The Business of Life Insurance: Betting on Your Own Mortality

Securitization of life insurance could create a market for shady brokers.

Oct. 5, 2009— -- After Dr. Eddie Powell lost both his legs to a hospital infection, he desperately needed financial help to support his practice and three children in medical school. So the 61-year-old did what more and more cash-strapped Baby Boomers are doing these days: He sold his life insurance. "For close to a million dollars of insurance, I got a hundred and some thousand dollars," Powell said.

Coventry, a life settlement company, took Powell's policies, bundled them with others and sold them to banks or hedge funds as investments. Since they pay the premium every month, the sooner he dies the more money they will make. And now, Wall Street wants in on the action and the life settlement industry welcomes the potential spike in business.

"The 'ick' factor is there and we're certainly aware of it," said Russell Dorsett, president of the Life Insurance Settlement Association. "The secondary market simply lets individuals bet on their own mortality. So, say that I am going to live longer than you think I am. I will take the money now rather than having to wait to die in order to get it. It's no different than the life insurance business itself. Basically mortality, morbidity is a multitrillion dollar market."

For critics, the move to securitize the life insurance industry harkens back to the early days of the subprime mortgage boom. That crisis began when banks gave loans to people who couldn't afford them, but it got much worse when Wall Street used exotic forms of investments (called collateralized debt obligations) to bet that those loans would go bad.

With Wall Street's trillions in play, banks had more incentive to issue more subprime loans. When those loans went bad, the investors got rich but the housing market -- and the entire economy -- nearly collapsed.

If Wall Street is allowed to bet on the early death of seniors or the terminally ill, some worry it could not only strain the insurance industry, but also create a market for shady brokers to prey on the sick and elderly while adversely affecting the health policy of the nation.

"People who have bets on early death will find themselves lobbying against effective health care," said Michael Greenberger, a University of Maryland law professor and former director with the Commodity Futures Trading Commission. "There's no two ways about it, this is an accident waiting to happen in terms of investment…. It's setting up the same wild financial infrastructure that turns out to be nothing more than a casino, unrelated to the underlying transaction."

While a life settlement spokesman acknowledges that around $40 billion worth of policies have been sold in the past five years, he says that number is a small percentage of the multi-trillion dollar industry and could never pose a risk to the system. "We estimate that maybe 1 or 2 percent of policies might qualify for a life settlement at some point," said Dorsett. "While that number will grow due to demographics it's still relatively small compared to the economy as a whole."

As for Dr. Powell, he says he regrets his decision to sell his life insurance for pennies on the dollar. "I made a stupid mistake," he said. Every few months, a representative from Coventry calls to see if he is still breathing. He plans to keep answering for a long time. "My grandma lived to be 115…you've got a long time before Eddie Powell dies," he said.

But if Coventry gets its way, there will soon be plenty of investors on Wall Street hoping, and betting, he is wrong.