The New York Times reports that Wall Street investment banks are considering securitizing “life settlements,” which are life insurance policies that ill and elderly people sell for cash. Jenny Anderson, New Exotic Investments Emerging on Wall Street, N.Y. Times, Sept. 6, 2009, at A-1. The news calls to mind Nassim Nicholas Taleb’s epigrammatic injunction that “People who are driving a school bus blindfolded (and crashed it) should never be given a new bus.” Nassim Nicholas Taleb, Ten Principles for a Black Swan-Proof World, Financial Times, April 7, 2009.
The Times reports that investment bankers plan to buy the life insurance policies for an amount that is a function of the life expectancy of the insured person. The bankers then intend to securitize the policies, packaging hundreds or thousands of them together into bonds, which will then be resold to investors, such as pension funds. Id. It calls to mind yet another can’t-miss prospect — securitized subprime mortgages.
The Times reports that the new investment vehicle may not necessarily be good for the insurance industry, because policyholders often permit their life insurance policies to lapse before they die, so that the insurer does not have to make a payout. In the case of a securitized policy, the investors will pay the premiums, thus ensuring that policies will remain viable and require payouts over time. The Times quotes Neil Doherty, a professor at Wharton, who observes that life insurers have thus based their premiums on assumptions that were erroneous. He speculates that insurers would “most likely…have to raise the premiums on new life policies.” Id.
Wall Street is anxious to pursue this new investment vehicle because there are $26 trillion of life insurance policies extant in the United States. Id. Thus, “even if a small fraction of policyholders do sell them, some in the industry predict the market could reach $500 billion.” Id.
The Times reports that Goldman Sachs has developed a tradable index of life settlements, which enables investors to bet on whether people will live longer than expected or die sooner than planned. Id. “Depending on various factors, they [investment banks] will pay 20 to 200 percent more than the surrender value an insurer would pay.”
Of course, there is a certain degree of risk that attends such investments. That is, the policyholder could live longer than expected. The Times notes that “it is not just a hypothetical risk,” citing the experience in the 1980s, “when new treatments prolonged the life of AIDS patients.” Id. To address this inconvenience, investment bankers have designed a bond that “would ideally have policies from people with a range of diseases—leukemia, lung cancer, heart disease, breast cancer, diabetes, Alzheimer’s.” In this manner, the bond would be designed to preserve the value of a “securitization portfolio” in the event that “a cure is developed,” thus inoculating the value of the bond from the advances of modern medicine. Id.
Finally, the Times notes that the insurance industry opposes the practice. A representative of the American Council of Life Insurers is quoted as explaining that “Just as all mortgage providers have been tarred by subprime mortgages, so too is the concern that all life insurance companies would be tarred with the brush of subprime life insurance settlements.” Id.
And, quite predictably, the Times reports that the plans of the investment bankers have caught the eye of legislators and regulators.
