With the mortgage securities market in shambles, bankers are frantically searching for new things to deal in. And it looks like they may have found a new money cow: life settlements.

When a person with a life insurance policy is expected to die in the foreseeable future, for instance because they are old or sick, they can sell their policy. Firms package thousands of these policies together, and resell those bundles to investors.

Selling life insurance policies is not new. When a person is unable to pay their monthly premium, or they no longer have kids or a spouse that depends on the proceeds, they can cancel the insurance. The insurance company then offers a cash surrender value, which is often only a fraction of the original sum. Alternatively, they can sell the life insurance policy to another party. The other party pays, for instance, 200.000 euros for a half-million life insurance policy, and pays the remainder of the monthly premiums. When the insuree dies as swiftly as expected, they can make a good buck.

Spreading the risks
The risk, of course, is that the original insuree continues to live longer than expected. This can reduce profit or even become a loss if the purchase sum together with the premiums exceed the proceeds. By bundling many life insurance policies, preferably from people with various diseases, from various locations, firms hope to spread the risks.

The advantages of this scheme are numerous: an old or diseased person with no beneficiaries gets a nice sum of money to make their last days more pleasant, and the firm or party that buys the insurance policy can make a tidy profit. It can also be argued that we need financial innovations like these to keep the economy afloat. However, there are also some downsides. Insurance premiums are calculated on the assumption that a number of life insurances are never paid out, since many insurees simply stop paying their premiums, thus nullifying their policies. When life insurances are bought up, more insurances will be paid out, forcing insurance companies to raise their premiums. Another disadvantage is that even though risks can be spread by bundling life insurance policies, the negative financial effect of, for instance, a cure for cancer could be considerable.

Incentive
The implications of this new incentive can be great. A timely death becomes profitable. With US$26 trillion in life insurance policies in force in the United States alone, the stakes are high. Suddenly, investing in cures for cancer, HIV/AIDS or simply passing healthcare reform plans can lead to substantial financial losses. Conversely, industries with a negative health impact, such as fast food and tobacco, obtain a new financial edge.

What do you think? Do the benefits outweigh the disadvantages? Do the rights of people to prematurely cash in on their life insurances outweigh the negative incentive created if this business is scaled up? Let us know in the comments.

Source: New York Times