range (annually). Carriers introduced GUL and SGUL, a new product with no historical precedent on which to base lapse rates, and expected lapse rates would be close to 3-3.5%. The lapse rates were a shockingly low 0.5% annually. To make matters worse for carriers, these policies haven’t built up cash value, which is what offsets the insurer’s liability. Policies haven’t built cash value because interest rates have been incredibly low for the last two decades and many of these policies were written shortly before the Great Financial Crisis. In addition to lower than anticipated lapse rates and meager growth in the cash value of the policy, regulators (NAIC) came out in 2006 with Regulation XXX which significantly increased the reserve requirements on Guaranteed Universal Life and Secondary Guarantee Universal Life. Effectively, this paper was hit by a triple whammy: lower lapse rates, a regulatory change that led to higher reserve requirements, and a low interest rate and total return environment. This paper has been a looming crisis for several major life insurance carriers; if interested, it’s worth listening to Lincoln National’s (LNC) Q3’2022 earnings call. Lincoln announced an actuarial review of its GUL and SGUL book that resulted in a $2 billion GAAP charge and a $550 million impact on statutory capital that resulted in them selling $1 billion of preferred stock to recapitalize. Talcott acquired Principal Financial Group’s book in 2022 at a big discount due, in part to, Principal’s GUL and SGUL book. Prudential has also been negatively impacted by its GUL and SGUL book, but Prudential has had significant other revenue to offset this headwind. Lincoln and Principal’s recent “blow ups” evidence that this is a timely issue for insurers.

How can Abacus help? Life insurance carriers are not allowed to adversely select their own book of business. They can’t purchase policies directly from beneficiaries. This law has been in place for approximately 50 years and would require insurers to offer the same amount to every policy holder. That is theoretically challenging (because policy holders have various health profiles) and prohibitively expensive to buy back an entire class. However, Abacus can buy policies from current beneficiaries at a significant premium to the cash value of the policy and turn around and sell the policy to the carrier and lapse the policy. For example, let’s say there is a $5 million GUL policy with a current cash-value of the policy is $200,000, and the carrier’s reserves on the policy are $2 million. Abacus could buy this policy for $1,200,000 and sell the policy to the insurer for $1,500,000. This is a win-win-win for Abacus, the carrier, and the consumer. Abacus makes a ~20% spread for providing this service. The carrier cleans up its book, free up reserves, and replaces the policy with better paper. This is highly accretive because the carrier is taking the policy off its books at less than current reserves. The consumer exits his policy with drastically greater than his cash value and knows that nobody will benefit from his death because the policy will lapse. We have heard estimates of over $500 billion in GUL and SGUL paper. Abacus is already working with a handful of large carriers. Abacus breaks out concentrations of face value by issuer; the last two quarters have included American General Life Insurance Company, ReliaStar Life Insurance Company, Lincoln National Life Insurance Company, and Transamerica. Investors who are interested should review Aegon’s third quarter earnings presentation. Aegon is the parent company of Transamerica. Aegon’s third quarter presentation highlights the Aegon’s goal of reducing mortality risk by purchasing at least $2.8 billion of Face Value institutionally owned universal life policies by 2027. Aegon is just ONE customer, and it is talking about buying more universal life policies than Abacus has bought in the last five years combined across the entire industry. We are very excited about this massive opportunity.

Abacus’s Underwriting Process

Now that we know what life settlements are and how the life settlement industry benefits consumers and can benefit carriers, let’s discuss the underwriting process and Abacus’s business model. Abacus re-underwrites beneficiaries contemplating selling their policy. The underwriting process includes an up-to-date bill of health of the beneficiary, which informs a new estimate of the life expectancy of the beneficiary. This allows Abacus to provide the beneficiary with the actual market value of the policy. This information is extremely valuable to the beneficiary and the beneficiary’s financial planner. The beneficiary now knows what his or her policy is worth and can use the life expectancy data to inform the rest of his or her estate planning. Additionally, this information gives Abacus an advantage over the carrier who does not have an up-to-date picture of the health of its beneficiary. Abacus will present the beneficiary with all available information using the updated life expectancy, including the estimated premium cost until maturity, expected rate of return for the policy, the current cash value of the contract, and the price at which Abacus is willing to purchase the policy.

Abacus effectively has three business models after purchasing a policy. Abacus will either sell the policy through its marketplace, hold the policy on its balance sheet, or Abacus sets up a partnership and acts as a portfolio manager collecting management fees and servicing fees in return for actively managing the underlying portfolio. Abacus’s primary business model is its marketplace aka active management platform in which Abacus is actively buying and selling policies. Marketplace transactions generate a 2% of face value origination fee and a trading spread between its acquisition cost and its sales price. Trading spreads average ~20%. Second, Abacus could choose to hold the policy on its balance sheet, pay the required premiums, and collect at maturity. Our understanding of Abacus’s strategy is that policies generally do not stay on its book for more than two quarters, but Abacus may hold onto its best policies for a couple of quarters. Finally, Abacus could raise outside capital and manage a partnership where Abacus acts as the portfolio manager. Abacus has done this in the past with its Longevity subsidiary. In the same vein, Abacus is planning on launching a mutual fund in 2024 for which we think there will be significant demand. LMA income funds raised $55 million in 2023, and those funds are only accessible to accredited investors. A 1940 Act mutual fund will be more accessible to retail investors. The 1940 Act mutual fund could give Abacus access to non-dilutive capital to allow Abacus to grow its book aggressively. The mutual fund will have a target yield of 6% and target growth of 8-10% for a return of 14-16%. The economic engine behind the yield will come from both trading spreads and maturities. Abacus will receive a brokerage fee for each policy it sells into the mutual fund.

Prior Public Comps

While there have been notable winners in the life settlement industry (Abacus and Coventry), there have been some massive losers that have left a stench on the industry. There were previously two public companies, GWG Holdings and Emergent Capital, which invested in life settlements that ultimately failed.

GWG Holdings (formerly GWGH) employed a fundamentally different business model from Abacus. GWG only had a buy and hold strategy, and GWG principally bought policies from brokers. GWG’s strategy of buying and holding life insurance policies is not necessarily bad, but it is very capital intensive. To the best of our knowledge, GWG was not actively underwriting policyholders and was relying on brokers to share information about the beneficiary while also using third-party medical actuarial firms to estimate the insured person’s life expectancy. Brokers collect fees of 20-25% for providing this service. GWG had little edge because it was simply acquiring policies and paying third parties to source and underwrite the beneficiary. The only thing GWG brought to the table was capital, and because it never sold policies, GWG participated in the life settlements industry in the most capital-intensive way possible. It’s incredibly difficult to sustain that business model. GWG issued bonds, common stock, and preferred stock to retail investors to finance its business plan. In 2018, GWG doubled down on its business model of owning capital intensive businesses. GWG purchased an 82% interest in BEN MLP issuing $400 million of stock and issuing $400 million of bonds. Beneficient (BENF) is a liquidity provider in the secondary market for alternative asset investments. Pro forma for that transaction, GWG managed two capital intensive businesses. This WSJ article details the saga that transpired after the Beneficient transaction. To summarize some of the most important points, Beneficient was investigated by the SEC in October of 2020. The SEC concluded that Beneficient “had been making loans to its own subsidiaries and counting the interest it received as revenue” in July of 2021. The SEC required Beneficient restate its financials. GWG didn’t release restated financial statements until November 2021, at which point management disclosed the “extent of losses in Beneficient’s private-equity investments” and simultaneously informed investors of the SEC investigation over a year after the probe began. GWG was unable to issue bonds without up-to-date financial statements, and GWG filed for Chapter 11 in April 2022. We found it interesting that Beneficient was spun out of GWG before the bankruptcy filing and went public in a SPAC merger in June 2023. BENF is down 95% from its SPAC merger. GWG’s buy and hold strategy became unsustainable when it was prohibited from raising capital by the SEC. In contrast, ABL is very actively trading its portfolio of insurance policies and is generally not imploring GWG’s buy and hold to maturity strategy.

Emergent Capital is more complicated and opaquer than GWG. Fortunately, there are two special sit writeups that give ample history, the more thorough write up is on VIC and a second is on Special Situation Investments. Emergent Capital was founded in December of 2006, and went public on the OTCQB in 2015 simultaneously changing its name to Emergent Capital. All Emergent Capital life insurance policies were held in a wholly owned subsidiary called “White Eagle Asset Portfolio.” Similar to GWG, Emergent employed a buy and hold strategy. Emergent Capital financed the acquisition of policies and premiums with a revolving credit facility. However, as detailed in both reports linked above, the portfolio was badly constructed, the company was mismanaged, expenses were bloated, and Emergent lacked liquidity to the tune of “hundreds of millions.” Lastly, as highlighted in the VIC writeup, “despite a US life expectancy of 78.6 years, Emergent somehow found 576 individuals that are so healthy that it’s statistically impossible for this cohort to exist.” In other words, Emergent’s beneficiaries lived a lot longer than expected. That’s a really bad combination of factors for a life settlements company. Fast forward to 2019. Emergent Capital had filed for bankruptcy and only retained a 27.5% equity interest in White Eagle Asset Portfolio. In contrast, ABL is very actively trading its portfolio of insurance policies and generally does not hold policies for longer than one quarter which allows ABL to avoid the risks and capital intensiveness of buy and hold strategies.

The chart below depicts the differences between GWG, Emergent, and ABL’s strategies. There are at least two important distinctions. First, unlike GWG and Emergent Capital, Abacus trades its book actively. Abacus does not only buy and hold strategies; this factor alone, makes Abacus’ business model more sustainable than GWG and Emergent who were perpetually dependent on access to capital. Second, Abacus has more control over the underwriting process and can acquire policies more attractively than GWG and Emergent Capital could because Abacus doesn’t rely on brokers as heavily as GWG and Emergent Capital did.

Valuation

Abacus Life does not have any publicly traded comps. However, there are some similarities between Abacus and publicly traded specialty insurers. The businesses are highly regulated, capital intensive, and generate substantial returns on equity. There are three big differences; 1) insurance companies receive premiums rather than pay premiums, 2) the life settlements industry seems less competitive, and 3) there is stigma associated with the life settlements industry. In Q3, ABL’s Adjusted ROE was 22%, which compares favorably to the publicly traded specialty insurers. A comp set of specialty insurers with similar ROEs trades for 21.0x Run Rate Adjusted EPS. If we apply the same multiple to the $9.2 million of Adjusted Net Income Abacus generated in Q3, we compute a ~$12.15 price target. Earnings would grow dramatically if ABL secured $200 million in cash from warrant exercises and deployed it successfully. At the current adjusted annualized ROIC, ABL would add $58 million to adjusted net income. At 15.0x Adj. EPS, ABL would be worth $17.60 after considering dilution from the warrants.

Conclusion

We like finding businesses that can generate durable 20% ROEs, and we think Abacus will be an attractive investment over a long period of time. We started our write up when ABL was trading for $7.50/share and the warrants were $0.55. We think Abacus’s strategy and strategic value in the insurance ecosystem will allow it to be successful. We generally like stocks with small floats because incremental improvements can drive outsized price action. Abacus’s small float and share repurchase authorization could result in a meaningful increase in the share price that drives warrant exercise and cash to Abacus that can be attractively deployed.

Disclosure

Our firm currently holds a long position in this security which can currently be considered a long-term holding. Our research is completely independent and based on public information, our proprietary research, and our analysis of that information. While Author has tried to present facts it believes are accurate, Author makes no representation as to the accuracy or completeness of any information contained in this note. The reader agrees not to invest based on this note, and to perform his or her own due diligence and research before taking a position in ABL or ABLLW. Reader agrees to hold harmless and hereby waives any causes of action against author related to the note above. As with all investments, caveat emptor.

Catalyst

Company repurchase announcement could drive a squeeze

Awareness

Discovery