Death Bonds

By | July 28, 2007
4 Comments

We discussed the future of medicine last night at the Boulder Future Salon. Some fascinating thoughts from the various participants, including the idea that health insurance is really just a gambling scheme. Every time we pay a premium, we’re betting that we’ll get sick. If we stay healthy, we lose the bet. If we get sick, we win. One of the members of the group is a woman who recently underwent a heart transplant operation — a big “winner” in the system by that accounting.

The parallel is even closer than most of us might realize. She explained that she is now essentially uninsurable. Think of the guy who figures out the winning blackjack scheme and then gets barred from all the casinos after taking too much of their money. Same basic idea.

Like health insurance, life insurance is a bet we place that pays out when something bad happens to us. With health insurance, we bet that we’ll get sick. With life insurance, we bet that we’ll die. Term life insurance is the most insidious. I’ve got a 20-year term policy that’s going to expire here in a few years. If I kick it at age 49, I’m way up. If I live to be 50, I lose.

Then this morning, I came across this (via GeekPress):

Death bond is shorthand for a gentler term the industry prefers: life settlement-backed security. Whatever the name, it’s as macabre an investing concept as Wall Street has ever cooked up. Some 90 million Americans own life insurance, but many of them find the premiums too expensive; others would simply prefer to cash in early. “Life settlements” are arrangements that offer people the chance to sell their policies to investors, who keep paying the premiums until the sellers die and then collect the payout. For the investors it’s a ghoulish actuarial gamble: The quicker the death, the more profit is reaped. Most of the transactions are done by small local firms called life settlement providers, which in the past have typically sold the policies to hedge funds. Now, Wall Street sees huge profits in buying policies, throwing them into a pool, dividing the pool into bonds, and selling the bonds to pension funds, college endowments, and other professional investors. If the market develops as Wall Street expects, ordinary mutual funds will soon be able to get in on the action, too.

I’m of two minds about this particular investment instrument. On the one hand, it seems that the people who get “invested in” this way have actually found a way to come out ahead on life insurance — they get to collect some of the money and be alive at the same time. On the other hand, I can’t muster a lot of good will towards those doing the investing — hoping that their fellow human beings will die sooner so that they see a better return.

Frankly, I hope many of them lose their shirts because the people they paid off end up living a lot longer than anybody anticipated.

  • KLCtheBookWorm

    I thought I ran across this investment idea before. Simon Wood’s has used it for a mystery: http://mjroseblog.typepad.com/backstory/2007/06/simon_woods_bac.html

  • https://www.blog.speculist.com Stephen Gordon

    It’s hard to convince people to buy something that they will never, personally, get any benefit from. That’s part of the reason why “whole life” insurance has become popular – even though most financial advisors agree that its too expensive for life insurance and it’s a poor way to invest. It’s like Shimmer – its neither a very good floor wax nor dessert topping.

    Perhaps a “life settlement-backed security” is a better hybrid. I’ll have to check it out.

  • http://triticale.mu.nu triticale

    “No, mister bond-seller, I expect you to die.”

  • MDarling

    A few observations:

    Let’s say your after tax income is $100k/year. And you have a choice to buy disability insurance that pays you 70% of your income (70k/yr) if you become disabled and cannot work for a 2500 annual premium.
    Your options are basically a four box grid:
    no insurance, no disability 100K income
    no insurance, disability 0 income
    Insurance, no disablity 97.5k/yr a
    and
    insurance, disability 70k/yr.

    Life insurance is a little different- though I wouldn’t go so far to say it has no benefit to the insured. I find tremendous benefit while living in knowing that in the event I die (future income 0) my family will have assets to adjust to my absence.

    So- given that I find benefit- the question becomes term (cheap, but not likely to pay off) or whole life (more expensive but guaranteed to pay off)

    In my mid 20′s I chose whole life for several reasons: I didn’t want to ever have to be concerned about becoming uninsurable; I knew that someday the premiums could stop though the coverage continued and if I outlive the policy, it pays me.
    Yes- if I used the same actuarial tables and assumptions as the industry, I could have bought term, invested the savings and done better on the investment side. But most term expires unpaid- so you do worse on the insurance side. Since to me the whole point was risk managment- not investment- I focusde on managing the risk, even though the investment value would under perform.

    Now- since life expectancy increases have improved faster than the actuarial assumptions of my youth, my premiums have been theoretically too high. But since I should also outlive the table, my payout would come well before my death.

    But either way- it’s risk management- not investment. And not really gambling- though both mathemateically and economically there are important similiarities.