Securitizing Life Insurance Settlements: the Doctor, the Clergyman and the Banker

The latest product from Wall Street's financial engineers evidently will involve buying life insurance policies from the elderly and infirm, pooling the purchased policies, paying the premiums and collecting on the policies when the original owners die. Investors in these life insurance pools bet that the proceeds from policy payouts will exceed the cost of purchasing the policies and paying the premiums (plus bankers' commissions, underwriting fees and other expenses). They receive better returns if the original owners die sooner than expected. Longevity, on the other hand, hurts the profitability of the investment. The original owners, who might be running out of other savings, sell the policies to get a lump sum, which they use to live on and pay medical and other expenses.

Let's take a look at the new, post-mostgage crisis Wall Street. The scene opens in the lobby of a too-big-to-fail bank that deals in life insurance backed securities.

"Please, sir, could I have some more?"

"I'm sorry, Harry, but all I can offer you is $40,000."

"But, Mr. Big Banker, you gave me $50,000 for my first life insurance policy and it had the same amount of coverage," said Harry.

"Interest rates have ticked up. In order to make the deal numbers work, I have to lower the amount I offer you," said the banker.

"I've lost my job and defaulted on my mortgage and my credit cards. My kids are starving and my wife is about to leave me. Couldn't you give me just a little more?"

"Harry, business is business. The offer is $40,000 firm."

Harry clutched his chest and began to choke. He fell on the floor and thrashed around.

"I can't breath," he gasped. Then he lost consciousness.

A man rushed up and began administering CPR.

"What are you doing?" demanded the banker.

"I'm a doctor. I'm trying to help this man."

"I remember you, Doctor," said the banker. "I placed a life insurance backed security in your retirement account, one that includes an interest in this man's first life insurance policy. If you save his life, the investment will be worth less."

"I'm a physician. I'm bound by the Hippocratic Oath to help this man," said the doctor. "Now please step back to give me more room to work."

Another man ran up, took Harry's hand in a comforting way and began whispering.

"What are you doing?" demanded the banker.

"I'm a member of the clergy. I'm praying for this man."

"I know who you are," said the banker. "I sold a life insurance backed security to your church's endowment fund. It includes an interest in this man's first life insurance policy. If you help save that man, your endowment fund may end up with a smaller return."

The clergyman gave the banker a cold look and said, "Let me just say that I will pray for you as well as poor Harry, because you need it."

Exasperated, the banker stormed out of the bank, shouting, "You people couldn't make a dollar to save your lives."

He went over to the assisted living facility across town, where he stopped in on his latest prospect, 75-year old Wilbur.

"So, you're selling me your policy, aren't you, Wilbur?" he asked.

"I haven't made up my mind," said Wilbur. "I don't understand what exactly you're offering me."

"Let me go over it again. You sell me your life insurance policy for $200,000. That will give you more money to cover the costs of staying here, maybe as long as three more years. Since you won't be spending the entire $200,000 at once, you invest the unused portion in one of my life insurance backed securities, and it will earn a good return until you need the money."

"Wait a minute," said Wilbur. "You want to buy my policy and then sell it back to me?"

"It's possible the security you invest in could contain the policy we buy from you, yes."

"Then you're asking me to invest in my own death."

"Wilbur, it's a win-win situation for you. You get the money to cover future expenses, so you win that way. But if you die early, your estate enjoys increased value from the security. You can't lose."

"Why do I smell a rat all of a sudden? You should talk to Herbie next door. He's almost broke, and they're going to kick him out next week."

"Herbie's body-mass index is too good. You're seriously overweight. Plus, you've got diabetes, heart trouble, and a good risk of cancer."

"You mean bad risk of cancer."

"It's a matter of perspective."

"Why don't you investment bankers do something constructive, like finance a new car company in America?"

"The bonuses are higher in the asset backed securities business."

"I ought to throw you out of here."

"Please wait until you sell us your policy. Then do something more physically taxing than your system can stand."

With the strength of righteous anger, Wilbur rose up from his wheelchair and tossed the banker out of his room. Then he smiled broadly, feeling better than he had in months.

The banker was leaving the assisted living facility when he was stopped by one of the attending physicians.

"So, will you finance the new product I'm developing to combat hospital-borne infection?" asked the physician.

"You told me that the product would save the lives of many patients," said the banker.

"That's what the clinical results show."

"I can't finance that product. It would undercut the interests of my life insurance backed securities investors. I have fiduciary duties to them, and must do my utmost to ensure that they maximize their profits."

"But we're talking about reducing human suffering," said the physician.

"You're talking about reducing human suffering," said the banker. "I'm talking about reviving the vitality of America's capital markets."

"Can't America's capital markets finance something besides gambling on the longevity of sick people?" asked the physician. "How about something productive that would help people, resuscitate the economy and increase employment?"

"There aren't many good investments you can make today in real businesses. Most real businesses are in poor shape. The Fed has pumped a lot of cash into the financial system and that cash is looking for a place to be invested. I'm developing the product that will attract that cash. The underwriting margins for life insurance backed securities look very attractive, and that would mean good-ole-days-size bonuses. You can do good, if you like, doctor. I intend to do well."