Merkel on life settlements

September 8, 2009

Sunday’s NYT piece about life settlements — selling a life insurance policy to a third party, who collects on it when you die — sparked much conversation in the blogosphere. Felix helpfully points out that there’s actually not much news in the story as the market is still minuscule. Still, this is a financial innovation worth discussing in its earlier stages, while there’s still time for legislators/regulators to kill it. It really is a terrible idea, one that will benefit no one besides those running Wall Street’s securitization machine.

But don’t take my word for it. Take David Merkel’s. David (FSA, CFA) is an actuary who spent 17 years working in the insurance industry, and five years outside analyzing it. For the last two years, he has been the Chief Economist and Director of Research for Finacorp Securities. He is the founder and writer of the The Aleph Blog, where he discusses financial, economic and insurance topics.

I sent him a quick e-mail asking for his thoughts. His response is worth quoting in full. I’ve included a few notes to help readers follow along.

I’ve been critical in the past about life settlements business, but in some ways it is back to the future.  Back in the mid-19th century there were often no cash values for life insurance policies.  If you terminated, you got nothing.  It was possible to sell your policy and get something, but because of the doctrine of insurable interest eventually that market was abolished.

[Reader note: in a nutshell, the doctrine of insurable interest is that you can’t insure another person’s property, someone else’s car, house or life, for example. The moral hazard is obvious, and highly problematic: If you insure property that isn’t yours, you have an incentive to destroy that property in order to get paid out on the insurance policy.]

It was abolished because it was gambling, and that it created an incentive for the third party to murder the insured. But Elizur Wright campaigned successfully for cash or nonforfeiture values.

That made life a little better for life insurance consumers, who would get something back on surrender, but not usually as much they could get through a sale to a third party, and not nearly the expected present value of the claim, less the unamortized value of the policy acquisition cost.  Nonetheless, the market stayed stable until the 1990s, until the life settlements business came along.  The doctrine of insurable interest had been weakened by the courts, which I think is bad on public policy grounds.  Third parties should not be allowed to gamble on the lives of others.

Now, the life settlements providers might say, “We aren’t gambling.  We have the law of large numbers behind us, and we are able to do advanced analyses of the health of insureds that insurance companies can’t legally do.  Besides, we offer some insureds, the sick ones, a better deal than they would receive from the insurance companies were they to surrender.  Why complain?”

If they are acting like insurance companies with the law of large nambers, let them be regulated as insurance companies.  Let their purchase practices be regulated as well.  Yes, they offer better deals to sick insureds, but the insureds are giving away a potentially more valuable future claim….It’s a free market, but insureds are not capable of estimating the fair value of a complex insurance claim, and many get cheated.

As to the securitization — [note: packaging multiple life settlements into securities to be sold to investors] — that’s not a problem.  Securitization is a tool, and ratings are a tool.  Only fools and regulators trust ratings implicitly.  Only the credulous buy certificates of a securitization without significant due diligence.  This is a game for big boys, and if you are not a big boy, don’t play.  If you are a big boy, do your due diligence.

Insurance regulations exist because of a philosophy of big companies knowing more than little people.  The same should apply to life settlements and insureds for the same reason.

One last note, if life settlements become widespread, life premiums will rise to reflect the loss of profitabilty, and life reinsurance premiums will rise as well.  There’s no free lunch.

This last point is crucial. The investors who want to get in on life settlements will argue that policy-holders get more cash by selling to them as opposed to surrendering the policy to the insurance company for its cash value. That’s true today, but only because life settlements are a small fraction of the market. If they become widespread, insurance companies will have to charge more for their policies up front.

By the way, one indicator that investors see lots of profits in life settlements is how much they’re willing to pay to advertise in Google search results. For keywords that are relevant to “life settlement,” investors are bidding $15-$20 per click. Even if you assume a high conversion rate of 1% — i.e. 1 out of every 100 folks who click on an investor’s Google ad end up selling their insurance policy — that means these guys are willing to pay up to $2,000 per deal. Compare to e-commerce sites that often can’t pay more than a nickel per click and still be profitable.

Update: Merkel fills in some gaps over on Aleph.


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Even if securitization is not an issue, many of the same incentives and information asymmetries that existed in the mortgage securitization pipelines currently exist in the life settlement business.

Posted by pwm76 | Report as abusive

If a life settlement is gambling, then insurers and policyholders have been gambling for years. Insurance of all types is a gamble, just ask the Muslim nations that prohibit it for that very reason. As to insurable interest, the US Supreme Court classified life insurance as an asset long ago, no different than an equity or bond, so “killing it” is not a slam-dunk option.Something that is being lost in this debate is the difference between term and permanent life. Term insurance, with no cash value and a fixed expiration is of no value to investors. The vast majority of life policies are term, a straight up offloading of the risk of income-loss due to an untimely demise. It was only with the advent of permanent or “cash value” life that risk mitigation was re-branded as an investment. And a pretty craptastic one at that given both the returns and the willingness of policyholders to sell.With the exception of estate planning for wealthy families, permanent life is one of the worst investments an individual could possibly make. And the commissions paid to agents (94% first year, 6% until maturity) reflect the fat incentive to push products you know are not in the best financial interest of your client.

Posted by Mike | Report as abusive

Thanks, Rolf, for publishing David’s most helpful explanation of this.Makes sense, doctrine of insurable interest.Boy, I hope the regulators wake up and stop this.

Posted by jg | Report as abusive

[…] a surge in life settlements may have on the life insurance industry.  (Rolfe Winkler, Aleph […]

Posted by Tuesday links: insurance costs Abnormal Returns | Report as abusive

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. Your guest stated “It’s a free market, but insureds are not capable of estimating the fair value of a complex insurance claim, and many get cheated.” 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. 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? 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.

Posted by stuart egrin | Report as abusive

Over 90% of life insurance policies lapse with no payment to anyone. Who is that better for? The life insurance companies who collected the premiums for years, certainly not the poor schlub who didn’t know he could sell his policy if he chose.Merkel states, “The doctrine of insurable interest has been weakend by the courts which I think is bad on public policy grounds. Third parties should not be allowed to gamble on the lives of others.”Not so. The doctrine of insurable interest still holds when a policy is purchased. The US Supreme Court ruled in 1911, that an owner has the right to sell his policy. It’s private property.I totally disagree with both of your arguments. I do agree with the state of Maine, where recently passed legislation requires life insurance companies to advise policyholders of their right to sell their policies, rather than just watch them lapse when they can no longer afford them or don’t want them.Why should citizens in other states expect anything less from their own state governments? Oh, I forgot, the life insurance industry lobby – the one contributing to the politicians.

Posted by realfactchecker | Report as abusive

[…] thank you Rolfe Winkler and Reuters.  I go off-line on Sundays because it is the Sabbath, so I don’t review the web or catch […]

Posted by On Life Settlements | Bad Credit Loan Lenders | Report as abusive

Ahhh, it has ever been so: financials exploit asymmetric information and use “flexibility” and “choice” as covers.This, of course, also raises the adverse selection (“moral hazard” if it worked the other way) concern: if I can get a fat buyout of my insurance, what’s to stop me from turning around and buying more, because I know my life to be probably longer than the “settlement” firm, or my “settlement” firm and I both know that my life is probably shorter than the insurance co’s?Ironic that this pops up just as the administration is proposing a substantial clarification of terms in loans.

Posted by Walt French | Report as abusive

For Walt French: What stops you from buying more life insurance is the limit of your insurability. Once you’ve reached it you cannot buy additional coverage. Life insurance companies share your information with each other to prevent this.

Posted by realfactchecker | Report as abusive

[…] is that the beast has been here for a long time, it is huge and may already be too big to slay. Reuters and the New York Times both had articles expressing concern over the life settlement market and how […]

Posted by Ed Hinerman On Life Insurance » Even Politicians Think It’s Wrong!! | Report as abusive

[…] is that the beast has been here for a long time, it is huge and may already be too big to slay. Reuters and the New York Times both had articles expressing concern over the life settlement market and how […]

Posted by Even Politicians Think It’s Wrong!! | Everyone Read It! | Report as abusive

It is surprising that life settlements are creating news. They have been around for 15 years at least. The National Association of Insurance Commissioners several years ago adopted model regulation (now in the process of being adopted by the various states)to protect consumers and, to some extent, insurers. Even securitization of life settlements isn’t new. Some hedge funds and pension plans reportedly like the risk profile of life settlements, since they are largely uncorrelated with financial market risks (except for securities placed in special purpose vehicles). Current non-forfeiture laws do not provide as high values as can be received in the secondary market, so it’s not surprising that life settlements have found a niche. It was good you asked an actuary (I am also an actuary), but you might also want to ask one who works in the field.

Posted by Arnold Dicke | Report as abusive

Insurance is a highly regulated industry. All insurance companies doing business in the United States are regulated by state law, and required to maintain enough capital and surplus to satisfy their obligations to their policy holders. The type and quantity of investments in which insurance companies may invest surplus capital is also limited by state law.

Posted by Jonathan Paul | Report as abusive

For anyone considering selling a policy I will say that the price you get, no matter what they offer is not worth it. We did that eight years back to Legacy Benefits Corporation of NYC, and now we have “strangers” attempting to invade our home, stalking and meeting me at the street with handguns with a silencer, their intentions are not a mystery. It so happens the three policies they acquired, a million each were set for a ten year period to keep the premium to a very low 22,000 annual, so they “knew” they would get a return in ten years, so now the eighth year we began experiencing a domestic terrorism at our home. My husband had to leave the state, we are permanently separated until the ten year anniversay, two more years to go, he is on the move, they are trying to locate him in various parts of the country, still present at our home, following me, appearing at his office parking lot etc. I don’t have to guess who is behind this, we were normal people, no large fancy home, or presence, just living in a rural home and suddenly our lives are turned upside down. We are hoping to have success by a lawsuit against United Mutual of Omaha to pressure them into returning those policies, we were deceived, had no idea what these were, did not know the broker received huge commissions, did not know they could be pooled to make 3 million instead of three of one million, did not know Legacy Benefits was not affiliated with United Mutual of Omaha etc. I have had no success with United Mutual or Legacy, the president of Legacy, Mr. Meir Aliav stated on the phone he will not return those policies, under any circumstance. I offered to pay him, his answer “No, Not Now, Not Now” and he cannot lose face now once they began a process of contracts to end the lives of those under “the list” as they call it. I can only hope and pray we overcome this, we have spent far more than the $120,000 we received on those premiums over the past three months in armed security 24 hours and moving my husband from one area of the country to another, and detectives, lawyers, the cost will eventually probably not be far from the face value of one of the policies. Unfortunately, the state said in spite of deceptive methods to acquire these the “statue of limitations, in most states, is seven years” so now, into the eighth year Legacy had the green light to kill. We have substantial evidence of the presence of these individuals, they began removing our mail, we found that out and had to put a locked box, and had to elimnate phone lines from the phone company to digital to avoid wire tapping etc. The “perfect crime” is so well organized, should a person die their estate never considers those “sold” policies as part of it, so once a death occurs, nobody would have ever even suspected anyone was going to benefit except those in the will or by state law entitled! Until we met the armed men at our home, and attempts to break in numerous times and the presence of them at the boundaries of our property daily, nightly we would not have expected anything. Unfortunately, law enforcement can and will do nothing until the crime is committed!!! They cannot arrest them for setting out at the roadside, entering our property and coming into our porches to pry open windows etc because once I call 911 they flee. They have scanners and are keeping aware of everything in our lives. Congress and states must enact immediate legislation which allows all of us to purchase them back that were deceived like us or are under attack by these actions. For the next two years we have to live apart to spare his life, and I personally have a mission to prove what I know about Legacy. If anyone has informaiton or lost a family or business associate and the death is undetermined, please look into whether you can find a trai of these transactions. Unfortunately, nobody keeps records of something that they consider no longer part of their lives. It took us amonth before we figured out what the threat was, and to realize what it was became so huge, they have resources to never quit. A full investigation into the deaths of persons whom had ever sold these should be performed by US representatives. I feel confident innocent persons are imprisoned by being accused of involvement in the death of a spouse, business associate, parent etc because they were the bona fide beneficiary of a portion of the estate or business, yet they are innocently accused because no other evidence surfaced , but I am certain a large number were deaths by the same arrangements that we are under attack for. Please do not consider this a panic letter or wild assumption from someone, I am a typical housewife that never had any fear and suspected nobody until this experience, and now our life is ruined. I don’t know if we will ever resume anything like normal again. I simply have a message that these brokers that arrange to purchase these policies get huge commissions, the insurance companies get premiums that would otherwise be dismissed, and the worst of all, the insured is a target for early death to collct. I do not know if other companies are involved like Legacy Benefits Corporation, but I will prove my case, some way, and I hope it is not by death investigation. Please pass the word to all. Sincerely, Sherrie Parker

Posted by sherrie parker | Report as abusive

[…] thank you Rolfe Winkler and Reuters.  I go off-line on Sundays because it is the Sabbath, so I don’t review the web or catch e-mail, […]

Posted by On Life Settlements | Report as abusive