The insurance-linked securities market has boomed in the last ten years. Still, not many people know what they are. Recently, these assets, or more precisely the secondary market for life-insurance policies, gained some attention as legal disputes involving them erupted.
In recent months, insurers are suing third-party investors in life-insurance policies, claiming these transactions are invalid.
Back in July, the Wall Street Journal also reported that the family of a deceased Indianapolis woman sued the insurer of her life-insurance policy for allowing it to be sold to an investor and tried to claim the policy payout.
The plaintiffs in these lawsuits generally claim the moral high ground, portraying investors as morbid and greedy individuals who heartlessly wager on the death of human beings. The Wall Street Journal, for its part, has repeatedly used the term 'death bets' to refer to this market.
Just what are insurance-linked securities and are they really 'death bets'?
Insurance-linked securities are based on income from a bundle of insurance policies, in this case life-insurance policies.
These policies are originally contracts between an individual and an insurance company, and the beneficiaries of the policy were likely the individual's family members.
When the policy is sold to a third-party investor, the investor pays the individual some amount of money, takes over the premium payments going forward, and is named the beneficiary of the life-insurance policy. When the individual dies, the third-party investor receives the payout from the life insurance company.
In a way, these investors are indeed betting on the demise of human beings and look morally reprehensible at first glance.
However, proponents of insurance-linked securities claim the moral high ground and assert that if anyone is the bad guy, it's actually the insurance companies.
Ed Lay and Wai-Keung Tang run the Emeritus International Group, which advises clients on purchasing insurance-linked securities.
They point out that in many cases, individuals who don't know their options simply stop paying their life-insurance premiums. When they die, their families don't get a cent and insurance companies pocket all the premiums that had been paid and are completely free from the risk of paying out any of that money.
Better-informed individuals call their insurance companies to cancel the policy. This way, they at least get part of the savings component of their insurance premiums back. However, Lay and Tang said canceling policies carry stiff penalties and individuals usually recover only a small amount of money.
They believe, absent a secondary market, that the relationship between individuals and insurance companies is inherently unfair because insurance companies are the only buyer available for individuals wanting to sell their policies.
It's like taking out a mortgage from Chase Bank and only being able to sell the house back to Chase, said Lay.
Some investors who are very informed (or those who had been approached by investors) sell their life-insurance policies to a reputable investor and receive more money than people who simply surrender their policies and people who negotiate with their insurance companies to cancel it.
Ed and Lay therefore assert that the secondary life-insurance market, in addition to giving investors an instrument that's completely uncorrelated with the stock market, provides a moral and needed service to people who want to sell their policies.
However, the problem, according to some critics, is that investors took advantage of senior citizens who didn't appreciate the consequence of selling their life insurance policy. In some cases, unscrupulous investors may just have given people a bad deal by paying them too little.
But just as unprincipled players in the mortgage market shouldn't discredit the whole concept of mortgages, which serve a legitimate function in society, the secondary life insurance market also shouldn't be discredited because of a few bad apples.
Like the mortgage industry, perhaps it just needs better government oversight.
Indeed, this market performs a valuable economic and moral service in society and it will continue to be needed as long as insurance companies refuse to return a fair amount of money to customers wanting to cancel policies.
Email Hao Li at email@example.com