In 2008 the so-called subprime mortgage industry in the United States nearly brought the world’s financial system to its knees. Now, while taxpayers across the globe will for many years keep on footing the bill for bailing out financial institutions, clever financial dealmakers are targeting another home of ordinary people’s accumulated life-savings – life insurance.
The latest strand of financial wizardry is called life settlements and mortality swaps in what is not much more than a mutation of the subprime beast in terms of structure, clustering risk and risking the integrity of one of ordinary people’s most important savings instruments.
A recent report in a US investment newsletter explains this latest investment instrument as follows:
“Life settlements are investment techniques that mirror what happened in the subprime mortgage situation that blew up the economy in the fall of 2008.
“In the subprime mortgage situation the banks cobbled together all the mortgages that they had let to potential homeowners into a big basket of investments, and they kept reshuffling them so it was confusing to understand what the principal financial question was. And there the question was: Will people who are not credit-worthy pay their mortgages?
“And, they so confused the issue and got the credit rating agencies to give these investments AAA ratings that people were dying to buy into the subprime mortgage market and buy a piece of this bundle of thousands and thousands of mortgages. That turned out to be a catastrophe.
“So shortly after the crisis — in the spring of 2009 — these banks start thinking 'well now that everybody's angry with us over subprime mortgages, why don't we do this with life insurance policies?' So they go to individuals who have life insurance policies and agree to pay them a certain amount of money to give up their policy.
“So they try to buy these policies as cheap as they can, take like thousands and thousands of these policies, put them in an investment vehicle, and have people invest in them.
“And, the trick is to hope that the people will die on the early side so the policies will trigger early and they'll make money. Because they'll make more money from that than (what) they paid out to the people they were settling.
“On the other hand, if people live longer, these investments may fall apart.”
It has always been possible for people to sell their insurance policies at a heavy discount – usually to the insurance company itself – if their needs/circumstances changed, to relieve extreme financial stress or to finance new priorities.
What is different with life settlements and mortality swaps is that the policies of many individuals are bundled together and then securitised as an investment opportunity for others.
Experts warn that, like the subprime industry, this industry is largely unregulated and has gotten off the ground under the radar screen.
It can be expected that in their drive to build their offering or investment stock financial institutions will be enticing people to sell their life insurance policies in a live now die later approach.
The business is open to all sorts of dubious practices and fraught with dangers of collapse in the longer run. It can only be hoped that regulatory authorities with move swiftly to nip it in the bud.