The Perfect Product

I wasn’t planning to write about this weekend’s New York Times article about the securitization of life settlements after reading Felix Salmon’s post saying there was no new news there. But I was thinking about it some more and thought it was an interesting concept, whether or not it gets off the ground.

Life settlements already exist. The idea is that someone has a whole life insurance policy with a death benefit of, say, $1 million. The insured bought it when he was 35 and had two kids; now he’s 70, the kids are working on Wall Street and don’t need the death benefit, but they’ve cut him off and he needs some cash to fill the prescription drug donut hole and pay his Medicare co-pays. The insurance company will give him a cash settlement value of, say, $100,000. I don’t know what this actual number is, but the key point is that it is less than $1 million at the insured’s expected date of death, discounted back to the present (let’s call that the current actuarial value of the policy). In a life settlement, an investor pays the insured a lump sum that is greater than $100,000 – say, $200,000 – and makes the premium payments (if any are left to be made) on his behalf; in return, the investor becomes the beneficiary on the policy. Again, this already happens, although there are concerns about churning, misrepresentation, the whole deal.

In a securitization, an investment bank would buy a whole lot of life insurance policies, pool them, and issue bonds in tranches (just like a CDO) to fund the purchase of the policies. The idea is that investors would get an asset that is uncorrelated or only loosely correlated with other assets, while insureds would get higher prices for their policies because there would be greater demand for them. This is not happening, although the Times articles makes it seem like it is going to start.

I think this is conceptually interesting because basically it is just securitizing an arbitrage trade. The obvious thing to compare it to is residential mortgages. When you securitize residential mortgages, you are expanding the pool of people willing to invest in buying houses, which spills over quite significantly into construction of new houses or improvement of existing houses. That is, you are moving capital to places where it is (theoretically) being productively invested. I’ve written several times about how this went too far, but the basic point is that securitization is promoting value-generating investment.

A life settlement, by contrast, is pure arbitrage: the ultimate thing you are investing in is just a financial product. Today, insurers make money because the cash settlement value is less than the current actuarial value; some people alternatively let their premiums lapse, and then they lose their death benefit, which is even better for the insurer. Expanding the market for life settlements would help those insureds because they would get the current actuarial value (less fees) instead of the cash settlement value. So the first order effect would be a transfer of money from insurers to insureds. But life insurance is a reasonably competitive industry; insurers will predictably raise premiums on everyone since they can’t count on people taking the paltry cash settlement values or letting their policies lapse. So the second order effect will be a transfer of money from insureds who keep their policies until death to insureds who sell them prior to death, with the insurers just as well off as before.*

So at the end of the day, all we’ve done is pushed cash around – except for those fees! So the people involved in originating, packaging, and selling the securitized life settlements take home their 4%, and the rest is a zero-sum game. I’m not sure any value has actually been destroyed, since investment bankers are people, too. It’s just that there used to be $100 shared among insureds and their beneficiaries, and now there are only $96 to share between insureds, their beneficiaries, and investors, and $4 to share among the brokers and the bankers.

Now arguably the way the $96 is being shared is more efficient than the way the $100 was being shared, since you no longer have the people who take cash settlements subsidizing the people who collect death benefits like in the current system. But I don’t think that we’ve gotten any aggregate social welfare in exchange for those $4 in fees.  I suppose there might be third-order benefits from efficiency here (might the insurance market function better in some sense? would this increase demand for life insurance? and is that a good thing?), but I’m skeptical.

* I got in an argument about this yesterday with someone who thought premiums could go down, but I can’t tell you the details because it was off the record.

By James Kwak

89 thoughts on “The Perfect Product

  1. P.S. A house is not a “value-generating investment”. A house produces nothing; in fact, it slowly rots away.

    That so many people can look at something slowly rotting away and consider it an “investment” is one indication of how pathological our system has become.

    Our modern financial system has approximately nothing to do with real value creation, theoretically or otherwise. It has everything to do with capturing real value creation and transferring it to the financial system.

  2. I can see where such products could cause premiums to increase (companies having to make more payouts, potential tax consequences, etc.), but not how they could make premiums go down…

  3. Pre-responding to your post (and the footnote), Matt Taibi believes that life insurance likely will go up as fewer and fewer policies lapse, which means more and more payouts. The insurance companies will be worse off than before unless they raise premiums, as you imply.

    http://trueslant.com/matttaibbi/2009/09/08/wall-street-gambles-on-old-people-dying/

    Personally, I don’t see how this is a zero sum game. If it really takes off, it’s going to be another bubble, one that makes life insurance policies little more than credit default swaps (can we call the underlying policy a “life default swap” now?). For example, what’s to stop somebody from buying multiple life insurance polices on himself, at the same time or sequentially, and flipping them? Now what you’re left with is a bunch of people each holding an obligation owed by the insurance companies when the person named on his policy defaults his life? Do we really want to expose the boring part of AIG, that did not contribute to our recent troubles, to the same types of risks that the exciting part of AIG was taking?

  4. What a sick little industry you’ve got, insurance people. How bout if we craft a plan that let’s us take direct care of seniors so that the don’t *need* insurance (take care of everyone so they don’t need insurance)?

    Do something worthy, insurance industry. Go cure cancer.

    Interminable discussion of sh*t we don’t need. We don’t need financial innovation. We don’t need insurance.

  5. “For example, what’s to stop somebody from buying multiple life insurance polices on himself, at the same time or sequentially, and flipping them?”

    For the policy to have greater value to investors, the insured needs to be relatively close to croaking, right? Not the best time to be taking out a new policy (unless you are into fraud).

  6. It’s quite likely that premiums will go up on contracts that don’t feature a premium guarantee, but much of the sales of this business in recent years was on policies that do have a premium guarantee, where insurance company profits are highly sensitive to lapse rates.

    You would think that based on this, investors in these securities would be creating a bubble by not sufficiently accounting for the default risk of the insurance carriers, much like CDS buyers didn’t factor in counterparty risk. But in this case, because of state guaranty funds and the general willingness of state regulators to step in and help insurance policyholders, it’s highly unlikely that the benefit payments won’t be made on policies underlying these securities (of course, this depends on just how much strain there is on the state guaranty funds).

    It’s worth noting that while the securities themselves are not very common yet, settlement firms have been generating policies to back these securities with reckless abandon for a few years now. One of the common ways in which this is done is called “non-recourse premium financing,” wherein a settlement firm will lend money to an insurable person over the age of 70 to purchase an insurance policy. If the person decides after two years (when the insurance policy’s contestability period expires) that they want to keep the policy, they can pay back the loan and keep paying premiums on the policy. In the more likely scenario that they don’t want the policy, they don’t have to pay the loan back, they just forfeit the policy to the settlement company. Thereby the settlement company can generate a large pool of policies to securitize.

  7. The house does slowly rot away, but the land underneath should get more valuable over time as population grows.

  8. First to address the gentleman above who said we don’t need insurance, that’s simple hogwash when it comes to life insurance. A working person with a couple of young children absolutely needs insurance unless they are an irresponsible boob. Now whether we need this product structure is another issue.

    I think the fundamental thing missing from Dr. Kwak’s analysis of net good is that the insured must die before there is any money. Assuming the life settlement is sufficiently more than the after tax value of the cash value of the policy the life settlement could keep the owner out of poverty, or allow them to have greater enjoyment of their golden years. There’s perhaps no overall economic benefit to that function but certainly a great benefit to the emotional and spiritual well-being of the former insured.

    If the securitization of these products does what financial innovation is supposed to do, compress the profits of the companies making the offers and put more money in the hands of the former insured, than it may be worth the price of the fees. What is needed and was absent in our last bubble was regulation. There is nothing inherently wrong with securitization unless it spurs unnecessary creation of the underlying products, as it did with mortgages. If only existing, long-standing policies were able to be securitized and there was a regulatory agency actually watching the hen house I don’t see the problem.

    In reality however, more and more insurance companies are simply creating this ability within the policy language itself to prevent the securitization of their products. I have a feeling if this “took off” the insurance companies would en mass add settlement options to their policies, for much lower fees than the securitizers could do, and cirumvent the whole process – just as they’ve almost eliminated viatical settlements by adding terminal illness riders to their policies.

  9. We don’t need insurance. Did the natives in the United States need insurance if they left their children orphans? No, the society took care of them (I’m guessing here. Maybe they put the kids on a raft and set it adrift at sea, but no matter). Everyone is so locked into this garbage, they can’t even see straight. Unemployment at 50%? is that what it’s going to take?

  10. …and as the neighborhood gets better, and as nifty hip businesses locate nearby, and as your school district improves, and as crime dissipates, and as better jobs move into the area, and as…

  11. irresponsible boob

    Funny, that’s what a door-to-door life insurance salesman called me the other day when I told him the country should have social insurance for these things.

    Are you sure that’s not part of their sales script?

  12. Give a bunch of senile people a chance to cash out for much less money than the premium rate they’ve been paying for God knows how many years. Genius.

    I’m sure no representatives from the insurance company would call them suggestion they cash out (much sarcasm there). And I’m sure none of their relatives would try to get them to cash out so they can abscond with the money (whichever relative cares the least for them).

    I’m sure the insurance companies would LOVE it.

    Hey James, ever heard of something called an ANNUITY???

  13. Identical reasoning applies to water, or to air. But those are not “value-generating investments”, either; not because they are worthless, but because they do not generate value. Similarly, land generates no value, even if its price appreciates due to scarcity.

    The context of these comments was “securitization promoting value-generating investment”, by which I believe Dr. Kwak meant the production of tangible goods, i.e. houses. Certainly, securitization can also encourage people to buy, but that involves the production of precisely nothing.

    Housing is consumption, not investment. In my view, financing consumption with borrowed money is manifestly insane.

  14. Not only that, land is the traditional source of “economic rents.” You know, of the “rent-seeking” we all rant about.

  15. Okay so let’s have social insurance, but we don’t so until we do you should have insurance to cover your family. We also don’t live in a tribal society where kids can easily be handed off to the extended family, once again that would be nice but we don’t live in that world. When that world reestablishes itself I’ll stop advocating for having life insurance. That doesn’t mean you need to buy the high commission, whole life policy for $50K that cost $200 a month, but $20-40 a month for $250K of term insurance until your kids are grown or you’ve saved enough money on your own you don’t need it anymore? Ideally I shouldn’t have to pay a water bill either, but there’s no well I can hike to an get it for free. We are living in this society not whatever utopia you’re gunning for.

  16. Edit: “Certainly, securitization can also encourage people to buy land, but that involves the production of precisely nothing.”

  17. Ted,

    The issue isn’t should this be allowed, it can happen now – they just don’t securitize the product.

  18. No argument there. Anyone who makes a living “investing” in land is a parasite on society, not a contributor to it.

    But then, I would probably say the same about more than half of the activities comprising U.S. GDP at this point.

  19. Not necessarily fraud… you can buy a huge policy, then take up smoking and sell it back at a profit as the payout is “brought forward in time”. :) You could even buy calls on your own policy. Brilliant.

  20. I’m farily certain they have insurance in Japan, Germany, France, Great Britain, Canada, Australia even India etc. So what the heck are you talking about?

  21. Yes, but I think it was either in that New York Times article or in another that the author mentions that life insurance policies usually make the most money when the people don’t collect. Their kids either grow up and they cancel the contract and stop paying premiums because they don’t need the coverage anymore or the premiums become too expensive for them so they cancel it. If you then have massive amounts of people selling their contracts to investors who outlive these old people and collect then you throw the whole profitability of the operation upside down. I think it’s good to have the ability to sell these contracts for people who run out of money late in life, but if it becomes a standard Wall Street securitized product then premiums will definitely go up and the insurance companies will not be nearly as profitable as in the past.

  22. Suggestion for Weekend Comment Competition: who can invent the best “innovative” financial product.

  23. My apologies to James Kwak. Sorry.

    Ya, securitization, even better. Wow, you know if James–of all people–wants to talk about new venues/branches of securitization, let’s all just hand over our bank accounts to Goldman Sachs and Hank Greenberg and save some time.

  24. It’s just overlaying one financial business on top of another financial business where the current profit structure will have to be addressed in order for both to make a profit. It’s cost shifting. Just like in health care. Premiums will go up. If not then you’ll end up with weaker insurance policies, less able to withstand the inevitable shocks the world always periodically comes up with.

    We really, really, have to start graduating young adults who know how to make something that improves productivity and increases incomes. But who’s going to teach them? We haven’t been doing this, except in technology and some biopharma, for more than a generation.

  25. Let me tell you about my amazing productivity-enhancing software patent, “the wage cutting analyzer.” It takes as input a person’s expenses, and tells you how many dollars an hour you can cut their wages without them starving to death.

  26. Maybe we can trade these life settlements individually, on an exchange. Each insured would have to get an annual checkup, publish the results, a bunch of newly minted MBA ‘life analysts’ could issue research reports, CNBC could give them a few minutes every morning to hawk individual policies, the CME could probably create an index, puts and calls, the whole magillah. Sounds less risky than NASDAQ stocks. Might even produce a return, unlike Treasuries. When a contract matures prematurely, the police would know who to investigate first.

  27. In the spirit of underwriting, I think investment banks should help certain people who’ve just found out they have cancer, to make a public offering of shares in their humongous life insurance policy. Depending on how the treatment goes and whether the policy-holder runs out of money to pay for it, the share price would rise and fall.

  28. well, you are right, it does rot away. but should not be there a human at the end of the spiral? the economy is not made for its own self and value is not an exclusive economics’ concept. it does ‘rot away’ into more fuzzy and less measurable or countable science.

  29. Once it’s built, you may be right. But building the house is the investment – taking land, materials, and labor and turning them into something that is worth more than their values as inputs. That’s the value-generating investment I’m referring to.

  30. Might it also encourage insurance companies, hoping to hold onto the business, to offer better settlements to individuals who wish to terminate their contracts?

  31. Actually, traditional societies see their children as their insurance. Kwak’s scenario that the well-heeled brats dump their dad is terribly American.

  32. The assumption here is that people are buying whole life policies. But the insurance companies prefer the universal life that is level premium but never develops cash value.

    Perhaps the whole model of life insurance needs revamping. Most people really need it for the twenty to thirty tears they have dependent children.

  33. This begins to sound ghoulish, as if we are trading on death. Does Ebeneezer Scrooge show up at your funeral? I read the initial news reports and feel that perhaps this is a poor substitute for bundling mortgages.

  34. I actually thought about that too, but the insurance companies have the advantage of time over the investment banks here (because investors want policies of people more likely to die soon, and that is not a cost-effective time to purchase a new policy). If they do not want their products securitized, they should sell the option for the insured to settle the contract at a predetermined discount to the specified benefit, call it a rider, and charge a fee for it. Peace of mind in case you stop liking your heirs, or something like that.

  35. Mortgage securitization produced a cadre of brokers who did and said whatever they had to in order to close a new mortgage. It brought “predatory lending” into our common vocabulary. Here it will be worse.

    Information assymetry has been a feature of individual insurance since its inception. It is partly responsible for its regulation and for the low esteem insurance companies enjoy in the courts. At the street level in this new setting will be people who, inevitably, will have a great deal less information and understanding of what they have than will the brokers. Unless there is extremely strong regulation (not likely), fraud and quasi-fraud will be rampant. The broker incentives in that direction will, as they were with mortgages, overwhelming. Misrepresenting the transaction, involving as it does, an inherently opaque “financial product” will be a cakewalk.

    At the larger level, the TImes article suggested that these investments become more valuable if people live less long, or die sooner. Where does THAT put the incentives? Will that fact not tempt those who own much of this new investment to ensure that cancer and AIDS cures never see the light of day? Drug companies’ incentives are already perverse, channeling research into Viagra and Flomax instead of cures for cancer or the common cold. Does anyone doubt that some big investors have the economic wherewithal to pull this off without getting caught?

    If I owned a hedge fund and my sources discovered a gifted scientist (or drug company) working on a life-extending elixer, surely it would be in my interest to pay that person not to work and keep her mouth shut, or to buy the whole drug company and order it to produce more Flomax. And even if such villains were not so direct, the entire system would have acquired a new incentive to ensure that our collective live expectencies were shorter rather than longer–the value of our collective retirement fund investments would depend on it. Beubonic plague would become an investor godsend!

    One hopes this newest example of “financial innovation” never sees the light of day. The collateral damage both at the individual and collective level would far exceed any gain this new gimmick could possibly produce.

  36. Some random facts.

    Believe it or not, there was a time in this country when one could not obtain a mortgage on a house older than 10 years.

    Typical downpayment was 50%, and the mortgage ran 5, 10 years at most.

    Hell, in the late ’70s, I was turned down on a VA loan because there was a crack in the sidewalk leading to the front door. Yes!, a crack in the damned sidewalk. VA wouldn’t budge until the section of sidewalk was cut out and repaired.

    Times change.

  37. Hey MK,

    I quoted you in one of my Baseline Fables. You got the “kicker” at the end of the story.

    Bond Girl, you also got quoted. I gave you the third paragraph. I rather liked the visual cue with your handle (Bond Girl) lining up with the tagline at the bottom of Casino Royale poster.

    You can find the story here.

  38. Is it true that if I make this kind of investment, I have to be the kind of person who hopes that the insureds (or at least the majority of them) die early?

  39. Thanks :) I attempted a subtle bit of humour by implanting a line referring to a certain industry. If you place your pointer on the poster and leave it there for a second or two the line should appear.

  40. Will hints at the key point and the key problem with this analysis when he says

    “Mortgage securitization produced a cadre of brokers who did and said whatever they had to in order to close a new mortgage. It brought “predatory lending” into our common vocabulary. Here it will be worse.”

    We analyze these products based on history, but the act of securitizing a product changes it. We begin to produce the product to fit the securitization process.

    It started (in my observations, at least) with Milken. He did brilliant research into the default rates of junk bonds and created beautiful analysis on the risks of pools of this debt. The junk that he analyzed (since there was no market previously for new-issue junk) was all companies that WERE investment grade and fell into junk status. The characteristics of that debt were seriously different than the debt that was at issue, junk debt.

    The data on default rates and prepayment rates on residential real estate largely came from a time when prepayments were rare, mostly due to relocation and such, and refinancing was almost non-existent. When we built a market for it, there weren’t home equity loans. By the time we hit this crisis, the market has been transformed by securitization so completely as to be almost unrecognizable. The bulk of this crisis stems from mortgages CREATED for securitization. Sub-prime, no doc loans and ninja are all loans created to feed the beast.

    So this analysis is fine, as far as it goes. The real question is what will arise when a ready market is built to receive it.

  41. Agreed. There’s no reason to trust that this little immorality play will be confined to those “relatively close to croaking” (as if they deserve to be exploited). CDOs didn’t start with sub-prime, they ended there after engendering reckless predatory lending that victimized not only borrowers but CDO investors who were told they were getting a smoking deal (and many of these folks were actually pension funds).

  42. “Corrupting Deviant Orifices” Much better. I’m tempted to copyright that. OK, anybody who uses that owes me 10 cents for each and every usage.

  43. “We analyze these products based on history, but the act of securitizing a product changes it. We begin to produce the product to fit the securitization process.”

    Ah, shades of Soros’ “reflexivity.”

    Excellent comment. Thanks for sharing it.

  44. Soros walks by and markets “reflexively” crash. I thinks that’s what he really means.

    What a pile of steaming rubbish. He does not “understand” markets better than we do. Nor does Buffett. They understand people and how to prey upon them. They don’t sit around waiting for inside information, they create it. That is all.

    “Oh dear!” they say. “Stolid old church-blessed State Street just shut out Reserve Primary. Reserve Primary’s CEO is in Rome! Oh what to do?!” Ice-9 give the credit markets the deep 6. It’s all so serendipitous! How could such trustworthy old institutions start the avalanche? How come no one figured all of this out at the time? How come they didn’t intercede to keep Reserve Primary going quietly?

    http://economistsview.typepad.com/economistsview/2009/09/the-real-villains-in-the-credit-crunch.html

  45. Did you title this post “Perfect Product” because it’s

    01. A product that everybody wants
    02. A product that everybody wants but nobody else has
    03. Priced to sell.
    04. Sold for a profit.

    or…

    because it will thrive on growing quantities of aged people who are going to die and will probably not put up a fight when you offer them a couple hundred thousand dollars?

    or…?

  46. as to traditional societes:
    in my nice little rural village they kept their seniors from entering care homes and getting professional care and yes that resulted in unpleasant things for the seniors but look one can’t have the cost of good care eat into the heritage …
    the only protection the seniors had, was that it couldn’t be done too openly
    and if you want to go really way back – I doubt that there was ever any society that let its seniors once they had become “useless” live out their life well cared for

  47. once you agree to having the totally mobile employee you have to have something to replace social nets with

    and once you have the assembly line with the huge concentrations of manpower it creates those assembly line providers want the uprooted worker with no social ties whatsoever
    after all rooted people tend to develop stubborn streaks have these ridiculous habits of cherishing things that withstand all money making efforts (at the same time it can be horrible for a misfit to have to live with rooted people)

    as always you can’t have the cake and eat it …

  48. right now it might seem a “perfect product” because the moment of death still seems kind of clearly defined to us – though the care taking industry already now has a vital interest in keeping people breathing long long after their due date and why not it secures their jobs.

    – but lets say there are these death papers out there and they are traded, might there not originate a trader with the interest of keeping cash out of the hands of these paper owners as long as possible colluding with the care taking industry …

    – if I were a finance wizard I at least would be wrecking my brain trying to find a method betting against that stuff

  49. “A house produces nothing; in fact, it slowly rots away.”

    what about the whole DIY market – who keeps that alive? all the people who do not own homes? and all those barbecue grills which need back yards to be tolerable by neighbors? and all those cars required for commuting?

    oh ya and what about cars which rot away even faster but are good for the repair shops that make a living off them?

    If that is not value generating in the definition of the financially literate – what is then?

    is this stuff about the house not generating value a part from Adam Smith worship? I somewhere read he said that about houses.
    But:
    At his time the manors had personnel that was close to serfdom surely there was no value generating around the house, Except for fancy garden designers, there probably wasn’t much need to buy outside help and thus his time and ours is really hard to compare.

  50. Since we’re discussing new products, how about securitizing promising high school students? Based upon their grades and SAT scores, we figure out how much they are likely to earn during their lifetimes, advance them say twenty percent of that in exchange for a mortgage on their earnings. Oh, no, we already have that. It’s called a student loan. But, doing it the other way, they wouldn’t have to waste all that time in college.

  51. as y’all keep moaning about the deterioration of your school system I have been thinking maybe they do not need it anymore because India and China generate now enough and much cheaper to hire brain power v. educating your own.

    now wouldn’t be betting on their schools result in a much bigger market of nice “securities”. The individual sums could not be as high, but think of the masses – after all “Kleinvieh macht auch Mist”= small animals sh..t also.

  52. oh ya and what about cars which rot away even faster but are good for the repair shops that make a living off them?

    Economic activity does not equal value creation; in fact, this is sort of my entire point. Breaking a window generates work for a glazier, but that does not imply it is a value-generating act.

    You use a car to get to work. The car is thus part of your productivity; it facilitates your own creation of value. The slow degradation of your car is part of the cost of that productivity. More reliable cars would reduce the work for repair shops, but they would make the country as a whole more wealthy. (You cannot make a nation more wealthy by destroying things. This is ½ of the reason “Cash for Clunkers” is idiotic.)

    Of course, having a place to live also facilitates your productivity. But for that, you do not need a McMansion in suburbia; you only need someplace large enough to lay your head and cook your meals. And raise your kids, if you are into that sort of thing.

    If buying a $1 million house could make you $1 million more productive, then it might qualify as an “investment”. Color me skeptical.

  53. Again my comments on this “perfect product”

    Oh yes! And I am sure there are already some innovative insurance policy originators putting together a big group of super-healthy with super long life-expectancies and selling them off as obese non-exercising smokers with extreme short life expectancies, in order to make a killing in intermediation fees.

    And yes! I can already hear a lot of bona fide smokers negotiating their own deals… “If they give me such a bum treatment everywhere let me at least get some of it back capitalizing on my shorter life expectancies”

    And yes! I can almost hear some hedge-fund managers discussing how the real survival rate on some of the products is turning out much longer than what they predicted which negatively affects their produced return rate, which makes them look bad when compared to other hedge funds… and asking “are there any contractors out there to take care of this problem for us?”

    And yes I can almost hear investors writing their congressmen asking them to stop any increase in spending on health because they have a constitutional right to a good financial return on their investment and these actually require average life-length to go down.

    And yes I can see the Basel regulators debating whether they need health-rating agencies?

    And yes I can see the actuaries making a killing in professional fees … move over lawyers

    I am immediately calling my daughter to forget her bank carrier and go into the actuarial profession since it looks there is going to be a lot of excitement there.

  54. James Kwak “That is, you are moving capital to places where it is (theoretically) being productively invested”

    Perfect product? Productively invested in the deaths of your fellow citizens?

    This sure sounds like a baby-boomer’s paradise allowing him to cash in the most on his death and “Après mois le deluge”. I saw you as quite young on the video James, but I might have been mistaken.

  55. Sorry unless I am reading it wrong I have a feeling that James is slightly out on a limb on this one. The only reason an investor would pay more for this than the cash settlement offered by the insurance company, and take on the responsibility of keeping on paying the premiums, is either because the policy has a guaranteed capitalization rate that is higher than what is currently available as returns in the markets (in which case he needs to worry about the insurance company being able to deliver- counterparty-risk) or you think that the insurance companies, after deducting their profits, do a better job at investing than yourself, in which case you might sign up your own insurance policy. Also most or perhaps all of these insurances have clear rules as to how much you are to be paid if pre-settling or how that amount is to be calculated, and it is not really up to the insurance company to make the offer they like. Besides you can also borrow against the cash value of your insurance.

  56. Instead of death let me offer an alternative “perfect product” for life. Why do you not securitize cash flow requirements of the students of a university? Outflows the tuition payments and inflows 10% of all their pretax income over their working years number 5 to 15. This should bring some transparent accountability on all those tenured professors… and whose retirement plans should of course also be fully invested in their own paper.

  57. In this job market and with the quality coming out of our universities in general, I’d like to short this product.

  58. In the wake of last night’s Presidential address, the perfect product is going to be health insurance. Imagine selling something everyone is required to buy! Imagine the incentive insurance companies will have to reduce premiums! Imagine all those one at a time customers lacking any group protection. A conspiracy buff might imagine this was the point of the whole crisis. The industry will be taking forty-six million new customers straight to the bank. Now we can all hold our collective breath waiting for the low cost public option. Hope I am wrong about this.

  59. without insurable interest, a viaticated contract is a “gamble” at best and an incentive to murder at worst.

  60. A residential property isn’t a ‘value-producing investment.’Commerical property can be rented to a non-owner and generate revenue. The improvements deteriorate/waste over time, but so does the machinery in a factory.

  61. thanks very much for the explanation – I will chew and re-chew it and hopefully get to the point where I really understand it – for the moment it is more than my on job security fixated mind can digest.

    got it!!!
    – that’s why German tax law allows tax deductions for commuting (under the heading of Werbungskosten=Advertising/Marketing cost) but not for rent (for mortgages though it does) unless you rent a second home because the commute would be too long. Now when new first home ownership triggers tax credits they say it is to make “little ones” into property owners but as I am always reluctant to believe in benign attitudes towards the little ones I ask isn’t it rather a state subsidy for the construction companies, the notaries, the bankers i.e. the whole industry? Hopeless to disentangle – have to sleep on it.

    Just one more question? wouldn’t the definition as of when a house is bigger than the growth in productivity vary with class? A McJob-Holder not entitled to as many square-meters, bathrooms and/or pools as Steve Jobs?

  62. I have a problem with creating securities that increase in value when people die sooner than expected.

    Not that Wall Street needs any more incentive for corruption – but there should be at least an appearance of difference between finance and the mob.

    When that BBB tranche starts outliving actuarial forecasts, I can just imagine the calls out to New Jersey for some help.

  63. It seems to me that unlike the residential mortgage market where, very often, those least fit to pay their mortgages were packaged up into the equity tranche of the SIV – with high correlation to folks that have low paying or service sector jobs, who tend to live in similar communities – the opposite is true here. The elderly & the poor who have lower life expectancies get packaged up as the A/AA tranche, and the CDX waterfall should almost always flow down to equity. If it appears that this is not true, then you actually have a perverse incentive to try and not provide health services thus hastening the death of the folks in the higher level tranches. TOTALLY SICK!!!

  64. Before this thread ends I just want to point out that collateralized death obligations may be the funniest thing ever posted on this site.

  65. What if you bundled the life settlements of people who all had the same health insurer, then bought the health insurer? THAT would be a good investment.

  66. What about the life settlement of people who all had the same insurer and who lived downwind from the same nuclear power plant? Then buy the health insurer AND the nuclear power plant.

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