Wall Street Securitizing Life Insurance Policies. Seriously.

Those lovable Wall Street ghouls have cooked up a new asset class to securitize — life insurance policies. I am not kidding you, they’re going into the business of buying life insurance policies from sick people, pooling them and then selling the securities to investors.

The NYT has the story:

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.

If you find that last paragraph confusing, the reason it could upset the insurance companies’ apple cart is that many policyholders let their policies lapse as they get older. For a variety of good reasons they quit paying the premiums. If the policies are bundled into a security, the new owners of the policy will continue to pay the premiums religiously and thus alter the actuarial assumptions of the insurance companies.

This business has been around for some time but it’s always been on the fringes. There are some good arguments in favor of it but at the same time, it’s always seemed just a bit tawdry. Then again, a bunch of guys who flooded the world with fraudulent mortgages probably aren’t too bothered about that.

I guess the contra argument would be that while smaller outfits have been doing this for some time with no apparent ill effects, that’s not a valid argument that there won’t be unforeseen consequences if it’s done on a massive scale. I’m not in the no financial innovation camp but this time I wonder if the benefit is really worth a roll of the dice.

One thing’s for sure. Nothing has changed on Wall Street. Securitization is the Holy Grail and come hell or highwater banks are going to keep on bundling whatever they can find.

Comments

[TinyTim:]

These life settlements or viatical settlements have been around for years.
Viaticals took off in the 80's when the AIDS epidemic forced people with life insurance policies but immediate high medical costs to sell at discounted rates.

There was an immediate stigma due to the "vulture" characteristics of the buyers and the fact that the return improved the faster the seller died. Since there were always story's about sellers going into remission, the only news here is the reduction of risk by securitization.

This could open up new avenues for Moody's and S&P to screw up. Not to mention bringing new meaning to bottom tranche.

Sep 07 01:17 AM

[Dirtnap:]

Time to purchase some CDSs on the U.S. economy. It clearly has a terminal illness.

Sep 07 02:34 AM

[Sean Ryan:]

Why all the harsh criticism of financial innovation? It advances human well-being as much or moreso than innovation in other fields.

Yes, some people got carried away with risk layering in the mortgage market in recent years, and rating agencies fell down on the job.

Those problems will be rectified and the market will ultimately rebound on a sounder basis.

More importantly, securitization, regardless of the underlying instruments, reallocates risk to those most willing to bear it, and reduces the cost of borrowing for all involved.

Mortgages rates are far lower than they would be without securitization. Holders of life insurance policies will be able to wring more value out of them as a result of securitization.

Even the yellow journalism of the NY Times is forced to concede as much.

Sep 07 03:13 AM

[joebaggadonuts:]

I guess what is needed here is another Madoff character to start one of these companies and pretend to have insurance contracts to bundle.

The job should be worth at the least a few billion before you get caught. I hear Van Jones is looking for work. Maybe he could do it.

Sep 07 04:08 AM

[Vuke:]

It's a natural step for Wall St industry. When predators run out of live prey they turn to scavenging the dead.

As the NYT points out, they may get the odd touch of food poisoning but medical treatment for that is covered by the Fed.

Sep 07 05:00 AM

[lower98th:]

Viatical settements are often part of the sale or demise of a small business, or the retirement of key or founding owners. These key man policies are often paid by the business or by heir policy owners, not the insured. When the policy is no longer needed to provide stability for a future business transition, the premium payer's needs change, the policies are cashed out or sold.

So a play on retiring boomers, fewer small businesses, as well as the obvious: desperate retirees.

Sep 07 07:23 AM

[lower98th:]

Hey Wall Street:

Wanna buy a slightly tattered IRA? 401K? With forced early retirement (that's not "unemployed," right?) and onerous penalties, maybe you could make me a deal.

Sep 07 07:49 AM

[Daniel Harr...:]

I'm all for innovation, but I'm not sure how much of it is genuinely going on here. This is essentially a ponzi scheme, since the product has a finite value (and maybe even negative value at some point if the premiums paid eventually top the settlement value) with an unlimited investment criteria, assuming its sold, re-sold etc.


On Sep 07 03:13 AM Sean J. Ryan wrote:

> Why all the harsh criticism of financial innovation? It advances
> human well-being as much or moreso than innovation in other fields.
>
>
> Yes, some people got carried away with risk layering in the mortgage
> market in recent years, and rating agencies fell down on the job.
>
>
> Those problems will be rectified and the market will ultimately rebound
> on a sounder basis.
>
> More importantly, securitization, regardless of the underlying instruments,
> reallocates risk to those most willing to bear it, and reduces the
> cost of borrowing for all involved.
>
> Mortgages rates are far lower than they would be without securitization.
> Holders of life insurance policies will be able to wring more value
> out of them as a result of securitization.
>
> Even the yellow journalism of the NY Times is forced to concede as
> much.

Sep 07 08:14 AM

[optionsgirl:]

Congress will help control the risk by putting additional obstacles in place to obtain life sustaining medical care. Cut life expectancy, and you have a "win-win" situation!

Sep 07 09:04 AM

[warrejt:]

The insurance policies being bought are not just terminally ill patients - far from it. In TX, the individual has to have at least 2 years life expectancy. It is much the same around the rest of the country.

Sep 07 10:30 AM

[Surfer Steve:]

Folks, I think the criticism is off-base here -- hear me out on an example. If someone has been paying their insurance premiums for years, and then decides they no longer need the policy or can't afford the premiums, they will receive little or no value for terminating their policy. Term-life has no cash value, and other policies such as whole life or universal life tend have cash values that are only 10-30% of the death benefit value. Who is getting screwed in this scenario? Clearly, it is the consumer (policy holder) who has been faithfully paying the premiums for years. This is also why insurance companies are so successful -- most people do not ever receive the benefit they have been paying for because they terminate their policy or fail to keep paying premiums. Pretty clever business model.

The life settlement business buys the existing policy for a much higher amount than the insurance company cash value, pays the premiums and receives the death benefit when the insured dies. If this were my mom or dad's policy that they no longer wanted, I think this makes much more economic sense than walking away from the policy and losing all their paid premiums or receiving the paltry cash value. The fact that someone is securitizing these things and packaging them as investments is not a big deal -- just about any type of predictable future cash flow can be securitized and sold to investors who need future income. Securitization is not inherently bad, it's used for credit card receivables, auto loans, tax liens, etc.

For the record, I worked in insurance for 15 years, but have no relationship or business interest in life settlements. I just understand how the game is played by the insurers. By the way, most insurance companies HATE these life settlement companies because they ensure that the death benefits will eventually get paid, thus costing the insurers money and adversely affecting their policy lapse models. Boo-hoo.

Sep 07 10:38 AM

[Bull Run:]

Wall Street's latest exotic investment vehicle?? Wall Street has finished cleaning out America's middle class with the last (scam), America's homes, using the sub-prime morgage,asset backed investment vehicle, now I guess all that's left is their life insurance policies. Maybe Wall street pimp's should get down on their knees, just as America's middle class is being put under 6 feet, and pull out their teeth, after all their might be some gold fillings, that could be bundled into a exoctic gold investment future play.

Sep 07 10:46 AM

[Bewildered:]

I think my screen name says it all!

Sep 07 11:08 AM

[Pat C:]

Securitization is not bad by itself as long as the originator is required to keep say 20% skin in the game and they are prohibited from hiding it off balance sheet. Also requiring them to be the servicer is a good idea. If not the actual servicer then at least reponsible oversight of the servicing.
This keeps everyone honest and keeps it from becoming overleveraged and out of control.

Sep 07 11:10 AM

[john1940:]

Not as bad as it sounds. Prior posts are correct that this purchase of life insurance policies began with the aids epidemic and filled a real need for people who were dying and running out of money. Recently it has been more "financialized" and Wall Street is packaging it for investors. Wall Street does that all the time so it should not surprising here.

The major question I have is how is there enough vigorish (a bookie term) available so that a Wall Street firm can do what the insurance company won't? The answer has to be that insurance is overpriced and not in a competitive market. I had an insurance salesman try to sell me a policy so that we could sell it to a fund two years later and make a substantial profit (before tax). It sounded like a get rich quick scheme and I avoided it. Like most insurance products, the seller knows the risks better than the buyer.

Sep 07 11:30 AM

[MikeX:]

Back to 2007. Signs of Financial Mania. As if the insurers will be able to deliver on the promise.

Sep 07 12:19 PM

[ForeheadVei...:]

Typical ignorant remarks by people who have a chip on their shoulder. Not all of you...there're a few comments above that are right on the money, but the ones who cry foul without even thinking about it, are just exposing their ignorance.
First of all, this idea of buying out Life Insurance policies and bundling them together (securitising them) has been going on for quite some time already. Second of all, if the demand for this product wasn't there, Wall Street wouldn't waste their time doing it (who would they sell it to?). Third of all, without the demand & Wall Street's innovation to satisfy that demand, all the people who want to cash out on their life insurance policies and whoop it up before they die wouldn't be able to do so....they would simply have to live their last few years in penniless misery and then their beneficiaries would get all the cash. And, obviously, nothing comes free...so Wall Street will charge fees for the service...big deal.

You think it's ghoulish & you imply that it's somehow a bit of a grave-robbing scenario?

All you losers love to razz on Wall Street....and yet if the financial industry were to disappear, then you'd be whining & moaning about not being able to get a loan, not being able to get a mortgage, not being able to buy a car. Your over-priced restaurant, or your overpriced lawn-mowing service, or your over-priced champagne cocktails, would all go unsold & you'd go belly up. It's OK when hedge fund guys come swooping into a crappy area like Tribeca (decades ago) and smarten it up & make it fashionable. It's OK when your crappy apartment suddenly is worth 5 times more than it should be. YOU take the credit for all of that, right? You had the foresight to buy a place in a run-down area....sure...And when your stock portfolio goes up, it's because of YOUR genius, right? But hey, as soon as anything goes down...your property or your stock portfolio, then it's all about "those wall street crooks stole my hard-earned money". And all the Wall St guys suddenly become a bunch of WASPs who went to Princeton & inherited all their wealth, whereas all you "victims" suddenly become the middle class coal miners who feature in Springsteen songs....HA! What a joke. The fact is Wall street is full of lower to middle class Italian, Irish etc types who simply worked their butts off to make it to where they are. You want to begrudge them their success and make it look like they "stole" it all? Gimme a break...tired of all this mock outrage and populist ranting about Evil Wall Street...
Not saying they're all saints, but for goodness sakes...look at the politicians who are making all the noise. They are a million times worse. Look at Lawyers. Look at the over-paid athletes whose stats are based on drug-enhancement. Look at the actors who make $25 million for a movie that stinks up the whole theatre. Let's get a little perspective here shall we?

Sep 07 01:14 PM

[ebworthen:]

The riots and collapse of the inner cities when things get really bad will make them money.

Insurance is about risk, right? Well, if the older folks are trapped in their homes due to civil unrest and can't get out for their medicine, treatment, or food the securitizers will make money off them dying.

They are betting on it; or gambling with the policy and premium.

Just what got us to last Fall...Brilliant.

Sep 07 02:11 PM

[user225084-...:]

Y'all understand what this means
<sarcasm alert>

Wall St will *want* to have Death Panels(*), because the bonds will become more valuable that way.

(*) not that they didn't already. We need to privatize the Death Panels so that they can be run more efficiently.

<sarcam off>

Sep 07 02:16 PM

[User241885/...:]

While moral outrage on the nature of life settlements makes for good headlines and sells papers, the NYT article was trying to raise the spector of another crisis created by "toxic financial products." And while the article over-reached the conclusions and under-mined the data, the one important but absent observation part was a discussion about how to avoid creating a new set of disasterous outcomes as insurance providers seek out new opporunities for profit.

The simple step that could have mitigated a substantial part of the credit default swap market fall out would have been to require that the beneficiaries of those contracts have "an insurable interest". this is a common sense legal necessity in life insurance and it is what keeps the life insurance industry able to pay its liabilities. That is also why the counter-parties to the secutized debt and credit defaul swap markets could not.

The pension manager who just bought $100MM corporate bond issue has a fiduciary obligation to protect his investment, so having an insurable interest, he or she can buy insurance in the form of a CDS. The hedge fund manager who is betting against the issuing corporation has no insurable interest. Had the insurable interest legal requirement been in place, there would have only been one credit default insurance policy issued on the entire bond issue, not several thousand policies, as the world learned too late from AIG's financial products group.

This is such a basic concept to the insurance industry, like compounding in finance, you have to have it in order for the process to work. I understand that many of the writers in the chain above are from the insurance industry, so it is a little dissapointing to see most of them going on the defensive about this line of business rather than providing insight into how to avoid similiar problems from happening again.

Isn't that what risk managers are supposed to do?

FAMCO

Sep 07 10:02 PM