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”.