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Subject: Life Insurance Speculation rss

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I got this in my email from Ralph Nader, I think it's very important.

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The Wall Street gang is at it again! It’s been one year since Wall Street’s collapse and bailout took trillions from taxpayers and the sinking economy. The speculative instruments that pulled down the economy were those super-risky sub-prime mortgages, credit default swaps, collaterized debt obligations—you know—Las Vegas East, using other peoples’ savings.

As if to elaborate their gigantic con job, the investment banks, guaranteed by you the taxpayers, are now packaging life insurances policies in what sane, on the ground businesses would consider deranged exotic money plays.

Here is how the New York Times described the new securitization packages emerging from such corporate welfare goliaths as Goldman Sachs, Credit Suisse and their eager rating agency, DBRS.

“The bankers plan to buy ‘life settlements,’ life insurance policies that ill and elderly people sell for cash--…depending on the life expectancy of the insured person. Then they plan to ‘securitize’ these policies…by packaging hundred or thousands together into bonds. They will then resell these bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die.

“The earlier the policy holder dies, the bigger the return—though if people live longer than expected, investors could get poor returns or even lose money.”

Continuing its lead front page story last Sunday, the Times describes Wall Street as “racing ahead for a simple reason: with $26 trillion of life insurance policies in force in the United States, the market could be huge.”

The Insurance Information Institute’s chief economist was not impressed. Speaking for the life insurance business, he said: “It’s not an investment product, [it’s] a gambling product.”

The wild and crazy derivative spree is about to inject a new and recklessly ghoulish game of chance into the financial industry. The Wall Street casino boys are already drooling over the huge fees they expect to collect. Whatever wreckage occurs down the road will soak the investors. Washington, standby for another bailout!

If this sounds alarming, consider the fact that Congress has not even reported out of any House or Senate Committee any regulatory authority for the giant derivatives businesses that places bets on bets on bets in very complex financial instruments.

Trillions of lost dollars, destabilization of the economy, depletion of pension funds and college endowments—to name some affects—and Washington is still in stasis, sitting on its cushions of corporate campaign cash and consorting with industry lobbyists who want nothing done.

Still, you the taxpayers are on the hook for another round with these corporate delinquents and gamblers!

The only difference is that this time the insurance industry seems ready to fight. It does not want to be tarred with what one executive called “the brush of subprime life insurance settlements.”

If so, my advice to insurance companies is to nip this in the bud by going to Capitol Hill. This madness will not be stopped by scattered state insurance commissioners.

With all the unmet needs for productive capital, the masters of the financial universe prefer making money from money through high velocity paper speculation, instead of financing real capital structures strengthening communities around the country.

To be sure, abstract derivatives are where the huge commissions and gigantic executive pay packages flourish. It is the arena where investment banks play blackjack. Heads they win, tails you lose.

But why do people have to pay 5,6,7 percent sales taxes in stores, but the derivative dealers on Wall Street pay no sales tax on hundreds of trillions of transactions every year? Seems like a hefty double standard, which is why Cong. Peter DeFazio (Dem. Oregon) has introduced legislation to tax such speculation. (HR 1068)

In addition, Congress needs to get going and regulate these derivatives and finally repeal Clinton-era and Bush-era laws that gave them a free ride.

Finally, there needs to be a prohibition on investments in such risky instruments by fiduciary institutions. And, standards of prudence have to be reinstated. Old time bankers and pensions managers would understand such reforms. Investor rights to sue these investment firms and rating agencies for deception and fraud are weak and require strengthening.

Someday, our society needs to decide how to increase peoples’ control over their own money and establish incentives that can attract capital flows to where they can be productive. At present, perverse incentives are reflecting sheer speculative power and are promoting grotesque uses of money.

Let these casinos and their gamblers on Wall Street do what they want with their own money, but don’t let them gamble with other peoples’ money.
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The earlier the policy holder dies, the bigger the return -- though if people live longer than expected, investors could get poor returns or even lose money.


I think it is fucking creepy, and I would have a problem profiting off someone else's death. Before long this will turn into thoese "death pool" games that you see paraded around on reruns of CSI.
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SpaceGhost wrote:

I think it is fucking creepy, and I would have a problem profiting off someone else's death. Before long this will turn into thoese "death pool" games that you see paraded around on reruns of CSI.


I agree, and with most people's passive use of 401k's, they won't even know they are making money off of dying Baby Boomers.
 
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As I've said in RSP before... I really admire Nadar. If he wasn't so fucking batshit crazy and wacky looking he really could have been President. This guy makes Ross Perot look positively normal... and I voted for Perot.

Good call by the congressman in Oregon to tax derivative trades.
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Putting aside the "creepy" factor, this doesn't look like it's necessarily something to get worried about.

The whole life insurance business is built on actuarial tables that enable a large company to offer payouts to people who die in exchange for premiums while they live. It's a classic example of a good insurance market, since people can pay a modest amount to defray the (financial) risk of high variations in lifetimes due to illness, mishap, etc.

This is really no different. A single policy is high-risk for the underwriter but a pool of them is relatively low risk. So, pooling them into securities is a sensible form of insurance (or reinsurance, depending on how you look at it).

I see a couple of areas of potential concern, both arising from the fact that these securities lose money if the covered people live longer than expected as a whole.

First, this could easily happen. A new medical treatment that extends people's lives by five years is hardly far-fetched. Thus, we may need regulation that prevents a repeat of the problems we had with mortage-backed securities (i.e. high leverage and derivatives turning a problem into a catastrophe).

Second, there is at least the theoretical potential for the nastiest form of moral hazard. A standard life insurer wants its customers to live forever since it pays out when they die. Holders of these policies want (from a financial point of view) the holders to die, since that's what they get paid for. I'm not big on conspiracy theories, but I'll be disappointed if someone doesn't write a really creepy book or movie about someone investing heavily in these securities and then killing the folks off.

A third, unrelated risk, is that if this market is highly profitable it will increase demand for these policies which may bring in more unscrupulous -- as we saw in the mortgage market.

I think these risks should be manageable, considering that we've (hopefully) learned something about regulation from the last debacle and this market isn't nearly as big nor as complicated as the mortgage market.

As an aside, I think the "that's creepy" argument is misplaced. These policies can be an important option for seniors. Let's say you take out $1 million of life insurance in your 20s or 30s to make sure that your family is provided for. You're not really buying a payout -- you're buying risk protection.

You're lucky and don't die...and now you're 65 or so and have been paying into a death payout for decades. Only now your kids are grown up and financially solvent (and probably have life insurance of their own) and you've got a $1 million payout coming in ten or twenty years that you'd much rather have NOW, thankyouverymuch so you can live a better retirement. The risk you insured against is gone and the insurance payment is now a valuable asset that you can't touch directly.

Instead of looking at the base policy as "making money off your death" I see it as a financial institution saying, "OK, we know from actuarial tables that you probably get this payout in 13 years. That means at current interest rates it has a present value of $X. We'll give you $X now in exchange for the later payout which we can afford to do because we'll do it with a lot of other people, reducing the variation in expected return." Sure, they make money off of those who die early and lose it off those who die late but the real reason they're making money is that they're charging a fee to a large group of people for undertaking a financial transaction that benefits said people.

Either way, the investment banks aren't even creating these policies. They're just pointing out that it makes a lot more sense for the financial side to be done by massive pension funds so that the companies selling the policies can concentrate on that and don't have to build up big balance sheets.
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Chad_Ellis wrote:
Said stuff


There are multiple issues here.

I don't think Ralph is actually condemning the insurance companies as much as the speculators and the fact that Congress still has not put any safeguards in place after the last debacle. So, you are right, with safe guards properly implemented and enforced, speculation on anything can work. It's just that history shows that Congress lacks backbone when it comes to reigning in speculators and Wall Street in general. It usually takes economy-crushing crises to make them fend off the lobbyists and do anything regulatory.

The creepy factor is fully on the gambling on people's deaths by the speculators. The insurance companies, by design, make money on the percentages and the creepiness of that depends on your sensitivity. The insurance companies make no bones about telling their clients about how much they pay and will someday receive with the implication that the insurance company gets the difference. The betting part is a whole different level.

I can foresee different types of bonds based totally by age groups, each level having different ratings based on risk. Some people might think this is goulish and never want to be part of it, yet they won't even know that their diversified 401k is invested heavily in this multi-trillion dollar business. In fact, they might not know that their pension plan is heavily leveraged in it. I guess it really is one of those socially responsible investing subjects. And I use the SRI term loosely, as it isn't always about SRI, sometimes it's just about investment choice in general. There are unfair pressures in retirement fund choice by using tax incentives to push people into limited choice 401k's that force you to invest blindly.
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TheChin! wrote:
I don't think Ralph is actually condemning the insurance companies as much as the speculators and the fact that Congress still has not put any safeguards in place after the last debacle. So, you are right, with safe guards properly implemented and enforced, speculation on anything can work. It's just that history shows that Congress lacks backbone when it comes to reigning in speculators and Wall Street in general. It usually takes economy-crushing crises to make them fend off the lobbyists and do anything regulatory.


First off, you're begging the question when you call this speculation. In its simplest form it is the precise opposite of speculation -- it is the buying of a large number of assets with variable payoffs so that together they have a lower variance.

Quote:
The creepy factor is fully on the gambling on people's deaths by the speculators. The insurance companies, by design, make money on the percentages and the creepiness of that depends on your sensitivity. The insurance companies make no bones about telling their clients about how much they pay and will someday receive with the implication that the insurance company gets the difference. The betting part is a whole different level.


OK, but you haven't really addressed my counter-points. Assume I've spent 30 or 40 years paying premiums in order to protect my family from an early death. Now I can't have an early death, my family is on sound footing and I have $1 million coming to me in roughly fifteen years.

Isn't it a good idea to let me sell that $1 million payout to someone in exchange for its present value? And, if so, how do you avoid the "creepy" factor?

Second, packaging the policies together together is the opposite of betting on deaths since the whole point is to get enough of them so that the resulting security captures the bell curve of results. Betting on death would be if people were buying individual policies from insurance companies and saying, "Maybe I'll get lucky and my guy gets hit by a car."

Quote:
I can foresee different types of bonds based totally by age groups, each level having different ratings based on risk.


Different age groups really shouldn't have different risk...and in general these should all be low-risk securities.

This is what I mean when I say that they aren't really betting on people dying. They are betting on the actuarial tables not being significantly off. If you take a man aged 70 and with a given set of statistics (e.g. does he smoke, drink, has he had a heart attack, etc.), the insurance companies have developed a huge amount of data on the bell curve of his life expectancy. As with any bell curve, any event is possible and if you just make a big policy with him you're gambling. If you have 10,000 people fitting a particular demographic you're pretty much getting the curve -- the only 'gambling' is on whether the basic data is wrong.

Quote:
Some people might think this is goulish and never want to be part of it, yet they won't even know that their diversified 401k is invested heavily in this multi-trillion dollar business.


Sure, but that's true in so many, many ways. Companies sell coffins, sell insurance, sell reverse mortgages, sell alcohol, sell cigarettes, sell porn, sell Bibles, sell fetish clothing, repossess property, pollute, etc., etc. If it's important enough to you to keep your assets from having any contact with something you find distasteful you have some big hurdles to jump. This is a product that helps elderly people live a better retirement rather than be tied to an insurance policy they no longer need. Moreover, it's a product that has existed for a long time -- and your diversified 401K is a lot more likely to be invested in the insurance companies that sell them than it is in the bonds that are created off of them.
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These are must buys with the imminent arrival of the death panels! You can't lose, invest now! And, if we're wrong, the government will bail you out.

Our governmental stupidity in bailing out failing companies is going to pay (negative) dividends for years!

But, it's ok, we have Barney Frank on the job to (not) regulate and insist that even though he'd been steering the ship of finance for a year and a half when it crashed, it was all the evil Republicans' fault.

I need to buy a bigger mattress......
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Chad_Ellis wrote:
First off, you're begging the question when you call this speculation. In its simplest form it is the precise opposite of speculation -- it is the buying of a large number of assets with variable payoffs so that together they have a lower variance.


Not really, you said yourself that the securities could lose money as it could easily happen that people live longer. People didn't expect people to not pay their mortgages either. It wouldn't take long for the influx of money to start creating incentives to make bad policies, which would be wrapped up in bonds that would have this illusion of legitimacy, just like the mortgage debacle. That's another source of the ghoulish factor, people getting sold bad policies on whether they die or not. As the insurance economist eluded to, legitimate insurance companies don't want to be associated with the sub-prime mess. How many new fly-by-night insurance companies will start getting into this business selling people bad policies?


Chad_Ellis wrote:
OK, but you haven't really addressed my counter-points. Assume I've spent 30 or 40 years paying premiums in order to protect my family from an early death. Now I can't have an early death, my family is on sound footing and I have $1 million coming to me in roughly fifteen years.

Isn't it a good idea to let me sell that $1 million payout to someone in exchange for its present value? And, if so, how do you avoid the "creepy" factor?

Second, packaging the policies together together is the opposite of betting on deaths since the whole point is to get enough of them so that the resulting security captures the bell curve of results. Betting on death would be if people were buying individual policies from insurance companies and saying, "Maybe I'll get lucky and my guy gets hit by a car."


Well, the first point, I did say that is what Insurance companies have traditionally done and it is, for the most part, transparent. Everyone knows the risk on both sides of the transaction.

As for your second point, for all intents and purposes you could be making the sub-prime mortgage packaging argument. I'm not saying this is as risky as sub-prime, but it could go very wrong with just a couple major medical advances. Without any regulation, it becomes very risky and open to abuse.

Chad_Ellis wrote:
Different age groups really shouldn't have different risk...and in general these should all be low-risk securities.

This is what I mean when I say that they aren't really betting on people dying. They are betting on the actuarial tables not being significantly off. If you take a man aged 70 and with a given set of statistics (e.g. does he smoke, drink, has he had a heart attack, etc.), the insurance companies have developed a huge amount of data on the bell curve of his life expectancy. As with any bell curve, any event is possible and if you just make a big policy with him you're gambling. If you have 10,000 people fitting a particular demographic you're pretty much getting the curve -- the only 'gambling' is on whether the basic data is wrong.


You are right, they should be, and mortgage securities should be also, until sub-prime started. What I am getting at with age groups, is that there are ways to group certain kinds of policies into safe and risky, and they will group them, because the speculation will generate more money.

Chad_Ellis wrote:
Sure, but that's true in so many, many ways. Companies sell coffins, sell insurance, sell reverse mortgages, sell alcohol, sell cigarettes, sell porn, sell Bibles, sell fetish clothing, repossess property, pollute, etc., etc. If it's important enough to you to keep your assets from having any contact with something you find distasteful you have some big hurdles to jump. This is a product that helps elderly people live a better retirement rather than be tied to an insurance policy they no longer need. Moreover, it's a product that has existed for a long time -- and your diversified 401K is a lot more likely to be invested in the insurance companies that sell them than it is in the bonds that are created off of them.


Right, and the difference is, the ethical insurance company sells a product to a person with full disclosure of where the money goes and what happens to it. At least we have to assume that for arguments sake. From an investment standpoint that makes it somewhat palatable.

When you take the next step and group policies by risk , i.e. these people are more likely to die and these people aren't, and then sell them back and forth between third parties to make a profit on it, it's a bit more squirrelly morally.
 
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I'm no financial expert, but here's another thing I "think" could be a problem, thinking about these like pension funds. What happens if a particular bond does go bad against the odds and there isn't enough money in it to pay out claims? What happens to the families expecting that insurance money? Or is this not how it would work?
 
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SpaceGhost wrote:
Quote:
The earlier the policy holder dies, the bigger the return -- though if people live longer than expected, investors could get poor returns or even lose money.


I think it is fucking creepy, and I would have a problem profiting off someone else's death. Before long this will turn into thoese "death pool" games that you see paraded around on reruns of CSI.


For awhile (maybe they still do?) Walmart was taking out life insurance policies on employees and naming it's self as beneficiaries. They got "outed" and I don't think the still do it?
 
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TheChin! wrote:
I'm no financial expert, but here's another thing I "think" could be a problem, thinking about these like pension funds. What happens if a particular bond does go bad against the odds and there isn't enough money in it to pay out claims? What happens to the families expecting that insurance money? Or is this not how it would work?


I think you're almost certainly mistaken about how it works.

Bonds like this generally work as follows:

1. A collection of related assets are bought by an investment bank.
2. The bank issues securities whose payouts are tied to the payouts of the assets.
3. Investors buy the securities (like any other bond) and then receive the payouts.

For a normal investor the only risk specific to the bond is that the timing of the payout isn't fully guaranteed. Thus, instead of getting an internal rate of return of (for example) 7.4% the investor might get 7% or 7.6%. Theoretically everyone could live ten years longer than expected and the return could be lower still but it can't be negative since the total payouts will always be higher than the amount invested.

It's as though I said, "Give me $100 now and I'll pay you back $140 in X years time, where X is determined by the roll of a d6." Your return can't be negative but it could be low or high based on the roll. If, however, you repeat the deal 1,000 times you can reduce the variance to a much smaller amount.

The only real financial problem that can arise is if investors speculate on the bonds with derivatives or make highly-leveraged purchases.
 
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TheChin! wrote:
Chad_Ellis wrote:
First off, you're begging the question when you call this speculation. In its simplest form it is the precise opposite of speculation -- it is the buying of a large number of assets with variable payoffs so that together they have a lower variance.


Not really, you said yourself that the securities could lose money as it could easily happen that people live longer. People didn't expect people to not pay their mortgages either.


A few points. I said that it was a theoretical risk -- I don't actually think it "could easily happen" that people live a lot longer all of a sudden. Moreover, even this would only reduce the return, not create some wildly different outcome unless we add in high leverage or derivative speculation.

Second, even allowing for the possibility that a group of people currently alive break the actuarial tables, it's still the case that lumping large numbers of these securities together is designed to reduce variance rather than increase it. It's still the opposite of speculation.

Quote:
It wouldn't take long for the influx of money to start creating incentives to make bad policies, which would be wrapped up in bonds that would have this illusion of legitimacy, just like the mortgage debacle.


That's possible, but there are some major differences between the products we're talking about. Life insurance policies are structurally a lot more boring than mortgages. Another difference is that in a mortgage the person gets the money up front and the future payments come from them whereas with insurance the customer pays first and counts on the other party to make the large payment. That makes a huge difference in terms of how hard it is for fly-by-night companies to enter the market since brokers and customers will always prefer large, stable companies they know can pay up. Finally, and most importantly, this market is about life insurance policies that have already been held for a long time, not for policies that are sold today.

Quote:
As for your second point, for all intents and purposes you could be making the sub-prime mortgage packaging argument. I'm not saying this is as risky as sub-prime, but it could go very wrong with just a couple major medical advances. Without any regulation, it becomes very risky and open to abuse.


There's a major difference. I can default on a mortgage. I can't default on death. If you own a life insurance policy on me, it will pay off. If you paid $900,000 to own my $1,000,000 payoff you can't get a negative return. A mortgage-backed security can, given a systemic crisis in the housing market, turn out to be worth much less than I paid for it. An insurance-backed security can only pay me a smaller-than-expected positive return.

Can customers still get into trouble? Sure...if they buy with high leverage or speculate on derivatives. But the bonds themselves are in the most basic way probably less risky than any corporate bond, since they can't default. (Technically they can default if the insurance company's underwriting the policies all went under, but the balance sheets of that industry bear no resemblance to those of the banking industry.)

Chad_Ellis wrote:
Different age groups really shouldn't have different risk...and in general these should all be low-risk securities.

Quote:
You are right, they should be, and mortgage securities should be also, until sub-prime started. What I am getting at with age groups, is that there are ways to group certain kinds of policies into safe and risky, and they will group them, because the speculation will generate more money.


I think you're mistaken here. For any given demographic the calculation will be done on actuarial data for that group. The risk is one of standard deviation of result and as long as the group is large enough I don't see how any one group is going to be riskier than another.

Quote:
Right, and the difference is, the ethical insurance company sells a product to a person with full disclosure of where the money goes and what happens to it. At least we have to assume that for arguments sake. From an investment standpoint that makes it somewhat palatable.

When you take the next step and group policies by risk , i.e. these people are more likely to die and these people aren't, and then sell them back and forth between third parties to make a profit on it, it's a bit more squirrelly morally.


The insurance company pays differently depending on how risky a person is as well. If a company packages one group into one security and another into another security all that does is mean that one security is worth more because the actuarial data says that it will pay out faster meaning the present value of the payments is higher.

It seems to me that you're trying to paint the insurance company in a good light by calling them ethical and saying there's full disclosure. Disclosure of what? It's a fairly straightforward transaction -- I have a life insurance policy I don't want but that has some financial value today. The insurance company buys it from me, so I get the present value of that money today.

How does that become dirty if an ethical investment bank (OK, I know that seems a contradiction in terms) packages those assets into a relatively predictable stream of payments (at which point it looks a lot like a bond) and sells it to financial institutions?

(edited to fix quotes)
 
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Life insurance doesn't really have to pay out... it all depends on the terms of the insurance itself. My father worked on more than a few trials where insurance companies were refusing life insurance payments for different technicalities. I could not tell you how often those things happen in the US though, but it's obvious that they do happen.

If I insured myself for 10 million, and at my old age, I sign up for one of those plans to pay for medical bills. Then, tired of the suffering from my disease, that would keep me alive for an extra year tied to a bed, I decide to go for some form of euthanasia. Would the original insurance company pay up?

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hibikir wrote:
Life insurance doesn't really have to pay out... it all depends on the terms of the insurance itself.


That's a fair point, but it's not a systemic one so it doesn't really play to the risks of the bond. Let's say 1% of life insurance policies don't pay out (or 0.01% or 15%, whatever it is). If a bond is based on a large pool of policies, that just becomes a reduction in the overall expected returns and figures into the bond price.

The one thing I guess could make an exception of this is if it turns out that people who have sold off their insurance policies become significantly more likely to commit suicide. That's not unreasonable...if I know that euthanisia could cost my heirs $1 million I might suck it up longer. I don't know if there's any data on this, though.
 
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