Life settlements: Still no dice

By Felix Salmon
September 6, 2009
published in December 2006. He mentioned that Wall Street was getting interested in such things:

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The NYT has an excellent article on the life settlement industry, explaining its pros and cons in a balanced and clear-eyed manner. If you’re interested in such things, you should read it: it was written by Charles Duhigg, and published in December 2006. He mentioned that Wall Street was getting interested in such things:

Trading in life insurance policies held by wealthy seniors has quietly become a big business. Hedge funds, financial institutions like Credit Suisse and Deutsche Bank, and investors like Warren E. Buffett are spending billions to buy life insurance policies from the elderly…

This nascent market illustrates one way that investors are hoping to make money from a large and wealthy generation of Americans as they reach retirement age.

Today, Jenny Anderson covers most of the same ground but adds little in the way of actual news. What she does add is a much more ominous tone:

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…

If a small fraction of policy holders do sell them, some in the industry predict the market could reach $500 billion…

Some financial firms are moving to outpace their rivals. Credit Suisse, for example, is in effect building a financial assembly line to buy large numbers of life insurance policies, package and resell them — just as Wall Street firms did with subprime securities.

If Wall Street is really “racing ahead”, it’s been doing so for well over a decade now, and doesn’t seem to have got very far. There have been people on Wall Street trying to securitize and trade life settlements for as long as I can remember, and nothing much ever seems to happen. Is anything different now? Not really: Anderson has managed to find exactly one securitization of life settlements, and even that one she only mentions in passing:

Standard & Poor’s, which rated a similar deal called Dignity Partners in the 1990s, declined to comment on its plans.

In fact, Dignity Partners launched in March 1995, and was the grand total of $35 million in size. “Could” the market “reach $500 billion”, as “some in the industry predict”? Well, anything’s possible. But so far it’s managed to go from $35 million to zero over the course of the past 14 years. Wake me up when something happens: for the time being there’s nothing at all.

None of the big three ratings agencies is involved right now: the closest thing to a news hook in Anderson’s story is that DBRS, which she describes as “a little known rating agency in lower Manhattan”, is thinking about applying ratings to these things. Is there any evidence that investors are going to trust DBRS on this one, in the event that anything gets off the ground? No.

In general, Anderson seems to be at pains to overstate the degree to which there’s anything to worry about here. Not only does she repeatedly say that life settlements could be the next subprime, she also says that they could be damaging to America’s seniors:

“Predators in the life settlement market have the motive, means and, if left unchecked by legislators and regulators and by their own community, the opportunity to take advantage of seniors,” Stephan Leimberg, co-author of a book on life settlements, testified at a Senate Special Committee on Aging last April.

The quote could have used a bit of context. Leimberg thinks that life settlements are a good thing, in principle, and is looking for legislation to ensure that the industry grows up in a healthy and well-regulated manner, rather than being rife with predators. (And please, NYT, if you’re going to quote Senate testimony, would it kill you to link to it?)

The fact is that life settlements can be wonderful things for seniors who get seriously ill. At the same time, however, that’s not what life insurance was designed to do, and trying to make it perform that function has a raft of nasty potential consequences. For one thing, it could mean life insurance premiums rising substantially, since the price of life insurance currently is kept down by people who let their policies lapse. If they sell those policies instead of letting them lapse, that’s very expensive to the insurer.

But there’s another reason, too, why life settlements are potentially very bad for the insurance industry — and neither Duhigg nor Anderson mentions it. Life insurers, unlike most investors, pay no tax on their investment gains. That’s why buying a life insurance policy is generally a very tax-efficient way to invest money you want to leave to your heirs. But if these policies start being traded on the secondary market, with the benefits going not to heirs but rather to hedge funds and traders, then there’s a serious risk that the life insurance industry will lose its tax-sheltered status. The Wall Street banks looking at securitizing life settlements should be very worried about this: if they start showing signs of success, Congress could, at a stroke, kill their golden goose.

Update: I love Blossom’s idea of calling these things “Collateralized Death Obligations”.

19 comments

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These used to be called Viatical Settlements, and got a bad reputation for fraud and as poor investments. Do a news search on “viatical settlements” and you mostly find horror stories.

The industry has thus decided to rebrand them as Life Settlements or Senior Settlements in an attempt to remove the stigma and stimulate the supply side. They can be a good deal for all involved. Let’s hope the industry keeps things clean this time.

Posted by crimsongirl | Report as abusive

What’s to stop a cancer patient from running out and buying a billion dollars in life insurance, then cashing it in to one of these funds? In a sane world, obviously the premiums would stop him or her from doing this. If he can parlay one policy pre-payment into another, I’d think he could run up a pretty big tab quickly.

Also, what’s to stop touts for these funds from prowling around nursing homes, hospice care centers, or even skid row? It sounds absurdly Dickensian, but given the behavior we’ve seen in the last ten years, I don’t think it’s so far-fetched.

Posted by John | Report as abusive

It is in correct to say “life insurers pay no tax on their investment gains.” The insurers, that is the inusrance companies do in fact pay federal income tax on investment gains. What is true is that the BENEFICIARIES of a life insurance death benefit pay no federal tax on their benefits paid by reason of death of the insured. This misstatement was a quite unfortunate and sophomoric error. I wish we had commentators in the financial press who knew a little something about their subject.

Posted by J. D. Stinson | Report as abusive

The last time they did Viatical Settlements Pharma came up with HIV medications and they went broke.

DBRS is headquartered in Toronto. It has an office in Manhattan, of course, but it’s still a very strange way to describe the firm.

Posted by Ginger Yellow | Report as abusive

I say eliminate the middleman. Bring back the tontine.

Let’s all throw our policies in the pot and then kill each other. The last survivor takes all the loot.

Now that is a capitalism at its best !

Posted by T. Menino | Report as abusive

I would just like to refuite the ending paragraphs regarding the taxation of death benefits. Under current tax law, a policy “transfered for value” such as in a life settlement situation loses its income tax free death benefit status, so there is no reason for Congress to make further changes.

If anything, these hedge funds or securitizers may be ignorant of current tax law and expecting something they are not going to realize (which would not surpsise me).

Posted by ken | Report as abusive

Where are people getting this idea that lapses are good for the profits of life insurers? They figured out a long time ago that a policyholder in his 80s is more likely to die than a policyholder in his 30s, and charge you accordingly. The mechanisms for that increase in charge depend on the type of policy, but the increases are there. Yes, the industry has some lapse-supported products, but regulators in the US have been doing their darnedest to stamp that out over the last twenty years.

Posted by greenback | Report as abusive

yes, I thought that the interesting thing in that article was the guy from a life company who was suddenly claiming that lapses are a big driver of profitability. That sort of cross-subsidy was meant to have been driven out of the industry years ago.

Posted by dsquared | Report as abusive

Matthew Goldstein, now Mr. Salmon’s colleague at Reuters, quite aptly called life settlements “Death Bonds” in a cover article back, I think, in 2006. And Crain’s New York Business wrote about Wall Street securitizers getting into the business in the spring of 2006. Here’s a link, though there’s a subscription firewall. http://www.crainsnewyork.com/apps/pbcs.d ll/article?AID=/20060417/SUB/604170711
Sometimes things are news only to the New York Times.

Why not call them Collaterialized Death Obligations,
CDOs, and be done with it?

Posted by Blossom | Report as abusive

John: In both your hypos, someone still has to pay the premiums. Try to think rationally here. Why would an insurance company be obligated to pay out on a policy on which no one paid the premiums? I don’t think there are a lot of guys living on the street who have been faithfully paying their life insurance. Likewise, life insurance on a terminal patient is going to be prohibitively expensive.

If we assume that anyone paying life insurance premiums is responsible enough to understand and form an insurance contract (a necessary assumption for insurance contracts to exist), then we don’t have to go much further if we figure that they’re capable of selling their insurance settlement at a fair price, barring some sort of fraud or misrepresentation that would already be illegal under existing law about marketing/fair insurance practices. Of course people are terrible at net present value of uncertain future cash-flow calculations, but if we regulated that insurance companies couldn’t make + present value contracts with people we would regulate the insurance companies out of business.

Posted by najdorf | Report as abusive

First of all converting what would be an income tax free event, that being, a death benefit paid out to the initially designated beneficiary, such as a spouse or children, to an investor which would be taxable based on Rev Ruling 2009-14 would seem to me to be a thing the current administration would gladly support. Second, policy holders are not being talked out of exisiting life insurance policies, they are attempting to receive an economic benefit greater than that being afforded to them by the life insurance company that issued the policy. They are going to surrender or let lapse a policy they no longer want or need. Third, the $35 million your refer to I believe is face amount of policies not settlement value, cash value, or premium that needs to be paid by the investor up to time of claim. When a person purchases a life insurance policy, properly referred to as an insurance contract, they acquire certain rights. One of those rights recognized by the U.S. Suprement Court in 1911 was the right of the policy owner to sell their rights in the contract to a third party. The people who benefit from a life settlement are the ones who own those rights, namely the policy owner. How they benefit is by being able to obtain the true value of the policy instead of merely receiving the cash surrender value upon surrender or nothing upon letting the policy lapse. If a person no longer wants or needs their life insurance then why should they be denied the opportunity to receive a value greater than the cash surrender value but less then the death benefit? Instead it is the life insurance company that reaps the total economic benefit from the surrender or lapse. How can a free market exist if it is not permissable for a policy owner to seek out the advice and counsel, for example, of their CPA, Lawyer, Insurance Agent, Financial Advisor or Financial Planner to help them determine what a fair value is? or for that matter being prohibited from exercising a contractual right? Along the same line of reasoning, are insured’s capable of estimating whether or not the initial purchase of their cash value policies was a fair deal and that they were not being cheated? Imagine that the insured is being served by an AGENT of the INSURER. The agent is not a fiduciary of the insured. In regulated states the life settlement broker, is a fiduciary to the insured and policy owner to act in their best interests and to follow their instructions. Imagine the life insurance industry putting in force policies based on lapsed based pricing assumptions, meaning they have full knowledge and belief that the policies will in fact lapse in 5-7 years therefore no claims will be paid. So would you then say that the public is being cheated because they bought permanent insurance which is under-priced knowing full well that the public is not going to reap any financial benefit upon lapse or surrender? Life insurance premiums are potentially on the rise because of stiffer reserve requirements set by the states, not because of life settlement activity. Remember “the market is still minuscule”. Are you not concerned that there is an industry that readily admits that they do not want to face contractual claims they put in force for fear they will not have enough funds to pay them? That is the risk they face being an insurer and mispricing their policies. The policy owner, the consumer, is the one that benefits from a life settlement. Why should they have this right and economic opportunity denied them? Finally, the investors are large financial institutions and are already regulated. Perhaps the regulations already on the books need to enforced or enforced better.

Felix you are wrong about the fact.

[begin quote]
Even the Federal Reserve Bank of New York is now invested in this asset class as AIG used a securitization of an $8.4 billion pool of life settlement policies to repay its $1.2 billion loan to the Feds.
[end quote]

http://www.reuters.com/article/pressRele ase/idUS103641+16-Apr-2009+MW20090416

and

http://www.reuters.com/article/ousiv/idU STRE56U5UX20090731?pageNumber=2&virtualB randChannel=0

This deal was done in March. How could Ms Anderson miss this in her yellow journalism article? It’s AIG and FED for Christ’s sake. WOW it’s the US taxpayers as a whole who will benefit more from these people dying sooner than later!

Sarcasm aside, it proves one more time how easily the public can be fooled by yellow journalism and be instigated by politicians. Many people do not know the difference between viatical settlements and life settlements (the former is specifically for AIDS patients), or the fact that the majority of the policies settled are for rich people with big face amount (death benefit, usually multi-million). Now do the general public feel better because it’s not an average American, but some rich bas***ds you hate may become target of hitmen hired by Wall Street?

The reason why this industry exist is the fact that insurance companies overcharge premiums for the healthy and for those who no longer need the policy at some point. Now the life settlements industry, including but not limited to Wall Street, and even insurance companies themselves, like AIG, plus Warren Buffett, step in and want a share of the profit. In any type of insurance (life or property & casualty), there’s always subsidy from one group of people to the other. I highly recommend people who have genuine interest in economics/insurance/finance read Tim Hartford’s book, “The Logic of Life”, and “The Undercover Economist”, where he described this problem with a lot of insight. If you like “Freakonomics” you will love reading Tim’s books as well.

BTW, the term “Collateralized Death Obligation” has been used many times as a joke in the past and it’s nothing new.

Posted by snt | Report as abusive

http://www.spiegel.de/international/busi ness/0,1518,646385,00.html

“Deutsche Bank and other financial institutions manage complex funds that buy up Americans’ life insurance policies and pay their premiums in return for their payouts. But angry German investors are finding that Americans aren’t dying as quickly as expected — and that only the bankers are making a buck.”

“In 2008, it launched a third Life Kompass fund, though it has been structured somewhat differently, which collected investor funds in two tranches, one of $100 million and the other of $144 million.”

Tranches!

I love Aaron Elstein’s comments “Sometimes things are news only to the New York Times.”

Posted by snt | Report as abusive

Every “useful idiot” with 1/2 a brain is “commenting” on an industry they know nothing about – life settlements quoting statistics that are not true. This is not the US Government for crying outloud.

As an industry insider – let’s separate a little fact from fiction. The size of the life settlement market is currently around $15 billion in face amount purchased – primarily by instituional investors.No one is predicting the growth of the industry to eventually be $500 billion.
The closest lange range estimate to that is about 1/3 that size.

The life settlement market evolved from the viatical (terminal illness) market in the late 90s. Warren Buffet was one of the early investors. The horror stories on viaticals were from investors in viaticals who lost money on AIDS cases that lived well beyond the predicted life expectancies due to medical breakthroughs treating the disease. There were no horror stories from the insureds receiving payment to pay for the cost of care.

What effect would a $15 billion industry have on an industry that routinely issues over $1 trillion in new insurance anyway? A secondary market exists for virtually every financial asset – why do people scream that life insurance now has a secondary market for people who don’t need, want, or can afford their policy?

If you are going to dispose of a policy that you can’t afford, that the kids or grandkids won’t assume premium obligation on, that you don’t need – why not try to maximize the cash you can receive? It’s NOT rocket science folks!

Posted by Bill Tsotsos | Report as abusive

Life settlement policies, from the buyers perspective, are not an appropriate investment for the retail market. The folks that sell them on the retail market make no effort to “qualify” people who think they want to invest. Indeed, they go on the radio advertising what a good investment they are, especially recently, taking advantage of people who can’t tolerate stock market volatility. Life settlements are not volatile at all. The only problem is your money is tied up in an illiquid investment for an indeterminate duration. So while the insured live on, you are losing money on regular returns you could get with a decent income mutual fund. On top of that, if the insured live past the premium escrow period (for which the buyer funds the seller to set up, along with a fee) then you get to begin making premium payments for an indeterminate duration, further reducing one’s return. And there is nothing one can do to retrieve their money unless they could potentially (fat chance) find a 4th party buyer for the policy shares, who would more than likely expect some sort of coupon to purchase, since the policy is aged and premiums would begin sooner. Sellers always advertize double digit returns, but if the insured live anywhere close to the average American, based on social security administration actuarial data, then the policy holder might be able to make all of around 2% annual returns on their investment. And this presumes that the selling company both stays in business that long and makes a decent effort to properly admnister the policy premiums. Life settlements are a very good deal for the insured, and likely for the broker, but for the buyer they are a scam!

Posted by MPK2 | Report as abusive

If one really has to have outsized returns and doesn’t mind some illiquidity, instead of buying life settlements, I have a better suggestion: Buy some lease property, or some kind of investment property like a foreclosure. It could be commercial or residential. Better yet, put the money into a quality REIT. The life settlement equation doesn’t work out for retail investors because the sellers and brokers have the long end of the deal. Buyers get screwed because they don’t have the leverage to a)make their own evaluations of the insured and to b)pick the best policies and c)they pay fees determined by the brokers, with no negotiating leverage. They have to trust brokers’ evaluations of insured, and rely on the broker to select their policies on a small lot basis, another issue because on an individual basis the policies don’t necessarily mature like the statistics say they will.

Posted by MPK2 | Report as abusive

MPK2, you are correct in stating that life settlement investments are not suitable for retail investors. There has been some bad behavior in the business with providers selling individual policies to investors. Of course, that leaves the investor with an undiversified investment of unknown duration. Not a good position to be in.

However, there is also some very good behavior in the business with firms building funds comprising many policies which mitigates the longevity risk. Institutional investors are taking multi-million dollar positions in these funds and realizing consistent annual double-digit returns with low volatility. Best to look for a fund whose general partner owns a meaningful position in the fund. When they “eat their own cooking” the tend to follow best practices of the industry.

Posted by JimGnecco | Report as abusive