The “securitization” of mortgages — bundling mortgage policies and selling them on to investors — is considered to be one of the major reasons for last year’s financial collapse.
Now, Wall Street banks want to do it all again — but this time, with life insurance policies instead of real estate.
The New York Times reports that large investment banks are lining up to begin securitizing “life settlements,” life insurance policies that ill and elderly people sell so that they can get cash before they die.
According to the Times:
[Banks] 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.
Life settlement companies — companies that buy life insurance policies and cash in when the original policy holder dies — have been around for some time, but this would mark the first time that life insurance policies are turned into big business on Wall Street.
THE FASTER YOU DIE, THE MORE INVESTORS MAKE
One of the principal dangers in this plan is that it creates an incentive to see ill people die quickly. The investors who buy life insurance policies have to pay the premiums on those policies in order to collect when the original holder dies. So the faster an ill person dies, the fewer premiums have to be paid, and the higher the profit.
Conversely, life insurance securitization would create a disincentive for finding cures for diseases. If a person sells their life insurance policy and then their illness is cured, the investor who bought their policy loses money.
As the Times points out:
In addition to fraud, there is another potential risk for investors: that some people could live far longer than expected.
It is not just a hypothetical risk. That is what happened in the 1980s, when new treatments prolonged the life of AIDS patients. Investors who bought their policies on the expectation that the most victims would die within two years ended up losing money.
LIFE INSURANCE PREMIUMS WILL GO UP
A certain percentage of life insurance policies is never paid out by insurance companies. This is because some policy-holders stop paying their premiums, either because they no longer need the additional financial security or because the premiums have become too expensive.
But if life insurance policies are packaged and sold to investors, those investors will invariably pay the premium until the original policy holder dies. Insurance companies calculate their premiums on the expectation that some policies will lapse. If fewer policies lapse, the insurance industry will have to raise insurance premiums.
“This defeats the idea of what life insurance is supposed to be,” Steven Weisbart, chief economist for the Insurance Information Institute, told the Times. “It’s not an investment product, [it’s] a gambling product.”
PREYING ON THE WEAKEST?
One of the principal reasons people sell their life insurance policies is to be able to pay for their health care before they die. If the buying and selling of life insurance policies becomes big business, then there would be little incentive to reform health care, as reform would — presumably — make treatment more affordable, thereby reducing the number of people willing to sell their life insurance.
Thus the plan to securitize life insurance would likely create even more resistance among bankers and investors to any plan to reduce health care costs, or to introduce a public health care option. Indeed, a public health care option would eliminate the need for terminally ill people to seek new sources of money, thereby potentially decimating the life insurance securities market.
The Times names two companies that it evidently believes to be heading up the effort to securitize life insurance. One is the Swiss bank Credit Suisse, and the other is investment bank Goldman Sachs.
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.
The bank bought a company that originates life settlements, and it has set up a group dedicated to structuring deals and one to sell the products.
Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than planned. The index is similar to tradable stock market indices that allow investors to bet on the overall direction of the market without buying stocks.
According to the Economist, the life-settlement market in existence today is worth about $18 billion to $19 billion, meaning that about that amount of life insurance policies is bought and sold every year. The Times estimates that a securitized market for life insurance policies could be worth about $500 billion.