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.
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