It’s brilliant.
It’s diabolical.
It’s both.
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Following the implosion of the mortgage market last year, Wall Street started searching for the next big thing.
They found it in your sock drawer.
It’s your life insurance policy. Speculators near and far are clamoring to get a piece of the action.
These Transactions Have a History
Wall Street bankers are not trying to sell you more. They want to take it off your hands.
They’re called Life Settlements. On paper, it’s the perfect plan.
Just about everyone has life insurance. And unless science has missed something along the way, everybody is going to die.
Now a new crop of bankers is paying cash to the sick and elderly to buy their life insurance benefits at a deep discount. A $1 million policy may sell for $400,000.
Brokers specializing in this type of investment call it a “viatical settlements.”
Transactions of this type have been around since the early 1900s. HIV/Aids sufferers in desperate need of cash created an underground market for these policies in the 1980’s.
In the wake of the credit crisis, when many elderly have seen the value of their homes and retirement portfolios decimated, life insurance is one of few assets that has kept its face value.
Up to this point, the discounted sale of life insurance benefits generally has been transacted one policy at a time, with the speculating purchaser betting that Aunt Sally or Uncle Fred will kick the bucket sooner than later.
In the jargon of Wall Street, the bankers want to “securitize” these policies by bundling thousands together into bonds that they plan to sell to investors and pension funds that will pay out when the policyholders die.
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If you think rating mortgage-back securities was dicey, valuating these packages may be the actuarial equivalent of voodoo.
Life insurance always has been a controlled bet.
Insurance statisticians, known as actuaries, have long used life expectancy tables to rate risk.
They know if they issue a $1 million life insurance policy to a 45-year-old non-smoking, non-diabetic white male, it’s a good bet he’ll live to be 73. That means the company can count on 27 years of premiums before it will be forced to pay out any benefits.
More Complicated Than It Appears
For investors buying into these viatical bonds, the earlier the policyholder dies, the greater the return. But if Uncle Fred outlives his life expectancy, investor returns will be substantially diminished or even turn into a losing proposition.
Here’s the catch.
Investors aren’t just buying the policies at a discount. They’re also on the hook for the monthly premiums.
In addition to rating the mixed risks associated with each bundle of life benefits, bankers marketing these securities also will have to rate the long-term solvency of the insurance companies that issued the original policies. If the issuing insurance company goes under before the payout can be made, the investors will be out-of-luck.
Given the inherent nature of this risk, it will not be a surprise if some geek from the Street comes up with the idea of selling insurance to insure the insurers.
Sound familiar?
As of June, the Economist magazine estimated that the life settlements market was valued between $18-19 billion. Once Wall Street ramps up the program for these instruments, the real value may dwarf the now moribund market for mortgage-backed securities.
If this market takes off, investments in life- extending wonder drugs may take a nose dive. For environmentalists, this may be an elegant solution to overpopulation.
These days, everyone wants cash.
The only question is, how many investors are willing to bet your life on it.
John Cohn is a senior partner in the Globe West Financial Group, based in West Los Angeles. He may be contacted at www.globewestfinancial.com
