And Next Up, A Good Game of RISK

If you still need motivation to get on my bandwagon for new bank regulation, go read “Back to Business: Wall Street Pursues Profit in Bundles of Life Insurance.” While the nation is having a good scream over communists in the White House and Bolshevik health care reform, the bankers are playing Risk with your tax dollars.

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,” policies for life insurance for elderly parents which allow the 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.

Oh, that’s just great! The same folks left unregulated and un-rebuked from the mortgage meltdown (and rewarded with subsidies) get to misprice yet another set of iffy securities. If this isn’t a more “exotic” investment than credit default swaps and harder to price, I’ll turn in all my Phd class credits (including the one specifically geared to Risk Theory) for an electrician’s license. Investment bankers seem to be on hyperdrive to find the next big thing before congress even realizes the horses are back out of the barn again.

“It’s bittersweet,” said James D. 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 A. Doherty, a professor at Wharton who has studied life settlements.

Indeed, Mr. Doherty says that in reaction to widespread securitization, insurers most 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.”

Read that last line because that’s exactly right. You’re basically assuming that life insurance companies with all their actuarial tables and nerdy statistics guys are getting it wrong. It’s a bet that they screwed up. Instead of betting the farm which is what they did with the credit default swaps, they’re going to bet your life.

So exactly how big could this market be? That’s my way of implying how interconnected can all the players get playing with this thing so that if the market implodes from bad side bets, how huge of bailout lurks in our collective future? Well, the NYT writer Jenny Anderson puts the real assets at $26 trillion dollars. That’s the number for life insurance policies in force. You may remember that the majority of the CDS market didn’t actually involve hedging or securitizing the real assets. A good portion of the market was synthetic or the result of financial engineering which means no one holds the real deal and no who intends to deliver the real deal. It’s based on getting in and out before the delivery dates and a market move against you. It’s essentially momentum trading or as I like to call it, hanging in there because you really believe you’re on a lucky streak and can’t lose. You’re betting you can out guess the market essentially. So, how is this different than a trip to Las Vegas other than if the market collapses it could force people to overpay for life insurance that many either really need or have been huckstered into buy needlessly to feed the greed. Oh, and there’s the little thing that the tax payer bails out investment bankers and not The Flamingo.

So, who exactly is right there on the cutting edge? Why, it’s the administration’s big donor! Surprise ! Surprise! Look over there!!! It’s a tea party!!! It’s a communist Czar!!! It’s a Bolshevik health care plan!!

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.

Oh, also, you may remember that one hooker loving Governor made his career sniffing out this kind of fraud too. You remember him and the odd circumstances that found him out? (Okay, SOD, send me my tin foil pill box hat pronto!)

But the industry has been plagued by fraud complaints. State insurance regulators, hamstrung by a patchwork of laws and regulations, 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, called “stranger-owned life insurance.”

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.

The bottom line is that this market sets up a gamble on how long people live and that is basically unknown and unknowable. The best you can do is make an educated guess. So, this is going to be the same deal as betting on the housing market going up ad infinitum. We’re betting basically on people not living so long. You can always loose a bet on something based on probabilities.

Since this is a game of information asymmetry, you should be thinking, well, to really place a good bet I need more information right? Let’s think about how nice it would be to have every one’s health records on easily accessible, shared networks. How much do you think some one would pay to know the name of every one with HIV/AIDS or Hep C or various forms of Cancer? It sure would be nice to not just store that data at your doctor’s office but have it available on a national database some where, wouldn’t it?

This is yet another very bad idea coming from the Masters of the Universe and the Vampire Squid. They’re right back to their old tricks and no one is watching them. Go read the details in the article and ask yourself if this is the kind of financial innovation we need.

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