I bet you didn’t think life insurance policies could be securitized. You would be very wrong:
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. But some who have studied life settlements warn that insurers might have to raise premiums in the short term if they end up having to pay out more death claims than they had anticipated.
An investment based on complex mathematical models with no risk for the creators of these products. What could possibly go wrong? I’m sure they’ve done lots of analysis to make sure nothing bad could happen:
To test how different mixes of policies would perform, Mr. Buckler has run computer simulations to show what would happen to returns if people lived significantly longer than expected.
But even with a math whiz calculating every possibility, some risks may not be apparent until after the fact. How can a computer accurately predict what would happen if health reform passed, for example, and better care for a large number of Americans meant that people generally started living longer? Or if a magic-bullet cure for all types of cancer was developed?
If the computer models were wrong, investors could lose a lot of money.
But, wait! It also drives up the cost of a legitimate product, life insurance:
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.
“When they set their premiums they were basing them on assumptions that were wrong,” said Neil A. Doherty, a professor at Wharton who has studied life settlements.
Indeed, Mr. Doherty says that in reaction to widespread securitization, insurers most likely would have to raise the premiums on new life policies.
Critics of life settlements believe “this defeats the idea of what life insurance is supposed to be,” said Steven Weisbart, senior vice president and chief economist for the Insurance Information Institute, a trade group. “It’s not an investment product, a gambling product.”
But don’t worry, it’s only estimated to be at least a $500 billion market.
I wonder if there’s a derivatives market for cadavers.