Death bonds: The perils of sub-prime death


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The US secondary market in life insurance is being extended to sellers who can ill afford to relinquish their policies.

Life settlements, whereby people over the age of 65 can cash in their life insurance policies with a third party, are, on the surface, a means of creating a more efficient market. A senior no longer wanting to hold a policy can sell it to a life settlements buyer rather than allowing the policy to lapse or cashing it in with the life insurance provider for a small amount. The buyer then pays the premiums for the rest of the policy’s life – that is, until the seller dies – and then collects the benefit (hoping that the seller dies sooner rather than later).

It is a small but growing market, with many banks looking to join in and potentially securitize the underlying policies and sell so-called death bonds. The secondary market is growing by about $1 billion a year in the US, and some forecasts suggest that it will be a $160 billion market in several years.

Making money out of people dying does not sit well with everyone, but an argument can be made that if the policy holder no longer feels that their nearest and dearest will need the benefit, or that they no longer want to pay the premiums, then, if there is a willing buyer, it is a financial transaction like any other.

What is disturbing, however, is the type of life policy owners that are now being targeted. Until recently, originators have looked for policies with an average face value of about $5 million. These sellers are considered to be financially savvy people who can afford the services of lawyers and tax specialists to advise them on whether they are getting a good deal for their policy and, more important, whether they should indeed be selling the policy at all.

As long as these sellers are well informed, why should they not make some money back from the premiums they have paid in? In March, however, JG Wentworth, the US’s largest buyer of structured settlements, annuities and life insurance, announced that its life settlements arm had been granted licences in 22 states to purchase policies with a face value of as low as $50,000.

Why are alarm bells not ringing here?

Holders of $50,000 policies are unlikely to be able to afford advice on whether their policies should be sold for 10% or 25% (the latter is the current average price paid but there have been cases of the former). Furthermore, there is a lack of industry standards and clear regulation, so who is to say a situation will not arise in which buyers target policy owners who are financially impaired and desperate for some extra money? Unsavvy sellers will end up selling their policies for a pittance out of desperation, and if their health deteriorates will not be able to afford another policy, possibly saddling their family with debts on their death.

It bears an uncanny and frightening resemblance to sub-prime mortgages. There simply are not enough policies with a face value of $5 million-plus to create a large enough secondary market with the potential for securitization, so greed is inspiring originators to look to less wealthy segments, and potentially less well-informed ones, to provide the market.

Their spin is, why shouldn’t less-wealthy people be allowed to cash in their benefits? Much like: why shouldn’t people with credit difficulties be allowed to buy a property?

Of course, they should be allowed to on both counts. But as history has proved, in markets with no firm regulation there are certain to be some life policy owners who simply do not realize that there is no such thing as a free lunch. Although a life settlements market has its benefits, the potential disaster is too great to warrant its existence until formal regulation is in place.