Sub-life Insurance Securities

This is my behaviour when I'm in the office. I don't get into work mode straightaway. What I do is I go online and read up on local and international news (including business). Today, I read something that caught my attention in The New York Times (NYTimes). The article was published in 6 Sept 2009. It was about bundling life insurances as new securities in the investment market. Oh my blipping crap!!

How it works? Briefly:-

1. You buy life insurance (the policyholders).
2. You are not rich and you may need money. On top of it, you're diagnosed with some terminal disease (touch wood).
3. You sell your life insurance to the investment bank and receive a one-time premium, depending on the quality of your life i.e. how long are you still going to be in this world!! People actually do this (seriously) because of the uncertainty factors that surround the them.
4. Let's say we follow what NYTimes had stated; USD400k paid to policyholder for an insurance policy with sum insured (SI) of USD1m.
5. Investment bankers securitise the life insurances (into bonds) by bundling the bad ones (those policyholders with terminal illnesses) with the relatively good ones, the latter are just to maintain "good" rating, given by the rating agencies the likes of S&P, Moody's and etc.
6. 1 year later, you die.
7. You don't get the USD1m anymore because you sold your policy. The investment bankers and investors get it as payout to their investment, along with the fees they (bankers) charge investors to administer/manage such bonds.
8. If you die 2 years later, they get payout later.
9. If you die 10 years later, they get payout even later which would also mean that they would get poor returns or lose money altogether, when you take into consideration interests and etc, because your yields are slow in coming.

THEREFORE, THE FASTER YOU DIE, THE FASTER THE INVESTMENT BANKERS AND INVESTORS GET THEIR RETURNS.

Put yourself in the investors' shoes... you would do this:-

"Dear God, please make the policyholders with terminal diseases whom have sold their life insurances DIE FASTER. Otherwise, I'm losing money in my investment".

That's pretty fucked up! (pardon the language)

Basically, you're making a profit at the expense of people's health misfortunes. What have we become? Investment bankers actually have the audacity to create such financial instruments, bearing in mind (very clearly, I must add) that the recent financial upheaval was just starting its painful "journey" on the road to recovery. Plus, is this morally acceptable? Where's the conscience?

Now, what happen if actuaries and underwriters make big mistakes big time in their analyses of mortality of these policyholders? What happen if there was suddenly a cure for AIDS? What happen if there was suddenly mind-blowing developments in the R&D of terminal diseases and patients live longer?

All those that would've been projected, say people die within 5 years of AIDS, or people die within 1 year of certain terminal diseases, become "incorrect" and people starts to live longer, live healthier. What will happen to this "market"?

Simple. You'll have another financial meltdown because your investment turns bad - the yield is either gone (lose money) or not attractive. Extrapolate this to the impossibly huge pool of USD26 trillion of life insurances that are still effective and people are not dying as soon as they were projected to be... you will get a major screw up!! To protect against such risks, maybe investment bankers and investors could get financial insurance to cover the potential losses, just like the CDSes for the subprime mortgages securities. Then you will also screw up the insurance market, when the instrument blows up in your face!

Unlike the recent meltdown of subprime mortgages and CDS, should the market screw up, you not only have the option to buy back bad securities, you have the option to "kill" people to get your investment income. Although this will never happen (I hope), theoretically, it's an option.

The rating agencies would need to value these bonds carefully and rate them as what they would be and not be clouded by the spread of risks as we've learnt in the previous meltdown that the spread of risks could go awry.

Sub-life insurance securities, anyone??