The growing life settlements market could be profitable as an alternative asset class for experienced investors, but must be approached with caution and a thorough grasp of the risks involved with longevity, according to a new report from Mercer.

Research by Mercer’s Alternatives Boutique unit in Melbourne, Australia, suggests settlements may suit investors seeking an asset uncorrelated to capital markets.

“Mercer believes this asset class has the potential to offer an attractive return stream,” said Ryan Bisch, the report’s author and senior associate of Mercer’s Alternatives Boutique, an arm of Marsh & McLennan Companies Inc., New York. “Investors can capture an underlying risk premium, which is effectively an arbitrage against the insurance company.”

The settlement market has been growing but recently experienced a drop in demand, the report says. Estimated deal flow in 2005 was $5.5 billion, climbing to $11.7 billion in 2008 and dropping to $8 billion in 2009, according to the report.

Bisch cites the difficulty of raising capital during the downturn, the after-effects of longer life expectancy projections in late 2008, and competition from new asset classes as reasons for the slowdown.

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