August 14, 2006

For No Man Knoweth the Risk Nor the Return

Watch ye therefore, for ye know not when the Master of the house cometh: at evening, or at midnight, or at the cockcrowing, or in the morning.

-- Mark 13:35

OVER THE PAST couple of weeks, I’ve noticed the concept of speculator-initiated life insurance (SPIN) has been getting a rather rough rap. Simply put, SPIN lets speculators buy (and pay for) life insurance policies on the elderly, whom they pay for the privilege. The people being insured get two years’ use of their policies for free, and some small cut of the policies’ face value – say 1 pc or so.

Yet the way certain commentators describe it, one would think the speculators were lying in wait to suffocate the elderly in their hospital beds. One such commentator is Terry Savage of the Chicago Sun-Times. Writing for TheStreet.com, she says:

It sounds like a script from "The Sopranos": Someone takes out a life insurance policy on your life -- then decides to order a "hit." Of course, in real life that would never happen to ordinary people. Or would it?

A new life insurance practice -- not exactly a scam because it is legal, but dangerous -- could put you in the position of being a target. At the very least, it gives someone a tremendous incentive to see you dead sooner rather than later!

Mrs Savage goes on to argue that because “little old ladies” are being offered the deals, something is clearly rotten in Denmark. It’s not the only article TheStreet.com has carried on the practice, either. A few weeks earlier, it had published a news story showing that large insurance firms, investment banks and – this should surprise no one – hedge funds were among those funding the industry. This brings us back to Mrs Savage’s article, in which she warns that eventually, those elderly who sign up for such deals ultimately don’t know who owns the policy on their lives, a supposedly nausea-inducing state of affairs.

Now, all that said, I don’t mean to entirely discount Mrs Savage’s argument. After all, as a graduate of the University of Michigan, Mrs Savage is clearly a person of refinement and discernment. Plus, she was once an options trader; so if this creeps her out, perhaps there is something a bit off about it.

Still, this is how I see things:

1. Speculator A offers to buy a life-insurance policy on elderly Patient B, and pay Patient B 1 pc of the policy’s $1 million face value, or $10,000, for the privilege. Speculator A will also loan Patient B the money to pay for the policy from Life Insurer C for two years. If Patient B passes on during that time, Patient B’s estate will benefit accordingly, and Patient B can get that fancy obelisk marker he was considering.

2. For a simple example, let us say the “break-even” point on Patient B’s policy is in 15 years’ time. Should Patient B pass on in more than two years, but less than 15 years’ time, Speculator A will have earned a return at the expense of Life Insurer C. If Patient B passes on in more than 15 years’ time, Life Insurer C will start to earn an outsized return on premium dollars, at the expense of Speculator A.

3. Patient B gets money from Speculator A for essentially doing nothing. Plus, he gains an incredible amount of enjoyment knowing that no matter how things turn out, Speculator A or Life Insurer C has a good chance of getting screwed. This boosts Patient B’s Internal Spite Reserve to the point where Patient B has a good chance of living until he is 110 years old.

4. Patient B is having trouble seeing a downside here.

5. Now we’re just haggling over price.

I mean, really. At first blush, if there’s anything wrong with the offers being put to these “little old ladies” down in Florida, it’s that they’re not getting their fair share of the investment. For God’s sake, folks, haggle. There’s no reason, other than sheer naked greed, why these speculators are only offering 1 pc to the people who, in the end, have to do all the work. Why not 2 pc, or 3 pc, or even 5 pc?

Of course, one would have to make sure taking on the policy made sense, and be sure about any financial or tax consequences that might arise as a result. But still: why not 2 pc, or 3 pc, or more?

As for the fear that parties unknown might try to bring about someone’s hasty demise, that’s a bit silly. For one thing, some large corporations already take out life insurance on their rank-and-file workers, and we haven’t heard about any firms knocking off stockroom clerks to make their quarterly numbers. For another, knocking off the elderly would have what the industry might call “significant downside potential.”

I mean, I’m sorry, but even the most rabid hedge fund trader wouldn’t risk giving up his great and well-compensated life for life in an institution. Particularly when life in said institution would “underperform” in terms of “liberty,” and “outperform” in terms of – well, use your imagination. Besides, that’s not even getting into the whole “eternal damnation” thing, and if there’s justice in this world, eternal damnation would be the natural consequence of putting strychnine into some senior’s lunchtime fruit cup.

But anyway. I’ll be the first to agree the whole idea of speculating in life insurance is a bit morbid and creepy. I also think it’s an extremely foolish proposition – but primarily so for the buyers of such policies, who would seem to shoulder an amazing amount of risk. After all, medical technology keeps getting better, and people generally want to stay alive as long as they can. Still, if the buyers – and the life insurers – are shouldering all the risk, it also seems like a proposition in which the insured could potentially enjoy a nice return. Even if one doesn’t know exactly what is in one’s fruit cup.

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OBLIGATORY BOILERPLATE ADDENDUM: Investment involves risk, and people can and do lose money. Amazing sums of money. So much money you wouldn’t believe. As such, you should strongly consider consulting with a licensed financial advisor before making investment decisions. You absolutely must do so if you’re considering something like the above, which is bound to be an incredibly complex series of transactions. Always read the prospectus. Past performance does not equal future results. Don’t enter into any contract you don’t fully understand, and if you’re buying life insurance over television, for the love of God read all the fine print and make sure you realize what you’re buying, etc. etc., forever and ever, Amen.

Posted by Benjamin Kepple at August 14, 2006 10:51 PM | TrackBack
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