Wall Street Pursues Profit in Bundles of Life Insurance

[Andy Nguyen]

Life finance, as we know it, has been a big business for the past few years. The NYT is just now writing about it on the frontpage.

Wall Street Pursues Profit in Bundles of Life Insurance
By JENNY ANDERSON

After the mortgage business imploded last year, Wall Street investment banks began searching for another big idea to make money. They think they may have found one.

The bankers plan to buy “life settlements,” life insurance policies that ill and elderly people sell for cash — $400,000 for a $1 million policy, say, depending on the life expectancy of the insured person. Then they plan to “securitize” these policies, in Wall Street jargon, by packaging hundreds or thousands together into bonds. They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

The earlier the policyholder dies, the bigger the return — though if people live longer than expected, investors could get poor returns or even lose money.

Either way, Wall Street would profit by pocketing sizable fees for creating the bonds, reselling them and subsequently trading them. But some who have studied life settlements warn that insurers might have to raise premiums in the short term if they end up having to pay out more death claims than they had anticipated.

The idea is still in the planning stages. But already “our phones have been ringing off the hook with inquiries,” says Kathleen Tillwitz, a senior vice president at DBRS, which gives risk ratings to investments and is reviewing nine proposals for life-insurance securitizations from private investors and financial firms, including Credit Suisse.

“We’re hoping to get a herd stampeding after the first offering,” said one investment banker not authorized to speak to the news media.

In the aftermath of the financial meltdown, exotic investments dreamed up by Wall Street got much of the blame. It was not just subprime mortgage securities but an array of products — credit-default swaps, structured investment vehicles, collateralized debt obligations — that proved far riskier than anticipated.

Read more Back to Business - Wall Street Pursues Profit in Bundles of Life Insurance - Series - NYTimes.com

 

[Landis]

In response to this article, my question to the quant community here is whether or not the risks inherent in the securitization of life policies is manageable through diversification because life expectancies are pretty reasonably normally distributed?

 

[Andy Nguyen]

People assume a lot of things are normally distributed and it doesn't help them understand or manage risk any better. You live and die with that assumption.
I read about these life finance things and it's said that they have statistical models for policy holders i.e smokers, women, men, single, married with kids, educated, etc. Things can get really complicated.
The CDC just releases a report that the expected life expectancy is at all time high in the US so that will factor a lot into premium of these LF products.
U.S. Life Expectancy at All-Time High - Well Blog - NYTimes.com

 

[Eugene Krel]

In response to this article, my question to the quant community here is whether or not the risks inherent in the securitization of life policies is manageable through diversification because life expectancies are pretty reasonably normally distributed?

Insurance companies are still around, therefore the risk is manageable in some sense. You may want to take a look at some of the principles of actuarial science that deal with life insurance. The mortality tables that are used are generally empirical rather than a particular assumed distribution.

 

[Andy Nguyen]

(ChattahBox)—Since the near collapse of Wall Street from the sub-prime mortgage crisis, traders have been jonesing for a return to the adrenaline rush they once enjoyed from the slew of exotic financial instruments cooked up in the dark recesses of special hedge fund units.

And according to a piece in the New York Times, they have found it with a ghoulish scheme gambling on death, by repackaging life insurance policies sold for a fraction of their worth by sick and desperate elderly people. Once people die, the investors make money. And it’s much more profitable if you die sooner rather than later please.

The concept of so-called securitized-viaticals is not new, but what’s different now, is the scope and large-scale bundling of the securitized life settlements into bonds. Sick and dying people with life insurance policies sell them to life settlement companies for a fraction of their value, but typically 20 to 200 percent more than the low cash surrender value offered by the life insurance company holding the policy.

The life settlement companies continue to pay the premiums to keep the policy in force and cash out when the insured dies. The sicker and closer to death of the owner of the policy, the better it is for the life settlement company.

Now, Wall Street is scooping up the policies from the life settlement companies and repackaging them into securitized bonds, with the seal of approval of a Triple-A rating from a bond-rating agency to attract investors. This is the same gambit Wall Street traders used to create the risky collateralized debt obligations and sub-prime mortgage instruments that nearly destroyed Wall Street.

But this time, traders are not only returning to their former risky exotic instruments, but are betting on our early deaths and hoping that a new cure or treatment for a terminal disease is not found. Any development that raises the odds in favor of a longer life, like improved health care because of the passage of health care reform, means that investors in life-insurance securitizations would lose money. There is something fundamentally wrong with an investment in a person’s early death.

And there is money to be made at every stage of the process. The firms receive fees for creating the instruments, reselling and trading them, with the bond agencies cashing in as well.

Goldman Sachs is making it easy to invest in a person’s early death without ever having to invest in the actual bonds, by providing “a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than planned.”

The rating agency involved in the ” early death investments,” DBRS, employs a “mathematics whiz” who has created computer models to manage the risk of investing in life-insurance securitizations. The risk being of course, people living longer than expected.

The math wiz, Jan Buckler, also has a PH.D. in nuclear engineering and she has devised a scheme of packaging the bond instruments based on the type of disease to lower the risk. She recommends bundling policies with a mix of certain diseases such as leukemia, lung cancer, heart disease, breast cancer, diabetes and Alzheimer’s.” The theory is, if too many people with breast cancer are in the securitization bundle and a cure is developed, the value of the bond would drop.

Wall Street is betting against a cure for cancer.

The financial industry and the life settlement companies, are in dire need of regulation and reform. And the life insurance companies are ready to do battle to push back against large-scale trading of life-insurance securitizations.

Sarah Palin was looking for her death panels in the wrong place.
Wall Street Vultures Betting on Death: If You Die Early, They Cash In | ChattahBox News Blog

 

[Eugene Krel]

The ethical problems with this particular business are very dark and scary. It won't be long before an internship at Goldman Sachs might consist of helping people sleep with the fish.

 

[DominiConnor]

Eugene has a point about the ethical issues, and it points to a basic truth about the justification for our line of work.

There are a range of products that offer people the chance to cash in assets like life settlements or equity in their homes.

The rates offered are often really very poor because the competition for this business is not as keen as in other areas, and because the firm buying the asset finds it hard to sell it on, pushing their costs and risk up.

So increasing the number of players here, as in so many areas is good for "society" whatever that means.

Of course some people sell things that are not in their best interest and that is a thorny issue and applies to almost any financial product. I am conflicted on this since I observe that most people don't have the education to understand properly many of the decisions they make, not just finance but health, etc. I don't believe the government is much better either.

Some firms will lose money, others will make piles, some will oscillate between these two states, so what ?

We are engineers, financial engineers, even if we have bits of paper that claim otherwise.
When you engineer, you risk screwing up, sometimes very badly that is what we do.
Bridges fall down, planes crash, drugs have scary side effects weapons kill the wrong people and financial products destroy banks.

Live with it.

We need to learn lessons of course but the rational response to a city sized power failure is to upgrade the electrical grid, not to back to gas lamps.

 

[Stefan Zota]

But this time, traders are not only returning to their former risky exotic instruments, but are betting on our early deaths and hoping that a new cure or treatment for a terminal disease is not found. Any development that raises the odds in favor of a longer life, like improved health care because of the passage of health care reform, means that investors in life-insurance securitizations would lose money. There is something fundamentally wrong with an investment in a person’s early death.

As usual, I will play the "contrarian". Betting on life extension is something that sounds appalling when it is done by traders. However insurance companies may do that when they will charge large premium for life insurance. Or, health insurance companies may try to find any loophole to avoid funding expensive treatment. In both cases, there is a significant conflict of interest.

At least the traders are an external factor. If they are not carrying baseball bats and going at the guys door, then they won't be able to make his life shorter.
So let people bet, have some fun

 

[Dave Haan]

Felix Salmon covered this well:
http://blogs.reuters.com/felix-salmon/2009/09/06/life-settlements-still-no-dice/

...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 & Poors, 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, anythings possible. But so far its 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 theres nothing at all.