Life Insurance Policies may be the way to recovery
Bankers recovering from the economic melt down are looking for another big idea to sell to their investors. Bankers now plan to buy "life settlements", "securitize" them and sell as high quality triple-A investments. In other words, life insurance policies that the ill and elderly sell for cash - depending on their life expectancy - is being purchased by the thousands and repackaged into bonds. The bonds will be sold to pension funds and other large investors who will receive the payouts when the policyholders die.
Betting on death
How does this all work in the mind of a financial engineer? How can anyone conceivable benefit from this kind of scheme. Well lets break it down into a few WIIFMs (What's in it for me). Lets take the following example. A man aged 70 has a life policy worth $1 million and pays premiums of $25,000 annually. He is expected to live until age 75 based on his health and needs cash now. From the insurance company the "cash surrender" of his policy is $50,000 only a fraction of the $1 million it is worth. But from a "life settlement" company the same policy might be worth as much as $200,000. For the "life settlement" company this policy would be worth up to $800,000 profit before expenses should the policy holder die in the estimated timeframe.
Predictions
The earlier the policyholder dies the better the payout. There is a still potential risk to this kind of scheme. This is because some people may life longer than expected. This is not just a hypothetical risk if you are only purchasing policies from those who are dying from lung or liver cancer. This did happen in the 1980s when new AIDS treatments prolonged patients lives for decades after their expected death. That is why these insurance policies are "securitized" in such a way to lower the risks.
Securitization and the risks
In the securitization process a bank takes a large number of policies and lumps them together and sells them to investors. To cut the risk they combine policies from a number of different kinds of diseases and life expectancies. The risk is that, just like home mortgages, all the risks are not entirely evident. If there is a medical cure for all types of cancers, then investors who have to continue to pay the insurance premiums until the policyholders death, must realise much lower levels of returns. In our previous example, instead of a $800,000 payout there is only a $300,000 payout.
Judging the risks
DBRS, a rating agency in lower Manhattan published criteria in early 2008 for ways to securitize a life settlements portfolio so that the risks were minimized. Many companies and Hedge funds looking for ways to buy and trade policies more easily are looking for ways to get their securitization machine working again. Mr. Terrell the former co-head of Bear Stearns' longevity and mortality desk, which traded unrated portfolios of life settlements, thinks life settlements have big potential.
"It's an interesting asset class because it's less correlated to the rest of the market than other asset classes."
Getting it done
Ms. Tillwitz, an executive overseeing the project for DBRS says "We want this market to flourish in a safe way." Noting that DBRS spent nine months getting used to the risks associated with rating a pool of life settlements. While insurance regulators from Illinois and Florida and a Democratic senator from Wisconsin call for more regulation of these kinds of investments ultimately there is nothing that can be done to prevent this kind of securitization. The trick is to find the right pool to dive into.
Source:
New Exotic Investments Emerging on Wall Street. Anderson, Jenny. The New York Times, Sunday September 6, 2009.
