Revisited: Could Life Insurance Policies Lead to Murder?

I have been reading about an online virtual hedge fund started by Keith McCullough in 2008. Moise Silver Hedgeye, in his Valentine's Day blog for Fortune Finance entitled the "Big Ugly Business of Death", tackles the subject of third party insurance policies from an investor's point of view.

When a person takes out a large dollar value life policy, the policy holder profits when the insured dies. The only way the insured would benefit is by selling it, while alive, to an investor for a discounted amount to live on, like an annuity. When he expires, the purchaser can then cash in for the balance left in the policy.

Sometimes the reason a policy was started no longer exists so the payments stop. A third party can come in and pick up payments so it will stay in effect. However the purchaser will not make money if the insured out-lives the equity.

In 2008 there were over $12 billion worth of these policies sold. Therefore it is a branch of banking that should be regulated,legislated, or even prohibited. I wrote about this in May 2010 and want to bring it up again.

Here is my article from last spring:

Monday, May 3, 2010

Could Wall Street Derivatives Lead to Murder?

AARP is running a cute TV ad asking us to support Congress' efforts to regulate Wall Street but this is no laughing matter. Bills, in both the Senate and House, concern transparency for derivatives trading by insurance companies. The Senate bill would impose the same transaction rules for derivative trading as the rest of the market and they would have to be listed. Banks, who have bundled these "custom" derivatives without previous scrutiny, have successfully lobbied the House Bill and continue to operate without transparency or controls.

Derivatives, up to now, were "futures" intended to lock in the price of fuel or raw materials for agriculture. These futures were bought and sold with definite dates for holders to take delivery. This is vastly different from insurance industry "exotic derivatives", where maturity dates are determined by the death of the named insured.

Derivatives are not like stocks either; they are a form of trading without anything substantial to back them up, a gambler's way of continuing to play the game without something solid behind the bet. Here are some examples:

When someone takes out a large life insurance policy, say a million dollars worth, and then changes his mind and doesn't make payments, one could expect that it would be cancelled. Not necessarily.

Aunt Millie has a million dollar policy but becomes ill. She goes to her broker to cash out four hundred to spend on her bucket list. One could expect six hundred dollars left in the policy. Is the policy over?

Or, Uncle Ed's children do not survive him and he decides, "What the heck". and decides not to make payments....you would expect that the policy is dead.

Since a life insurance policy can now be owned by someone other then the named (in order for a business to carry insurance on an executive who might be hurt in a business associated risk), a climate now exists where ownership of a life policy is possible by a totally impersonal and unrelated entity whose only goal is making a profit.

In each of these above examples, you might think there is no longer a liability for the insurance company as the policies revert to the company which will no longer need to keep reserves for these million dollar accounts. Wrong. Speculators (Banks) bundle these policies together and sell them to investors. Of course, the investors will not get a payout until the person in the policy dies, but they do have to pick up and continue the premium payments. Obviously the longer the person lives, the more payments the investor has to come up with, and the more diluted the value in the bundle.

You might ask why banks do this, but the answer is simple. Banks carry these bundles (derivatives), and make their money by charging fees to move them through the market. Congress is investigating the millions Goldman Sachs made from creating these bundles, reselling them and then trading without full disclosure. Their business practices were like a huge Ponzi scheme, with success being dependent on bringing in fresh clients, fresh money, fresh suckers at the bottom of the pyramid to support the payout to the top. If the bottom does not continue to bring in new accounts, the entire structure crumbles.

My concern is for the morality of these life insurance derivatives. The longer a person lives, the less the policy and his portion of the bundle is worth. For millions of dollars seeping away as the bundle ages, and the ongoing cost of payments to keep it viable, this could be motive for hoping for an early demise.

If I knew that someone had a life insurance policy on me, and I was about to undergo a life threatening medical procedure, I would be horrified if a decision were made to let me die just so a policy holder could cash in. It would make a terrific plot for "Castle" but it really isn't too far fetched in this "insurance derivatives market".

In my perfect world, private insurance companies would not be in the medical business anyway and definitely would not be trading life policies like North Sea Crude.

Have a good day.

Seniors Rock!