08 September 2009

The latest from Wall Street - securitized death benefits

The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.

Either way, Wall Street would profit by pocketing sizable fees for creating the bonds, reselling them and subsequently trading them...

Indeed, what is good for Wall Street could be bad for the insurance industry, and perhaps for customers, too. That is because policyholders often let their life insurance lapse before they die, for a variety of reasons — their children grow up and no longer need the financial protection, or the premiums become too expensive. When that happens, the insurer does not have to make a payout.

But if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have been abandoned; as a result, more policies will stay in force, ensuring more payouts over time and less money for the insurance companies.

Indeed, Mr. Doherty says that in reaction to widespread securitization, insurers most likely would have to raise the premiums on new life policies...

Undeterred, Wall Street is racing ahead for a simple reason: With $26 trillion of life insurance policies in force in the United States, the market could be huge...

Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than planned. The index is similar to tradable stock market indices that allow investors to bet on the overall direction of the market without buying stocks.
There's nothing illegal about this, perhaps not even anything immoral, but for some reason the entire concept just makes me cringe. More details at the New York Times.

Via Metafilter, where there is a discussion thread.


  1. It makes me cringe, too. It was all their fancy packaging and reselling of stuff that got them into so much trouble. OK. Among other things.

  2. Yeh it sounds cringeworthy - but at the same time insurance is just a business. Including life-insurance.

    Without starting a debate here, securitisation is actually a good thing in that it can distribute risk to those that are willing to take it. Actually an efficient way of doing things. Problem with all these troubles now is that no-one knew what they were actually investing in, and what the risk was.

    This does sound crazy though - but then I think that life insurance is crazy (how do they actually manage the risk?).

  3. I work in life insurance and investment partnerships "investing" in life insurance policies are not at all new. The securitization aspect of it is new.

    There are many states which regulate these kinds of life settlements.

    Part oft he difficulty is out health care system which expects people to bankrupt themselves. Often, when a person becomes very ill, their life policy becomes very valuable. That makes the opportunity for leeches such as this to pay a third or a quarter of what they are really worth in order to get a large return on investment.

    It's a very sleazy business. Securitization won;t make it any less sleazy.

  4. There's a flip side to this that is beneficial, but the NYT article (and others) completely ignore. Suppose you are an insurer. You've agreed to accept a series of premium payments in exchange for making a big payout at the time the insured customer dies. You've accepted potential risk (the customer dies next week after just one premium payment). You've done so in return for potential reward (the customer dies many years down the road after making many premium payments). Having a market for the *collective* risk of many policies lets you mitigate the risks of each individual policy. i.e., In return for steadier cash outflows (no big losers), you accept steadier cash inflows (no big winners). It is then safer to insure a wider spectrum of customers. Bothe the insured and the insurer can also trade the index or derivatives thereof to offset both known costs and potential risks. - Daniel


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