Street's next big cash cow:
The New York Times
By Jenny Anderson
September 6, 2009
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, such as 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 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 anticipated.
The idea is 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.
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.
The debacle gave financial wizardry a bad name everywhere else, but not on Wall Street. Even as the federal government debates increased financial regulation, bankers are scurrying to concoct new products.
In addition to securitizing life settlements, for example, some banks are repackaging their money-losing securities into higher-rated ones, called re-remics (re-securitization of real-estate mortgage-investment conduits). Morgan Stanley says at least $30 billion in residential re-remics have been done this year.
Financial innovation can be good by lowering the cost of borrowing for everyone, giving consumers more investment choices and, more broadly, by helping the economy to grow. The proponents of securitizing life settlements say it would benefit people who want to cash out their policies while they are alive.
But some are dismayed by Wall Street's quick return to its old ways, chasing profits with complicated new products.
“It's bittersweet," said James Cox, a professor of corporate and securities law at Duke University. "The sweet part is, there are investors interested in exotic products created by underwriters who make large fees and rating agencies who then get paid to confer ratings. The bitter part is, it's a return to the good old days."
Indeed, what is good for Wall Street could be bad for the insurance industry, and perhaps for customers, too. That is because policyholders often let their life insurance lapse before they die, for a variety of reasons: their children grow up and no longer need the financial protection or the premiums become too expensive. When that happens, the insurer does not have to make a payout.
But if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have been abandoned; as a result, more policies will stay in force, ensuring more payouts over time and less money for the insurance companies.
"When they set their premiums, they were basing them on assumptions that were wrong," said Neil Doherty, a professor at the University of Pennsylvania's Wharton School who has studied life settlements.
Doherty said that in reaction to widespread securitization, insurers likely would have to raise the premiums on new life policies.
Critics of life settlements believe "this defeats the idea of what life insurance is supposed to be," said Steven Weisbart, senior vice president and chief economist for the Insurance Information Institute, a trade group. "It's not an investment product, a gambling product."
Undeterred, Wall Street is racing ahead for a
simple reason: With $26 trillion of life-insurance policies in force in the
United States, the market could be huge.
Not all policyholders would be interested in selling their policies. And investors are not interested in healthy people's policies because they would have to pay those premiums for too long, reducing profits on the investment.
But even if a small fraction of policyholders do sell them, some in the industry predict the market could reach $500 billion. That would help Wall Street offset the loss of revenue from the collapse of the U.S. residential mortgage-securities market.
Some financial firms are moving to outpace their rivals. Credit Suisse, for example, is 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 indexes that allow investors to bet on the overall direction of the market without buying stocks.
Spokesmen for Credit Suisse and Goldman Sachs declined to comment.
If Wall Street succeeds in securitizing
life-insurance policies, it would take a controversial business — the buying
and selling of policies — that has been around on a smaller scale for a couple
of decades and potentially increase it drastically.
Defenders of life settlements argue that creating a market to allow the ill or elderly to sell their policies for cash is a public service. Insurance companies, they note, offer only a "cash surrender value," typically at a small fraction of the death benefit, when a policyholder wants to cash out, even after paying large premiums for many years.
Enter life-settlement companies. Depending on various factors, they will pay 20 to 200 percent more than the surrender value an insurer would pay.
But the industry has been plagued by fraud
complaints. State insurance regulators have criticized life-settlement brokers
for coercing the ill and elderly to take out policies with the sole purpose of
selling them back to the brokers.
In 2006, while he was New York attorney general, Eliot Spitzer sued Coventry, one of the largest life-settlement companies, accusing it of engaging in bid-rigging with rivals to keep down prices offered to people who wanted to sell their policies. The case is continuing.
"Predators in the life-settlement market have the motive, means and, if left unchecked by legislators and regulators and by their own community, the opportunity to take advantage of seniors," Stephan Leimberg, co-author of a book on life settlements, testified at a Senate Special Committee on Aging last April.
In addition to fraud, there is another potential risk for investors: 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 most victims would die within two years ended up losing money.
It happened again last fall when companies that calculate life expectancy determined that people were living longer.
The challenge for Wall Street is to make securitized life-insurance policies more predictable — and, ideally, safer — investments.
Despite the mortgage debacle, investors like Andrew Terrell are intrigued.
Terrell was the co-head of Bear Stearns' longevity-and-mortality desk — which traded unrated portfolios of life settlements — and later worked at Goldman Sachs' Institutional Life Cos., a venture that was introducing a trading platform for life settlements. He thinks securitized-life policies have big potential.
"It's an interesting asset class because it's less correlated to the rest of the market than other asset classes," Terrell said.
Some academics who have studied life-settlement securitization agree it is a good idea. One difference, they concur, is that death is not correlated to the rise and fall of stocks.
"These assets do not have risks that are difficult to estimate, and they are not, for the most part, exposed to broader economic risks," said Joshua Coval, a professor of finance at the Harvard Business School.
The insurance industry is girding for a fight. "Just as all mortgage providers have been tarred by subprime mortgages, so too is the concern that all life-insurance companies would be tarred with the brush of subprime life-insurance settlements," said Michael Lovendusky, vice president and associate general counsel of the American Council of Life Insurers, a trade group that represents life-insurance companies.
The only thing necessary for evil
to triumph over good
is for good men to do nothing
In which group are the sycophants, and which group has the tyrants; the members of Congress in the House and Senate who suck-up to Special Interest Groups or the Special Interest Groups who buy off Congress?
The reason this question needs to be addressed
The rich, shameless and greedy on Wall Street have been bailed out by Presidents Bush, Obama and Congress;
they all love bribes and chase after gifts.
Which one is the Tyrant, which one is the Sycophant, which one is in the others pocket; the one who offers the bribe or the one who accepts the bribe
All I know is
Tyranny is legal when tyrants make the rules
We are over our heads in a serious pile of Crap
The Trickle Down theory of economics does not
work. The reason being, nobody bothered to account for that most basic of human
nature, called greed.
Most people when left to their basic instincts are greedy and the only way to stop that in a capitalistic society is to tax those who refuse to share. Is there anybody really worth a billion dollars a year? Is there anyone worth 100 million dollars a year? Is there anyone worth 10 million dollars a year? NO, NO, and NO.
I found long ago that everyone is expendable and replaceable, graveyards the world over are filled with irreplaceable and unexpendable individuals.
I have yet to meet anyone worth $250,000 a year, so a simple solution would be for society to cap what individuals can earn and anything above the cap (say $1 million a year) would be taxed at 100%.
Because nobody wants to be taxed at 100%, those people, instead of giving their money to the government would use their excess wages to build factories and hire others; right now the only incentive the greedy people have is to exploit others to maximize profits.
Being taxed at 100% of wages after $1,000,000 gives them (the greedy people and Special Interest Groups) incentive to invest in the future of America.
19,980 people could have $50,000 a year jobs if just 1 person who made a billion dollars was capped at a $1 million wage package. (The greed of HMO, Hedge Funds, Insurance and Bank Executives and Lawyers, Lobbyists just to name a few, is destroying the American dream.)
Is this going to upset those who have manipulated Congress and the financial systems for their own greedy gain? YES; but it would be better than the blood that could roll down the streets as happened when the financial systems were manipulated prior to World War II. (By the same groups that are manipulating the system today one might add.)
To those who have not crawled into bed with the “K Street” crowd and their ilk please disregard.