Life settlements ignore lessons of 2008

As America continues to deal with the repercussions of the economic crisis, Wall Street has moved on more quickly than expected. Investment banks are still searching for new, profitable products, and the latest one has “subprime” written all over it.

The new plan is to buy life settlements — insurance policies that ill and elderly people sell for cash — and securitize them by packaging thousands of them together into bonds that can be sold to investors. When the people die, the investors receive cash from insurance companies. Essentially, the banks are selling bets on how long the insured people will live — the earlier they die, the higher the return.

Thomas Curry | Daily Trojan

There are a few benefits to the idea. Banks who are leading the charge, such as Credit Suisse Group and Goldman Sachs, are arguing that they provide a public service by allowing ill and elderly people to cash out of their policies at higher rates than their insurance agencies will give. And if the bundles of life insurance prove to be highly profitable for the investment banks, they could help speed economic recovery. After all, one thing we have learned from the global scale of the economic crisis has been that the strength of a country’s financial system is key to its overall strength; what is good for Wall Street is often good for America.

But economic strength is not measured just by size and profit margins. Soundness is important too. Promoters of this new product argue that it can be done safely by combining policies covering people with a variety of diseases and issued by a range of insurance companies. That way, if any one disease were to be cured, or if any one company were to go under, the damage to bondholders would be minimal.

Unfortunately, this is virtually the same logic that led credit agencies to give all-star AAA ratings to securitized subprime mortgages; because the packages included home loans from different regions and with different credit levels of borrowers, there was no expectation that they could lose significant value. Then housing prices dropped nationwide, and we all are still coping with the results.

A lesson that we should have learned from the financial crisis was that gambling on Wall Street to this extent is a bad idea. Low-risk investments traditionally refer to ones that stand to lose only a little money, but now it’s come to mean investments that have a small chance of losing a lot of money. Though it is likely to be profitable, the gamble is a huge potential threat to the country’s economy as a whole and should not be permitted.

For example, if health care reform were to pass and resulted in longer lifespans, the packaged insurance policies would plummet in value. Banks’ balance sheets would again be full of bad debt, credit could dry up and we might experience the last two years all over again. It is the government’s responsibility to step in and ensure that investment banks are not given another chance to put our economy on the line.

This is not the biggest problem with the new product, however. Nobody pretends to think that ethics trump profits on Wall Street, but few have stopped to wonder if there is something seriously wrong with investing in people dying early.

Rita Yeung | Daily Trojan

Do we really want to bet against a cure for cancer? Something that has been the dream of the medical research community for years would suddenly represent a potential threat to the entire death-insurance financial system — which would put us in a precarious position. After all, the system promotes the sale of policies that pay off the quicker people die.

It seems pretty crass to minimize risk by making sure that each securitized bond includes people with leukemia, heart disease, lung cancer and diabetes; if too many people have one disease and the cure is developed, the value of the bond would plummet. In all of the financial analysis of the potential gains and losses from the new product, it seems that the gross immorality of its very nature has been forgotten.

It is as if we have learned nothing from the 2007 economic collapse. We should not be gambling. We should not be creating moral hazard and encouraging predatory tactics. In the subprime mortgage market, it was lending to people who banks knew could not pay back their loans. Today, it is issuing insurance policies to people specifically for the purpose of having them sell it back for cash.

But most importantly, we should not pretend that there is such thing as a free lunch. Somebody is going to lose in this equation — whether it is the investors (because people won’t always die), the insurance companies (because they will have to pay out a higher percentage of their policies) or, most likely, the consumer (because this product will definitely lead to higher premiums on insurance policies).

This idea looks smart to Wall Street because, in reality, it will probably make them a lot of money. But it is unethical for Washington to allow it. If the idea takes off and becomes the $500-billion industry that it is conservatively estimated, we’ll have compromised our ethics for a cash windfall. Securitizing life insurance policies is speculative, a repeat of the subprime market and morally abhorrent.

When will we learn?

Daniel Charnoff is a junior majoring in international relations (global business).